Test Bank For Investments 9th Canadian Edition By Zvi Bodie, Alex Kane, Alan Marcus, Lorne Switzer, Maureen Stapleton, Dana Boyko, Christine Panasian Chapter 1-28 Chapter 01 The Investment Environment
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.
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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.
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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.
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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.
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5. _________ financial asset(s). A. Buildings are B. Land is a C. Derivatives are D. Canadian T-Bills are E. Derivatives and Canadian bonds are
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Buildings and land are real assets.
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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.
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7. A security that pays a specified cash flow over a specific period is called A. fixed income. B. stock option. C. mutual fund. D. real estate. E. index.
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8. _________ is a commodity. A. Swap B. Money C. Gold D. Future contract E. Treasury-bill
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9. Compared to investments in debt securities, equity investments tend to be A. equally risky. B. riskier. C. less risky. D. more important.
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10. Which one of the following is a not role of the financial markets? A. Consumption timing B. Information C. Separation of ownership and control D. Increasing wealth of the economy E. Risk allocation
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11. Holding highly diversified portfolios without spending effort or other resources attempting to improve investment performance through security analysis is a characteristic of A. Active management. B. Passive management. C. Both active and passive management. D. Risk-return trade-off. E. Efficient markets. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 01-05 Markets Are Competitive. Topic: 01-05 Consumption Timing
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12. The attempt to improve performance either by identifying mispriced securities or by timing the performance of broad asset classes is a characteristic of: A. Active management B. Passive management C. Both active and passive management D. Risk-return trade-off E. Efficient markets
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13. A common measure of credit risk in the banking sector is A. systemic Risk. B. treasury-bill. C. TED spread. D. LIBOR. E. yield curve.
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14. _______ is in an insurance contract against the default of one or more borrowers. A. Collateralized debt obligation B. credit default swap C. Freddie Mac D. Adjustable-rate mortgage E. Fannie Mae
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15. Systemic risk is A. credit risk. B. an insurance contract against the default of one or more borrowers. C. firm-specific risk. D. default risk. E. the potential breakdown of the financial system when problems in one market spill over and disrupt others.
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16. 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.
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17. 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.
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18. 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.
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19. 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.
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20. 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.
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Of the factors cited above, only the value of the related security affects the value of the derivative and/or is a true statement.
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21. 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.
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22. 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.
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23. 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.
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24. 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.
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25. 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
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26. 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.
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27. 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. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 01-03 Financial Markets and the Economy. Topic: 01-03 Financial Markets and the Economy
28. 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
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I, II, and III are all mentioned as causes of recent scandals.
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29. 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.
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30. 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 01-04 The Investment Process. Topic: 01-09 The Investment Process
31. 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 01-04 The Investment Process. Topic: 01-09 The Investment Process
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32. 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. Topdown refers to using asset allocation as a starting point.
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33. 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.
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34. _______ 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.
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35. 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.
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36. ________ 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.
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37. 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.
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38. 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
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39. 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
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40. 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
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41. 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
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42. 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
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43. 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.
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44. 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
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45. 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.
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46. 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.
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47. 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.
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48. 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.
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49. 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 01-07 The Financial Crisis of 2008. Topic: 01-17 The Financial Crisis of 2008
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50. 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.
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51. 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.
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52. 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
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53. ________ 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.
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54. ________ 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
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Chapter 02 Financial Markets, Asset Classes and Financial Instruments
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
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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.
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3. 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.
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4. T-bills are financial instruments initially sold by ________ to raise funds. A. commercial banks B. the Canadian government C. state and local governments D. agencies of the federal government E. the Canadian government and agencies of the federal government Only the Canadian government sells T-bills in the primary market.
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5. 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 02-02 The Bond Market. Topic: 02-02 Treasury Bills
6. 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.
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7. The smallest component of the fixed-income market is _______ debt. A. Treasury B. other asset-backed C. corporate D. tax-exempt E. mortgage-backed
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8. The largest component of the fixed-income market is _______ debt. A. Treasury B. asset-backed C. corporate D. tax-exempt E. mortgage-backed
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9. 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
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10. 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
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11. 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. 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.
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12. 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.
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13. 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.
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14. 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
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15. 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. "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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 02-02 The Bond Market. Topic: 02-02 Treasury Bills
16. 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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 02-03 Equity Securities. Topic: 02-03 Certificates of Deposit
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17. 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.
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18. 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 02-04 Stock and Bond Market Indexes. Topic: 02-04 Commercial Paper
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19. Which of the following indices is(are) market-value weighted? I) The New York Stock Exchange Composite Index II) The S&P/TSX Composite 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
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20. 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.
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21. Consider the following three stocks:
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Stock
Price
Stock A Stock B Stock C
$40 $70 $10
Number of Shares Outstanding 200 500 600
The price-weighted index constructed with the three stocks is A. 30. B. 40. C. 50. D. 60. E. 70.
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22. Consider the following three stocks:
Stock
Price
Stock A Stock B Stock C
$40 $70 $10
Number of Shares Outstanding 200 500 600
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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.
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23. Consider the following three stocks:
Stock
Price
Stock A Stock B Stock C
$40 $70 $10
Number of Shares Outstanding 200 500 600
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
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24. 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
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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 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
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26. 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 aftertax 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%
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27. 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%
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28. 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.
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29. 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.
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30. 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.
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31. Which of the following statements regarding the Dow Jones Industrial Average (DJIA) is false? A. The DJIA is a measure of the performance of the stock market. 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.
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32. 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.
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33. 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%.
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34. 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
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35. 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.
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36. 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.
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37. 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 Canadian Tbills. 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 Canadian T-bills.
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38. 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.
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39. 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.
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40. 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.
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41. 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.
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42. 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.
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43. 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.
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44. 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.
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45. 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.
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46. Suppose an investor is considering a corporate bond with a 7.17% before-tax yield and a municipal bond with a 5.93% before-tax 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%
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47. 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. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 02-03 Equity Securities. Topic: 02-03 Certificates of Deposit
48. 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).
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 02-04 Stock and Bond Market Indexes. Topic: 02-04 Commercial Paper
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49. 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.
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50. 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.
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51. 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.
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52. 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 aftertax 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%
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53. 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%
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54. 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%.
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55. 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%.
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56. 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.
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57. 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.
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58. 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.
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59. 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).
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60. 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).
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61. 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).
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62. The ____ index represents the performance of the Hong Kong 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).
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63. The ____ index represents the performance of the Canadian stock market. A. DAX B. FTSE C. S&P/TSX D. Hang Seng E. DOW Many major foreign stock markets exist, including the DAX (Germany), FTSE (UK), Nikkei (Japan), Hang Seng (Hong Kong), and TSX (Canada).
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64. 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.
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65. 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.
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66. 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.
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67. 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.
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68. Certificates of deposit are insured by the A. SPIC. B. CFTC. C. Lloyds of London. D. FDIC. E. All of the options are correct.
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69. 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.
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70. Canada's best-known stock market indicator is A. Wilshire 5000. B. DJIA. C. S&P/TSX Composite Index. D. Russell 2000. E. S&P 500
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71. 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.
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72. 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.
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73. 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.
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74. Unsecured bonds are called A. junk bonds. B. debentures. C. indentures. D. subordinated debentures. E. either debentures or subordinated debentures.
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75. 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
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76. 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.
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77. You purchased a futures contract on corn at a futures price of 3.50, and at the time of expiration, the price was 3.52. What was your profit or loss? A. $2.00 B. -$2.00 C. $100 D. -$100
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78. You purchased a futures contract on corn at a futures price of 3.31, and at the time of expiration, the price was 3.43. What was your profit or loss? A. -$12.00 B. $12.00 C. -$600 D. $600
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79. You sold a futures contract on corn at a futures price of 3.50, and at the time of expiration, the price was 3.52. What was your profit or loss? A. $2.00 B. -$2.00 C. $100 D. -$100
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80. You sold a futures contract on corn at a futures price of 3.31, and at the time of expiration, the price was 3.43. What was your profit or loss? A. -$12.00 B. $12.00 C. -$600 D. $600
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81. You purchased a futures contract on oats at a futures price of 2.33, and at the time of expiration, the price was 2.61. What was your profit or loss? A. $1400.00 B. -$1375.00 C. -$27.50 D. $27.50
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82. You sold a futures contract on oats at a futures price of 2.33, and at the time of expiration, the price was 2.61. What was your profit or loss? A. $1375.00 B. -$1400.00 C. -$27.50 D. $27.50
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Chapter 03 How Securities Are Traded
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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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).
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 03-06 Regulation of Securities Markets. Topic: 03-06 Initial Public Offerings
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.
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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
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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.
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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
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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
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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%
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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%
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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
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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%
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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
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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. E. Are lended to the broker Typically, the only source of shares for short transactions is the short seller's broker in street name; often these are margined shares.
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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 E. Market 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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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32. A ECN 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 fully automated market. 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.
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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.
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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.
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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.
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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
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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.
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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.
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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."
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40. All of the following are considered new trading strategies, except A. high frequency trading. B. algorithmic trading. C. dark pools. D. short selling.
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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.
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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%
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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.
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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
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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.
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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. E. $1,200 100 shares $45/share 0.50 = $4,500 0.50 = $2,250.
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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. E. $1,200 150 shares $27/share 0.45 = $4,050 0.45 = $1,822.50.
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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 E. $20.00
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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 E. $10.02
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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
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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
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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%
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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%
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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% E. 18.75%
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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% E. -12%
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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
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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.
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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% E. 15%
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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% E. 22.5%
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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 E. $30
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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 E. $78.5
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62. The preliminary prospectus is referred to as a(n) A. red herring. B. indenture. C. greenmail. D. tombstone. E. headstone.
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63. Bonds are traded A. on exchanges B. Over-the counter C. On a venture exchange D. NYSE E. AMEX
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64. An explicit trading cost is A. commission B. Execution cost C. Bid-ask spread D. Annual fee E. Dealer spread
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 03-06 Regulation of Securities Markets. Topic: 03-06 Initial Public Offerings
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.
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Chapter 04 Mutual Funds and Other Investment Companies
Multiple Choice Questions
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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.
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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.
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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.
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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
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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
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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
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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
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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16. A review of Canadian mutual funds by investment orientation at year-end 2017 shows that over half of assets were in A. balanced funds B. Index funds C. Exchange traded funds D. Hedge funds E. Bond funds
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17. ______ are balanced funds in which the asset mix can range from aggressive (primarily marketed to younger investors) to conservative (directed at older investors) A. Hedge funds B. Index funds C. Equity funds D. Life-cycle funds E. Target-maturity funds
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18. Fund of Funds are: A. Index funds B. mutual funds that primarily invest in shares of other mutual funds. C. Exchange traded funds D. Hedge funds E. Balanced funds
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19. Funds are commonly classified by A. Investment policy B. Asset allocation C. Security type D. NAV E. return
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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.
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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%
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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%
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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
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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.
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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.
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26. Global 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. mutual funds that invest in securities worldwide.
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27. 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
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28. 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.
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29. 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%
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30. 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%
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31. 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%
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32. 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%
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33. 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%
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34. 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
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35. 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
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36. 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
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37. 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
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38. 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.
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39. 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
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40. 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
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41. 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
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42. 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%
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43. 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%
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44. 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
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45. 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
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46. 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
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47. 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
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48. 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.
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49. 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.
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50. 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.
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51. 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.
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52. 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.
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53. 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.
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54. 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.
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55. 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.
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56. 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.
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57. 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%.
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58. 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%.
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59. 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%.
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60. 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%.
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61. 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%.
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62. 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%.
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63. 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%.
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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 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.
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Chapter 05 Risk, Return, and the Historical Record
Multiple Choice Questions
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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%.
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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%.
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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%
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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.
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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%.
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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%.
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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.
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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%
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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
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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
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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.
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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.
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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.
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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.
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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.
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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.
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17. You have been given this probability distribution for the holding-period return for KMP stock:
Stock of the Economy Boom Normal growth Recession
Probability
HPR
0.30 0.50 0.20
18% 12% -5%
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%
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18. You have been given this probability distribution for the holding-period return for KMP stock:
Stock of the Economy Boom Normal growth Recession
Probability
HPR
0.30 0.50 0.20
18% 12% -5%
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What is the expected standard deviation for KMP stock? A. 6.91% B. 8.13% C. 7.79% D. 7.25% E. 8.85%
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19. You have been given this probability distribution for the holding-period return for KMP stock:
Stock of the Economy Boom Normal growth Recession
Probability
HPR
0.30 0.50 0.20
18% 12% -5%
What is the expected variance for KMP stock? A. 66.04% B. 69.96% C. 77.04% D. 63.72% E. 78.45%
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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.
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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.
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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%.
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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.
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24. Toyota stock has the following probability distribution of expected prices one year from now:
State 1 2 3
Probability 25 % 40 % 35 %
Price $ 50 $ 60 $ 70
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%
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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
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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%.
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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.
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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
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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.
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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.
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31. You have been given this probability distribution for the holding-period return for Cheese, Inc. stock:
State 1 2 3
Probability 25 % 40 % 35 %
Price $ 50 $ 60 $ 70
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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.
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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%
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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%
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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%.
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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%.
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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%.
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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%
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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%
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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%
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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%
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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%
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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.
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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.
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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.
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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.
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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.
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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.
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48. You have been given this probability distribution for the holding-period return for a stock:
Stock of the Economy Boom Normal growth Recession
Probability 0.40 0.35 0.25
HPR 22 % 11 % – 9 %
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.
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49. You have been given this probability distribution for the holding-period return for a stock:
Stock of the Economy Boom Normal growth Recession
Probability 0.40 0.35 0.25
HPR 22 % 11 % – 9 %
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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.
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50. You have been given this probability distribution for the holding-period return for a stock:
Stock of the Economy Boom Normal growth Recession
Probability 0.40 0.35 0.25
HPR 22 % 11 % – 9 %
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.
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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.
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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%.
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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.
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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%.
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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.
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56. You have been given this probability distribution for the holding-period return for GM stock:
Stock of the Economy Boom Normal growth Recession
Probability HPR 0.40 30 % 0.40 11 % 0.20 – 10 %
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%
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57. You have been given this probability distribution for the holding-period return for GM stock:
Stock of the Economy Boom Normal growth Recession
Probability 0.40 0.40 0.20
HPR 30 11 – 10
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% % %
What is the expected standard deviation for GM stock? A. 16.91% B. 16.13% C. 13.79% D. 15.25% E. 14.87%
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58. You have been given this probability distribution for the holding-period return for GM stock:
Stock of the Economy Boom Normal growth Recession
Probability 0.40 0.40 0.20
What is the expected variance for GM stock? A. 200.00% B. 221.04% C. 246.37% D. 14.87% E. 16.13%
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HPR 30 % 11 % – 10 %
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%
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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
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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.
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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.
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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%.
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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%.
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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%.
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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%.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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%.
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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.
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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.
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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.
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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
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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.
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 05-06 The Normal Distribution. Topic: 05-06 Comparing Rates of Return for Different Holding Periods
Chapter 06 Capital Allocation to Risky Assets
Multiple Choice Questions
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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.
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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.
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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 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.
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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.
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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.
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6. In a return-standard deviation space, which of the following statements is(are)true for riskaverse 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.
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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.
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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.
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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% E. 5%; 10%.
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10. Assume an investor with the following utility function: U=E(r) - 3/2(s2). To maximize her expected utility, which one of the following investment alternatives would she choose? 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. E. Cannot be determined.
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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 E. 4
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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.
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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? 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 riskreturn trade-off.
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14. Use the below information to answer the following question.
Investment 1 2 3 4
Expected Return E(r) 0.12 0.15 0.21 0.24
Standard Deviation 0.3 0.5 0.16 0.21
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U=E(r)- (A/2)s2,whereA= 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.
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15. Use the below information to answer the following question.
Investment 1 2 3 4
Expected Return E(r) 0.12 0.15 0.21 0.24
Standard Deviation 0.3 0.5 0.16 0.21
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U=E(r)- (A/2)s2,whereA= 4.0. 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.
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16. Use the below information to answer the following question.
Investment 1 2 3 4
Expected Return E(r) 0.12 0.15 0.21 0.24
Standard Deviation 0.3 0.5 0.16 0.21
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U=E(r) - (A/2)s2,whereA= 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. E. Risk of investment.
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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. although not known with perfect certainty, do allow the advisor to create more suitable portfolios for the client. D. cannot be known with perfect certainty and, although not known with perfect certainty, do allow the advisor to create more suitable portfolios for the client.
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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. E. Is captured by the Sharpe ratio. 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.
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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.
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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.
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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.
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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.
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23. According to the mean-variance criterion, which of the statements below is correct?
Investment A B C D
E(r) 10 21 18 24
% % % %
Standard Deviation 5 % 11 % 23 % 16 %
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.
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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
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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. E. Line with same utility values. The CAL has an intercept equal to the risk-free rate. It is a straight line through the point representing the risk-free asset and the risky portfolio, in expected-return/standard deviation space.
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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. 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.
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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.
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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.
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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
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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.
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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. 0.11, 0.05
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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.
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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 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.
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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.
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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.
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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 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.
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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.
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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.
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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.
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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.
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41. The Sharpe 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.
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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. E. Borrowing rate lower than lending rate. 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.
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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. E. Identifying utility values. Assessing risk tolerance should be the first consideration in asset allocation. The other options refer to security selection.
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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. E. investors will hold same amounts of the risky asset in their portfolios.
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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. 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.
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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. E. The security allocation line The capital allocation line (CAL) illustrates the possible combinations of a risk-free asset and a risky asset available to the investor.
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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.
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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.
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E(Rp) Standard Deviation of P T-Bill rate
12.00 % 7.20 % 3.60 %
Proportion of Complete Portfolio in P Proportion of Complete Portfolio in T-Bills
80 % 20 %
Composition of P: Stock A Stock B Stock C Total
40.00 25.00 35.00 100.00
% % % %
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%
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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.
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E(Rp) Standard Deviation of P T-Bill rate
12.00 % 7.20 % 3.60 %
Proportion of Complete Portfolio in P Proportion of Complete Portfolio in T-Bills
80 % 20 %
Composition of P: Stock A Stock B Stock C Total
40.00 25.00 35.00 100.00
% % % %
What is the standard deviation of Bo's complete portfolio? A. 7.20% B. 5.40% C. 6.92% D. 4.98% E. 5.76%
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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.
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E(Rp) Standard Deviation of P T-Bill rate
12.00 % 7.20 % 3.60 %
Proportion of Complete Portfolio in P Proportion of Complete Portfolio in T-Bills
80 % 20 %
Composition of P: Stock A Stock B Stock C Total
40.00 25.00 35.00 100.00
% % % %
What is the equation of Bo's capital allocation line? A. E(rC) = 7.2 + 3.6 Standard Deviation of C B. E(rC) = 3.6 + 1.167 Standard Deviation of C C. E(rC) = 3.6 + 12.0 Standard Deviation of C D. E(rC) = 0.2 + 1.167 Standard Deviation of C E. E(rC) = 3.6 + 0.857 Standard Deviation of C
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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.
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E(Rp) Standard Deviation of P T-Bill rate
12.00 % 7.20 % 3.60 %
Proportion of Complete Portfolio in P Proportion of Complete Portfolio in T-Bills
80 % 20 %
Composition of P: Stock A Stock B Stock C Total
40.00 25.00 35.00 100.00
% % % %
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%
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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.
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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
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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. 0.075; 0205
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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.
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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. 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.
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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.
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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.
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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. 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.
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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.
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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.
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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. 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.
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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.
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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.
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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 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.
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Chapter 07 Optimal Risky Portfolios
Multiple Choice Questions
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1. Market risk is also referred to as A. systematic risk or diversifiable risk. B. systematic risk or non-diversifiable risk. C. unique risk or non-diversifiable risk. D. unique risk or diversifiable risk.
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2. Systematic risk is also referred to as A. market risk or non-diversifiable risk. B. market risk or diversifiable risk. C. unique risk or non-diversifiable risk. D. unique risk or diversifiable risk. E. None of the options are correct.
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3. No 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.
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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.
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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.
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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.
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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.
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8. The risk that can be diversified away is A. firm-specific risk. B. beta. C. systematic risk. D. market risk. E. Measured by standard deviation.
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9. The risk that cannot be diversified away is A. firm-specific risk. B. unique. C. nonsystematic risk. D. market risk. E. Measured by standard deviation. Market, systematic, and non-diversifiable 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.
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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.
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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. E. The difference of the securities' variances. 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.
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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.
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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.
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14. The efficient frontier of risky assets is A. the portion of the investment opportunity set that lies above the global minimum variance portfolio. B. the portion of the investment opportunity set that represents the highest standard deviations. C. the portion of the investment opportunity set that includes the portfolios with the lowest standard deviation. D. the set of portfolios that have zero standard deviation. E. an indifference curve. 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.
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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. E. the vertical line drawn from the variance of the risky security. The capital allocation line represents the most efficient combinations of the risk-free asset and risky securities. Only C meets that definition.
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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. E. equal to 2.
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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 The lower the correlation between the returns of the securities, the more portfolio risk is reduced.
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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.
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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.
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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. 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.
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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.
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22. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.10 0.20 0.20 0.30 0.20
Return on Stock A 10 % 13 % 12 % 14 % 15 %
Return on Stock B 8 % 7 % 6 % 9 % 8 %
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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. 10%; 8%.
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23. Consider the following probability distribution for stocks A and B:
State 1 2 3 4 5
Probability Return on Stock A 0.10 10 % 0.20 13 % 0.20 12 % 0.30 14 % 0.20 15 %
Return on Stock B 8 % 7 % 6 % 9 % 8 %
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% E. 1.9%; 1.8%
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24. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.10 0.20 0.20 0.30 0.20
Return on Stock A 10 % 13 % 12 % 14 % 15 %
Return on Stock B 8 % 7 % 6 % 9 % 8 %
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% E. 2.1%; 1.8%.
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25. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.10 0.20 0.20 0.30 0.20
Return on Stock A 10 % 13 % 12 % 14 % 15 %
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Return on Stock B 8 % 7 % 6 % 9 % 8 %
The coefficient of correlation between A and B is A. 0.46. B. 0.60. C. 0.58. D. 1.20. E. 0.5.
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26. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.10 0.20 0.20 0.30 0.20
Return on Stock A 10 % 13 % 12 % 14 % 15 %
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Return on Stock B 8 % 7 % 6 % 9 % 8 %
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.
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27. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.10 0.20 0.20 0.30 0.20
Return on Stock A 10 % 13 % 12 % 14 % 15 %
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Return on Stock B 8 % 7 % 6 % 9 % 8 %
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
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28. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.10 0.20 0.20 0.30 0.20
Return on Stock A 10 % 13 % 12 % 14 % 15 %
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Return on Stock B 8 % 7 % 6 % 9 % 8 %
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. 9.2%; 7%.
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29. Consider the following probability distribution for stocks A and B:
State 1 2 3 4 5
Probability Return on Stock A 0.10 10 % 0.20 13 % 0.20 12 % 0.30 14 % 0.20 15 %
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Return on Stock B 8 % 7 % 6 % 9 % 8 %
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.
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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
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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. 4%.
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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
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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.
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34. Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz?
Portfolio W X Y Z
Expected Return 9 % 5 % 15 % 12 %
Standard Deviation 21 % 7 % 36 % 15 %
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.
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35. Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz?
Portfolio W X Y Z
Expected Return 9 % 5 % 15 % 12 %
Standard Deviation 21 % 7 % 36 % 15 %
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.
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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. E. the reduction of systematic risk.
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37. The measure of risk in a Markowitz efficient frontier is A. specific risk. B. standard deviation of returns. C. reinvestment risk. D. beta. E. Systematic risk.
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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.
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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. E. depends on market changes. 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.
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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.
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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.
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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.
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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.
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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
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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.
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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
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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.
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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.
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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
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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
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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.
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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. 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%.
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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.
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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.
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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.
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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-to-variability ratio, which is the slope of the CAL. It will also allow the investor to reach his highest feasible level of utility.
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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
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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.
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59. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.15 0.20 0.15 0.30 0.20
Return on Stock A 8 % 13 % 12 % 14 % 16 %
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Return on Stock B 8 % 7 % 6 % 9 % 11 %
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. 8%; 10%.
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60. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.15 0.20 0.15 0.30 0.20
Return on Stock A 8 % 13 % 12 % 14 % 16 %
Return on Stock B 8 % 7 % 6 % 9 % 11 %
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% E. 3.2%; 1.10%.
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61. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.15 0.20 0.15 0.30 0.20
Return on Stock A 8 % 13 % 12 % 14 % 16 %
Return on Stock B 8 % 7 % 6 % 9 % 11 %
The coefficient of correlation between A and B is A. 0.474. B. 0.612. C. 0.590. D. 1.206. E. 0.25.
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62. Consider the following probability distribution for stocks A and B:
State
Probability
1 2 3 4 5
0.15 0.20 0.15 0.30 0.20
Return on Stock A 8 % 13 % 12 % 14 % 16 %
Return on Stock B 8 % 7 % 6 % 9 % 11 %
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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. 8.3; 1.8%.
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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
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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. 5%.
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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
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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
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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
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68. Consider the following probability distribution for stocks C and D:
State
Probability
1 2 3
0.30 0.50 0.20
Return on Stock C 7 % 11 % – 16 %
Return on Stock D – 9 % 14 % 26 %
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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.
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69. Consider the following probability distribution for stocks C and D:
State
Probability
1 2 3
0.30 0.50 0.20
Return on Stock C 7 % 11 % – 16 %
Return on Stock D – 9 % 14 % 26 %
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% E. 9.25%; 11.5%.
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70. Consider the following probability distribution for stocks C and D:
State
Probability
1 2 3
0.30 0.50 0.20
Return on Stock C 7 % 11 % – 16 %
Return on Stock D – 9 % 14 % 26 %
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.
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71. Consider the following probability distribution for stocks C and D:
State
Probability
1 2 3
0.30 0.50 0.20
Return on Stock C 7 % 11 % – 16 %
Return on Stock D – 9 % 14 % 26 %
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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. 8.5%; 10%.
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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
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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.
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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
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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
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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
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Chapter 08 Index Models
Multiple Choice Questions
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 08-01 A Single-Factor Security Market. Topic: 08-01 A Single-Factor Security Market
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.
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3. As diversification increases, the firm-specific risk of a portfolio approaches A. 0. B. 1. C. infinity. D. (n - 1) n.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 08-01 A Single-Factor Security Market. Topic: 08-01 A Single-Factor Security Market
4. As diversification increases, the unsystematic risk of a portfolio approaches A. 1. B. 0. C. infinity. D. (n - 1) n.
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5. As diversification increases, the unique risk of a portfolio approaches A. 1. B. 0. C. infinity. D. (n - 1) n.
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6. The index model was first suggested by A. Graham. B. Markowitz. C. Miller. D. Sharpe. E. Fisher. William Sharpe, building on the work of Harry Markowitz, developed the index model.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 08-02 The Single-Index Model. Topic: 08-02 The Input List of the Markowitz 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. E. Interest rate.
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8. Beta books typically rely on the __________ most recent monthly observations to calculate regression parameters. A. 12 B. 36 C. 60 D. 120 E. 6 Most published betas and other regression parameters are based on five years of monthly return data.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 08-02 The Single-Index Model. Topic: 08-02 The Input List of the Markowitz 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. M = 0.35; (eA) = 0.20; (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.
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 08-02 The Single-Index Model. Topic: 08-02 The Input List of the Markowitz Model
11. The intercept in the regression equations calculated by beta books is equal to A. in the CAPM. B. + rf(1 + ). C. + rf(1 - ). D. 1 - . E. 1.
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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 of the asset. B. the of the asset. C. the of the asset. D. the of the asset. E. The Sharpe ratio. The slope of the regression line, , estimates the volatility of the stock versus the volatility of the market, and the estimates the intercept.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 08-02 The Single-Index Model. Topic: 08-02 The Input List of the Markowitz 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 of the asset. B. the of the asset. C. the of the asset. D. the of the asset. E. The Sharpe ratio. The slope of the regression line, , estimates the volatility of the stock versus the volatility of the market, and the estimates the intercept.
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 08-01 A Single-Factor Security Market. Topic: 08-01 A 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 08-04 Portfolio Construction and the Single-Index Model. Topic: 08-04 The Single-Index Model
16. If the index model is valid, _________ would be helpful in determining the covariance between assets GM and GE. A. GM B. GE C. M D. all of the options E. None of the options are correct.
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17. If the index model is valid, _________ would be helpful in determining the covariance between assets HPQ and KMP. A. HPQ B. KMP C. M D. all of the options E. None of the options are correct.
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18. If the index model is valid, _________ would be helpful in determining the covariance between assets K and L. A. k B. L C. M D. all of the options E. None of the options are correct.
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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.
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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.
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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.
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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.
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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. E. 0.9
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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. E. 0.8
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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. E. 0.2
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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 E. 300; 300. The expected returns of each of the 150 securities must be calculated. In addition, the 150 variances around these returns must be calculated.
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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 E. 200; 300. The expected returns of each of the 100 securities must be calculated. In addition, the 100 variances around these returns must be calculated.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 08-01 A Single-Factor Security Market. Topic: 08-01 A 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 E. 300.
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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 E. 200.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 08-01 A Single-Factor Security Market. Topic: 08-01 A 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 E. 300.
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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 E. 200; 300. For a single-index model, n(175), expected returns and n(175) sensitivity coefficients to the macroeconomic factor must be estimated.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 08-03 Estimating the Single-Index Model. Topic: 08-03 Normality of Returns and Systematic Risk
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 E. 200; 300 For a single-index model, n(125), expected returns and n(125) sensitivity coefficients to the macroeconomic factor must be estimated.
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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 E. 200; 300 For a single-index model, n(200), expected returns and n(200) sensitivity coefficients to the macroeconomic factor must be estimated.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 08-03 Estimating the Single-Index Model. Topic: 08-03 Normality of Returns and Systematic Risk
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.
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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 riskfree rate by 11%, and there are no firm-specific events affecting the stock performance. The of the stock is A. 0.67. B. 0.75. C. 1.0. D. 1.33. E. 1.50.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 08-02 The Single-Index Model. Topic: 08-02 The Input List of the Markowitz 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 of your portfolio was 0.20 and M was 0.16, the of the portfolio would be approximately A. 0.64. B. 0.80. C. 1.25. D. 1.56. E. 2.3
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37. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the of your portfolio was 0.22 and M was 0.19, the of the portfolio would be approximately A. 1.34. B. 1.16. C. 1.25. D. 1.56. E. 2.0
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38. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the of your portfolio was 0.18 and M was 0.24, the of the portfolio would be approximately A. 0.75. B. 0.56. C. 0.07. D. 1.03. E. 2.0
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39. Suppose the following equation best describes the evolution of over time: t = 0.25 + 0.75t - 1. If a stock had a of 0.6 last year, you would forecast the to be _______ in the coming year. A. 0.45 B. 0.60 C. 0.70 D. 0.75 E. 2.0
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40. Suppose the following equation best describes the evolution of over time: t = 0.31 + 0.82t - 1. If a stock had a of 0.88 last year, you would forecast the to be _______ in the coming year. A. 0.88 B. 0.82 C. 0.31 D. 1.03 E. 2.0
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41. Suppose the following equation best describes the evolution of over time: t = 0.18 + 0.63t - 1. If a stock had a of 1.09 last year, you would forecast the to be _______ in the coming year. A. 0.87 B. 0.18 C. 0.63 D. 0.81 E. 2.0
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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 is 0.5. The risk-free rate of return is 12%. The true of the stock is A. 0%. B. 3%. C. 6%. D. 9%. E. 5%.
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43. The index model for stock A has been estimated with the following result: RA = 0.01 + 0.9RM + eA. If M = 0.25 andR2A = 0.25, the standard deviation of return of stock A is A. 0.2025. B. 0.2500. C. 0.4500. D. 0.8100. E. 0.70.
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44. The index model for stock B has been estimated with the following result: RB = 0.01 + 1.1RM + eB. If M = 0.20 andR2B = 0.50, the standard deviation of the return on stock B is A. 0.1111. B. 0.2111. C. 0.3111. D. 0.4111. E. 0.22
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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 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% E. 10.0%
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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. M = 0.25; (eA) = 0.20; (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.
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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. M = 0.20; (eA) = 0.20; (eB) = 0.10. The standard deviation for stock A is A. 0.0656. B. 0.0676. C. 0.2561. D. 0.2600. E. 0.4500.
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48. The index model has been estimated for stock A with the following results: RA = 0.01 + 0.8RM + eA. M = 0.20; (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. E. 0.5000
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 08-01 A Single-Factor Security Market. Topic: 08-01 A 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.
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 08-03 Estimating the Single-Index Model. Topic: 08-03 Normality of Returns and Systematic Risk
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.
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 08-01 A Single-Factor Security Market. Topic: 08-01 A Single-Factor Security Market
54. In the single-index model represented by the equation ri= E(ri) + iF + 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.
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 08-02 The Single-Index Model. Topic: 08-02 The Input List of the Markowitz 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.
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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.
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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.
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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.
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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.
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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. E. 2.0
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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.
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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 E. 200.
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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.
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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 riskfree rate by 11%, and there are no firm-specific events affecting the stock performance. The of the stock is A. 1.57. B. 0.75. C. 1.17. D. 1.33. E. 1.50.
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66. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the of your portfolio was 0.25 and M was 0.21, the of the portfolio would be approximately ________. A. 0.64 B. 1.19 C. 1.25 D. 1.56 E. 2.0.
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67. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the of your portfolio was 0.18 and M was 0.22, the of the portfolio would be approximately A. 0.64. B. 1.19. C. 0.82. D. 1.56. E. 2.1.
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68. Suppose the following equation best describes the evolution of over time: t = 0.4 + 0.6t - 1. If a stock had a of 0.9 last year, you would forecast the to be _______ in the coming year. A. 0.45 B. 0.60 C. 0.70 D. 0.94 E. 2.0.
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69. Suppose the following equation best describes the evolution of over time: t = 0.3 + 0.2t - 1 If a stock had a of 0.8 last year, you would forecast the to be _______ in the coming year. A. 0.46 B. 0.60 C. 0.70 D. 0.94 E. 2.1.
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70. The index model for stock A has been estimated with the following result: RA = 0.01 + 0.94RM + eA If M = 0.30 andR2A = 0.28, the standard deviation of return of stock A is A. 0.2025. B. 0.2500. C. 0.4500. D. 0.5329. E. 0.900.
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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 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% E. 10.00%.
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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. M = 0.30 (eA) = 0.20 (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.
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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.
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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. E. 2.00
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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. E. 1.5.
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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.
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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 E. 250.
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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.
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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
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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 riskfree rate by 5%, and there are no firm-specific events affecting the stock performance. The of the stock is A. 0.67. B. 0.75. C. 1.0. D. 1.33. E. 1.50.
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81. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the of your portfolio was 0.24 and M was 0.18, the of the portfolio would be approximately A. 0.64. B. 1.33. C. 1.25. D. 1.56. E. 1.95.
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82. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the of your portfolio was 0.14 and M was 0.19, the of the portfolio would be approximately A. 0.74. B. 0.80. C. 1.25. D. 1.56. E. 0.92.
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83. Suppose the following equation best describes the evolution of over time: t = 0.30 + 0.70t - 1 If a stock had a of 0.82 last year, you would forecast the to be _______ in the coming year. A. 0.91 B. 0.77 C. 0.63 D. 0.87 E. 0.50.
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Chapter 09 The Capital Asset Pricing Model
Multiple Choice Questions
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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.
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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.
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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.
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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.
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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.
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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.
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7. The market portfolio has a beta of A. 0. B. 1. C. -1. D. 0.5.
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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.
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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.
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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.
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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.
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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 called the security market line; the other statements are true).
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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).
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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.
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15. According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to A. Rf+ [E(RM)]. B. Rf+ [E(RM) -Rf]. C. [E(RM) -Rf]. D. E(RM) +Rf.
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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.
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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.
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18. According to the Capital Asset Pricing Model (CAPM), underpriced securities have A. positive betas. B. zeroalphas. C. negative betas. D. positive alphas. E. None of the options are correct.
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19. According to the Capital Asset Pricing Model (CAPM), overpriced securities have 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.
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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.
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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.
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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.
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23. Robert Engle won the Nobel Prize for his A. work on econometric techniques to deal with time-varying volatility. B. work on developing the efficient frontier. C. work on developing the CAPM. D. work on interest rates. E. work on index models.
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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.
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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.
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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. 0.6(1.2) + 0.4(0.90) = 1.08.
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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%.
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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.
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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.
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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.
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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.
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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.
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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. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.
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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%.
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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%.
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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%.
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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%.
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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%.
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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.
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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.
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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.
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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.
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43. Given are the following two stocks A and B:
Security
A B
Expected Rate of return 0.12 0.14
Beta
1.2 1.8
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.
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44. Capital asset pricing theory asserts that portfolio returns are best explained by A. economic factors. 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.
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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.
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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
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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.
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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.
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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.
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50. Burton Malkiel results show that A. Beta tends to 1 over time. B. CAPM is not testable in practice. C. the distribution of alphas is roughly bell shaped. D. CAPM can be tested in empirical studies. E. Mutual funds overperform index strategies.
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51. Fama and French documented A. that CAPM is confirmed in empirical studies. B. number of other extra-market risk factors. C. Beta tends to 1 over time. D. CAPM is not testable in practice. E. the distribution of alphas is roughly bell shaped.
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52. 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.
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53. 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.
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54. 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.
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55. 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.
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56. 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.
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57. 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. The CAPM assumes that investors are price takers with the same single holding period and that there are no taxes or transaction costs.
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58. 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.
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59. 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.
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60. 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.
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61. 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.
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62. 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.
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63. 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.
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64. 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.
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65. 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
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66. 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.
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67. 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.
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68. Fama and French documented the predictive power of A. Beta only for asset returns. B. Alpha on asset returns. C. Yield spread for asset returns. D. Liquidity premium for asset returns. E. size and book-to-market ratios (B/M) for asset returns.
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69. 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.
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70. 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.
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71. 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.
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72. 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.
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73. 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.
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74. 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.
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75. 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%.
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76. 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%.
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77. 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%.
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78. 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.
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Chapter 10 Arbitrage Pricing Theory and Multifactor Models of Risk and Return
Multiple Choice Questions
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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.
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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%
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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.
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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.
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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.
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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.
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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.
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8. The APT was developed in 1976 by A. Lintner. B. Modigliani and Miller. C. Ross. D. Sharpe. E. Fisher. Ross developed this model in 1976.
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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.
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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.
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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. E. only systematic risk. Total risk (uncertainty) is assumed to be composed of both macroeconomic and firm-specific factors.
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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 E. APT, FF 3-factor model.
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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
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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
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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 welldiversified portfolio is approximately A. 3.6%. B. 6.0%. C. 7.3%. D. 10.1%.
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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 welldiversified portfolio is approximately A. 0.80. B. 1.13. C. 1.25. D. 1.56.
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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.
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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% E. 5%.
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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% E. 10.4%
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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%. E. 2.5%.
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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. E. -$2,000
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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%. E. 3.5% A: 19% = rf + 1(F); B: 24% = rf + 1.5(F); 5% = .5(F); F = 10%; 24% = rf + 1.5(10); rf = 9%.
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23. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%, respectively. The risk-free 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. E. 2.0. 19% = 10% + 5%(0.8) + 3%(x); x = 1.67.
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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 correct.
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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:
Stock
A B C
State of Nature Strong Growth 39 % 30 % 6 %
Moderate Growth 17 15 14
Weak Growth –5 0 22
% % %
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% % %
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. 10.0%.
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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:
Stock
A B C
State of Nature Strong Growth 39 % 30 % 6 %
Moderate Growth
Weak Growth
17 15 14
–5 0 22
% % %
1-316
% % %
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% E. 20.2%.
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27. 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:
Stock
A B C
State of Nature Strong Growth 39 % 30 % 6 %
Moderate Growth
Weak Growth
17 15 14
–5 0 22
% % %
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% % %
If you invested in an equally-weighted portfolio of stocks B and C, your portfolio return would be _____________ if economic growth was weak. A. -2.5% B. 0.5% C. 3.0% D. 11.0% E. -1.0%
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28. Consider the multifactor APT. There are two independent economic factors, F1andF2. The risk-free rate of return is 6%. The following information is available about two welldiversified portfolios:
Portfolio A B
on F1 1.0 2.0
on F2 2.0 0.0
Expected Return 19 % 12 %
Assuming no arbitrage opportunities exist, the risk premium on the factorF1portfolio should be A. 3%. B. 4%. C. 5%. D. 6%. E. 2%.
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29. Consider the multifactor APT. There are two independent economic factors, F1andF2. The risk-free rate of return is 6%. The following information is available about two welldiversified portfolios:
Portfolio A B
on F1 1.0 2.0
on F2 2.0 0.0
Expected Return 19 % 12 %
Assuming no arbitrage opportunities exist, the risk premium on the factorF2portfolio should be A. 3%. B. 4%. C. 5%. D. 6%. E. 2%.
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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. E. Beta equals zero.
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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. E. Fama-French three factor model.
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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. E. ignores macroeconomic risk factors. The CAPM assumes that market returns represent systematic risk. The APT recognizes that other macroeconomic factors may be systematic risk factors.
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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.
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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.
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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.
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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.
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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.
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38. A professional who searches for mispriced securities in specific areas such as mergertarget 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. E. Risk-shifting.
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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. E. 100%.
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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. E. A value weighted portfolio. 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.
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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.
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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 welldiversified 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. 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.
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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%
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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.
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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
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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.
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47. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of (ei) equal to 25% and 50 securities? A. 12.5% B. 625% C. 0.5% D. 3.54% E. 14.59%
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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%
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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%
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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%
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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.
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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.
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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.
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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%
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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.
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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.
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57. The states that A. assets that are equivalent have the same risk. B. if two assets are equivalent in all economically relevant respects, then they should have the same market price. C. risk and return are directly related. D. there are always arbitrage opportunities. E. risk arbitrage is bringing prices in equilibrium.
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58. The no-arbitrage equation of the APT states that A. the risk premium is equal to zero. B. Alpha is greater than zero. C. the risk premium (expected excess return) on a portfolio is the product of its beta and the market-index risk premium D. Alpha is smaller than zero. E. Beta is equal to 1. Beta is negative.
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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.
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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. E. 2.1. A: 12% = 5% +bF; B: 14% = 5% + 1.2F; F = 7.5%; Thus, beta of A = 7/7.5 = 0.93.
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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 welldiversified portfolio is approximately A. 1.58. B. 1.13. C. 1.25. D. 0.76.
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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.
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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.
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64. Multifactor model scan 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.
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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% E. 20.0%. 3% + 0.8(3%) + 1.1(5%) + 1.25(2%) = 13.4%.
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66. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 6% and 4%, respectively. The risk-free 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. E. 1.55.
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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 secondfactor 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%
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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
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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 E. A, B
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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 welldiversified portfolio is approximately A. 3.6%. B. 6.0%. C. 7.3%. D. 14.1%. E. 10.2%
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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 welldiversified portfolio is approximately A. 23.1%. B. 6.0%. C. 7.3%. D. 14.1%. E. 10.2%
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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 welldiversified portfolio is approximately A. 0.80. B. 1.13. C. 1.25. D. 1.57. E. 1.62%
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Chapter 11 The Efficient Market Hypothesis
Multiple Choice Questions
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 11-01 Random Walks and the Efficient Market Hypothesis. Topic: 11-01 Random Walks and the Efficient Market Hypothesis
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.
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3. The stock market follows a A. nonrandom walk. B. random walk 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.
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4. Womack focuses on changes in analysts' recommendations and finds that A. positive changes are associated with decreased increased stock prices of about 5%, and positive changes result in average price decreases of 11%. B. positive changes are associated with increased stock prices of about 5%, and negative changes result in average price decreases of 11%. C. positive changes are associated with increased stock prices of about 11%, and negative changes result in average price decreases of 5%. D. negative changes are associated with increased stock prices of about 5%, and positive changes result in average price decreases of 11%. E. negative changes are associated with increased stock prices of about 11%, and positive changes result in average price decreases of 5%.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 11-05 Mutual Fund and Analyst Performance. Topic: 11-05 Technical Analysis
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5. Patell and Wolfson show that most of the stock price response to corporate dividend or earnings announcements occurs A. within 10 hours of the announcement. B. within 10 days of the announcement. C. within 10 minutes of the announcement. D. within 10 seconds of the announcement. E. within 60 minutes of the announcement.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 11-01 Random Walks and the Efficient Market Hypothesis. Topic: 11-01 Random Walks and the 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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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14. The abnormal return due to an event is estimated as the difference between A. the stock's actual return and stock's expected return. B. the stock's actual return and the risk-free rate. C. the stock's expected return and a benchmark. D. the stock's actual return and a benchmark. E. the stock's actual return and the return on the t-bill.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 11-03 Event Studies. Topic: 11-03 Versions of the Efficient Market Hypothesis
15. 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.
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16. An event study describes a technique of empirical financial research that A. enables an observer to assess the impact of a particular event on a firm's risk. B. enables an observer to assess the impact of a particular event on a firm's standard deviation. C. enables an observer to assess the impact of a particular event on a firm's stock price. D. enables an observer to assess the impact of a firm's return on risk of the market. E. enables an observer to assess the impact of a firm's return on the market return.
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17. 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.
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18. 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.
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19. 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
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20. 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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 11-05 Mutual Fund and Analyst Performance. Topic: 11-05 Technical Analysis
21. 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.
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22. 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.
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23. 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.
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24. 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.
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25. 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
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26. 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.
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27. 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.
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28. One of the most commonly heard components of technical analysis is the notion of a resistance level, which refers to A. price levels below which it is unlikely for them to fall. B. price levels above which it is difficult for stock prices to rise. C. stock performance over a recent period to performance of the market or other stocks in the same industry. D. the present discounted value of all the payments a stockholder will receive from each share of stock. E. the future value of all the payments a stockholder will receive from each share of stock.
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29. 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 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 in not necessarily indicative of future performance. E. indicate that historical performance in not necessarily indicative of future performance and indicate that professional management of the fund insures above market returns.
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30. 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.
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31. 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.
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32. 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.
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33. 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.
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34. 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.
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35. 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.
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36. 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.
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37. Chartists practice A. technical analysis. B. fundamental analysis. C. regression analysis. D. insider analysis. E. psychoanalysis.
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38. 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.
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39. 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.
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40. 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.
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41. 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.
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42. Google has a beta of 1.0. The annualized market return yesterday was 11%, and the riskfree 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.
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43. 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.
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44. QQAG has a beta of 1.7. The annualized market return yesterday was 13%, and the riskfree 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.
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45. 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.
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46. 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.
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47. 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.
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48. 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.
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49. 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
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Chapter 12 Behavioural Finance and Technical Analysis
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.
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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.
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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. E. ability to never process information correctly
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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.
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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.
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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. E. stock-price expectations that are correct.
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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.
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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 E. mental accounting Single men trade far more often than women. This is due to greater overconfidence among men.
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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.
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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. E. mental accounting They attribute this to overconfidence.
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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.
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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.
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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 E. mental accounting 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.
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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 E. framing 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.
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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 E. framing
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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.
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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.
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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.
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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 E. 0.81; bearish
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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.
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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.
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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.
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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.
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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.
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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 riskadjusted returns and results of actual investments of professional managers.
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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.
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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.
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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.
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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 E. overconfidence Information processing errors can lead investors to misestimate the true probabilities of possible events or associated rates of return.
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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.
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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.
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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.
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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 E. just as; similar. Barber and Odean (2001) report that men trade more frequently than women and the frequent trading leads to inferior returns.
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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.
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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.
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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
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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.
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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 E. equal; overconfidence. 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.
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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.
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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 E. just as Barber and Odean (2001) report that men trade more frequently than women.
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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.
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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 E. earn about the same returns as Barber and Odean (2001) report that men trade more frequently than women and have lower returns.
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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 E. generate lower trading costs than Barber and Odean (2001) report that men trade more frequently than women and have lower returns.
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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.
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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.
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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.
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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.
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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.
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Chapter 13 Empirical Evidence on Security Returns
Multiple Choice Questions
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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
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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.
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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.
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12. If a professionally-managed portfolio consistently outperforms the market proxy on a riskadjusted 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.
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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.
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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.
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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.
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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.
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17. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the riskadjusted 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.
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 13-03 Fama-French-Type Factor Models. Topic: 13-03 Tests of the CAPM
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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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."
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 13-05 Consumption-Based Asset Pricing and the Equity Premium Puzzle. Topic: 13-05 Thin Trading
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.
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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.
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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.
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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.
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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
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 13-03 Fama-French-Type Factor Models. Topic: 13-03 Tests of the CAPM
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
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44. Jagannathan and Wang (2006) find that the CCAPM explains returns ______ the FamaFrench 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
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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.
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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.
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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.
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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.
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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
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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.
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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.
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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.
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Chapter 14 Bond Prices and Yields
Multiple Choice Questions
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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.
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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%.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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
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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. D. a low debt-to-equity ratio and a high quick ratio. E. a low times-interest-earned ratio and a high quick ratio.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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).
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24. Mortgage bonds are: A. subordinated debt obligations B. bonds issued with a property as collateral behind them C. a type of convertible bond D. safer than regular bonds E. a sinking fund
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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.
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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.
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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.
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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.
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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
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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.
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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
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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
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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56. Consider the following $1,000-par-value zero-coupon bonds:
Bond A B C D
Years of Maturity 1 2 3 4
Price $
909.09 811.62 711.78 635.52
The yield to maturity on bond A is A. 10%. B. 11%. C. 12%. D. 14%. E. None of the options are correct.
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57. Consider the following $1,000-par-value zero-coupon bonds:
Bond A B C D
Years of Maturity 1 2 3 4
Price $ 909.09 811.62 711.78 635.52
The yield to maturity on bond B is A. 10%. B. 11%. C. 12%. D. 14%. E. None of the options are correct.
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58. Consider the following $1,000-par-value zero-coupon bonds:
Bond A B C D
Years of Maturity 1 2 3 4
Price $
909.09 811.62 711.78 635.52
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The yield to maturity on bond C is A. 10%. B. 11%. C. 12%. D. 14%. E. None of the options are correct.
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59. Consider the following $1,000-par-value zero-coupon bonds:
Bond A B C D
Years of Maturity 1 2 3 4
Price $
909.09 811.62 711.78 635.52
The yield to maturity on bond D is A. 10%. B. 11%. C. 12%. D. 14%. E. None of the options are correct.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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%.
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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.
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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.
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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.
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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
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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 belowmarket 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.
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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.
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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.
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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.
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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.
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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.
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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
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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.
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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.
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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?
Time
0 (purchase date) 1 2 3 (maturity date)
Prevailing Reinvestment Rate 6.0 % 7.2 % 9.4 % 8.2 %
A. 6.43% B. 7.96% C. 8.23% D. 8.97% E. 9.13%
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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 $1,000/(1.11)27 = $59.74.
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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%
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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%
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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
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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.
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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.
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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.
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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.
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121. An increase in the bond's yield acts to reduce its price, which reduces the A. holding period return B. current yield C. coupon yield D. time to maturity E. face value of the bond
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122. What should happen to prices of zero-coupon securities as time passes? A. Prices increase. B. Prices should approach par value. C. Prices decrease. D. Prices remain unchanged. E. Prices cannot be determined.
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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.
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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.
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Chapter 15 The Term Structure of Interest Rates
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.
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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
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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.
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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.
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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.
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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.
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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
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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.
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16. Suppose that all investors expect that interest rates for the 4 years will be as follows:
Year 0 1 2 3
Forward Interest Rate (today)6 % 7 % 9 % 10 %
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.
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17. Suppose that all investors expect that interest rates for the 4 years will be as follows:
Year 0 1 2 3
Forward Interest Rate (today)6 % 7 % 9 % 10 %
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.
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18. Suppose that all investors expect that interest rates for the 4 years will be as follows:
Year 0 1 2 3
Forward Interest Rate (today)6 % 7 % 9 % 10 %
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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.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-03 Interest Rate Uncertainty and Forward Rates. Topic: 15-03 The Yield Curve and Future Interest Rates
19. Suppose that all investors expect that interest rates for the 4 years will be as follows:
Year 0 1 2 3
Forward Interest Rate (today)6 % 7 % 9 % 10 %
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.
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1-479
20. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
Maturity (Years) 1 2 3 4
Price $
943.40 881.68 808.88 742.09
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.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-04 Theories of the Term Structure. Topic: 15-04 The Yield Curve under Certainty
21. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
Maturity (Years) 1 2 3 4
Price $
943.40 881.68 808.88 742.09
1-480
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.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
22. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
Maturity (Years) 1 2 3 4
Price $ 943.40 881.68 808.88 742.09
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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.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
1-482
24. The "break-even" interest rate for year n that equates the return on an n-period zerocoupon 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 15-03 Interest Rate Uncertainty and Forward Rates. Topic: 15-03 The Yield Curve and Future Interest 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
26. Par Value Time to Maturity Coupon Current price Yield to Maturity
$ 1,000 20 10 $ 850 12
Years % (paid annually) %
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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.
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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
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1-484
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."
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The 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.
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
31. Year
1 2 3 4 5
1-Year Forward Rate 5.8 % 6.4 % 7.1 % 7.3 % 7.4 %
1-486
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
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32. Year
1 2 3 4 5
1-Year Forward Rate 5.8 % 6.4 % 7.1 % 7.3 % 7.4 %
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.
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33. Year
1 2 3 4 5
1-Year Forward Rate 5.8 % 6.4 % 7.1 % 7.3 % 7.4 %
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
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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.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-03 Interest Rate Uncertainty and Forward Rates. Topic: 15-03 The Yield Curve and Future Interest Rates
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
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
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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
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
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40. Suppose that all investors expect that interest rates for the 4 years will be as follows:
Year 0 1 2 3
Forward Interest Rate (today)3 % 4 % 5 % 6 %
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.
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41. Suppose that all investors expect that interest rates for the 4 years will be as follows:
Year 0 1 2 3
Forward Interest Rate (today)3 % 4 % 5 % 6 %
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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. 3% C. 9% D. 10% E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-03 Interest Rate Uncertainty and Forward Rates. Topic: 15-03 The Yield Curve and Future Interest Rates
42. Suppose that all investors expect that interest rates for the 4 years will be as follows:
Year 0 1 2 3
Forward Interest Rate (today)3 % 4 % 5 % 6 %
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What is the price of a 2-year maturity bond with a 5% coupon rate paid annually? (Par value = $1,000.) A. $1,092.97 B. $1,054.24 C. $1,028.51 D. $1,073.34 E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-03 Interest Rate Uncertainty and Forward Rates. Topic: 15-03 The Yield Curve and Future Interest Rates
43. Suppose that all investors expect that interest rates for the 4 years will be as follows:
Year 0 1 2 3
Forward Interest Rate (today)3 % 4 % 5 % 6 %
What is the yield to maturity of a 3-year zero-coupon bond? A. 7.00% B. 9.00% C. 6.99% D. 4.00% E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-03 Interest Rate Uncertainty and Forward Rates. Topic: 15-03 The Yield Curve and Future Interest Rates
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44. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
Maturity (Years) 1 2 3 4
Price $925.15 862.57 788.66 711.00
According to the expectations theory, what is the expected forward rate in the third year? A. 7.23% B. 9.37% C. 9.00% D. 10.9%
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-04 Theories of the Term Structure. Topic: 15-04 The Yield Curve under Certainty
45. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
Maturity (Years) 1 2 3 4
Price $925.15 862.57 788.66 711.00
1-494
What is the yield to maturity on a 3-year zero-coupon bond? A. 6.37% B. 9.00% C. 7.33% D. 8.24%
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
46. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
Maturity (Years) 1 2 3 4
Price $925.15 862.57 788.66 711.00
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
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
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47. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
Maturity (Years) 1 2 3 4
Price $925.15 862.57 788.66 711.00
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
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48. Par Value Time to Maturity Coupon Current price Yield to Maturity
$
1,000 18 9 $ 917.99 12
Years % (paid annually) %
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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.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-01 The Yield Curve. Topic: 15-01 The Yield Curve
49. Year
1 2 3 4 5
1-Year Forward Rate 5 % 5.5 % 6.0 % 6.5 % 7.0 %
1-497
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. $894.21 E. $871.80
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50. Year
1 2 3 4 5
1-Year Forward Rate 5 % 5.5 % 6.0 % 6.5 % 7.0 %
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%
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1-498
51. Year
1 2 3 4 5
1-Year Forward Rate 5 % 5.5 % 6.0 % 6.5 % 7.0 %
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 E. $719.75
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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%
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53. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
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
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 15-03 Interest Rate Uncertainty and Forward Rates. Topic: 15-03 The Yield Curve and Future Interest Rates
54. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
1-500
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? A. $966.87 B. $911.37 C. $950.21 D. $956.02 E. $945.51
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55. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
1-501
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
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56. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
1-502
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
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57. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
1-503
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
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58. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
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%
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1-504
59. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
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%
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60. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
1-505
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%
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61. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
What is the yield to maturity of a 3-year bond? A. 4.6% B. 4.9% C. 5.2% D. 5.5% E. 5.8%
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1-506
62. Year
1 2 3 4 5
1-Year Forward Rate 4.6 % 4.9 % 5.2 % 5.5 % 6.8 %
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%
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Chapter 16 Managing Bond Portfolios
Multiple Choice Questions
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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.
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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.
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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.
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 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. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
8. 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 higher. D. term to maturity is lower and coupon rate is higher. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
1-510
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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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.
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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.
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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.
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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.
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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 E. Cannot tell from the information given
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 16-03 Passive Bond Management. Topic: 16-03 Duration
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.
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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
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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.
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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. 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.
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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
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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
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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.
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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.
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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.
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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. 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.
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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
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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.
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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.
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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%
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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.
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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.
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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.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-03 Passive Bond Management. Topic: 16-03 Duration
39. Some of the problems with immunization are 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.
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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
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-03 Passive Bond Management. Topic: 16-03 Duration
41. Cash flow matching on a multiperiod basis is referred to as A. immunization. B. contingent immunization. C. dedication. D. duration matching. E. rebalancing.
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 16-03 Passive Bond Management. Topic: 16-03 Duration
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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 16-02 Convexity. Topic: 16-02 Interest Rate Sensitivity
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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 duration-with-convexity rule? A. 21.2% B. 25.4% C. 17.0% D. 10.6%
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 16-02 Convexity. Topic: 16-02 Interest Rate Sensitivity
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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 16-04 Active Bond Management. Topic: 16-04 What Determines Duration?
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. 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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 16-04 Active Bond Management. Topic: 16-04 What Determines Duration?
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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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 16-03 Passive Bond Management. Topic: 16-03 Duration
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.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 16-03 Passive Bond Management. Topic: 16-03 Duration
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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
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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
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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
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52. According to the duration concept, 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.
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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
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 16-01 Interest Rate Risk. Topic: 16-01 Interest Rate Risk
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.
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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.
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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.
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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.
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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 C. 7 year, 14% coupon bond D. 7-year, 10% coupon bond E. Cannot tell from the information given
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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
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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.
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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.
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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
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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
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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.
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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.
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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
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67. Which of the following bonds has the longest duration? 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
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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.
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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.
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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%
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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%
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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-with-convexity rule? A. 21.2% B. 25.4% C. 17.0% D. 13.3%
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 16-02 Convexity. Topic: 16-02 Interest Rate Sensitivity
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-with-convexity rule? A. 21.2% B. 25.4% C. 17.0% D. 52.3%
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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.
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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.
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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.
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Chapter 17 Macroeconomic and Industry Analysis
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Multiple Choice Questions 1. A top-down analysis of a firm starts with A. the relative value of the firm. B. the absolute value of the firm. C. the domestic economy. D. the global economy. E. the industry outlook.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-01 The Global Economy. Topic: 17-01 The Global Economy
2. An example of a highly cyclical industry is A. the automobile industry. B. the tobacco industry. C. the food industry. D. the automobile industry and the tobacco industry. E. the tobacco industry and the food industry.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-05 Business Cycles. Topic: 17-09 Business cycles
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3. Demand-side economics is concerned with A. government spending and tax levels. B. monetary policy. C. fiscal policy. D. government spending, tax levels, and monetary policy. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
4. The most widely used monetary tool is A. altering the discount rate. B. altering the reserve requirements. C. open-market operations. D. altering marginal tax rates. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
5. The "real," or inflation-adjusted, exchange rate is A. the balance of trade. B. the budget deficit. C. the purchasing-power ratio. D. unimportant to the Canadian economy. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-01 The Global Economy. Topic: 17-01 The Global Economy
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6. The "normal" range of price-earnings ratios for the S&P 500 Index is A. between 2 and 10. B. between 5 and 15. C. less than 8. D. between 12 and 25. E. greater than 20.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
7. Monetary policy is determined by A. government budget decisions. B. Prime minister's mandates. C. the Governing Council of the Bank of Canada D. congressional actions. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
8. A trough is A. a transition from an expansion in the business cycle to the start of a contraction. B. a transition from a contraction in the business cycle to the start of an expansion. C. a depression that lasts more than three years. D. only something used by farmers to feed pigs and not an investment term.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-05 Business Cycles. Topic: 17-09 Business cycles
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9. A peak is A. a transition from an expansion in the business cycle to the start of a contraction. B. a transition from a contraction in the business cycle to the start of an expansion. C. a depression that lasts more than three years. D. only a feature of geography and not an investment term. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-05 Business Cycles. Topic: 17-09 Business cycles
10. If the economy is growing, firms with high operating leverage will experience A. higher increases in profits than firms with low operating leverage. B. similar increases in profits as firms with low operating leverage. C. smaller increases in profits than firms with low operating leverage. D. no change in profits. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
11. If the economy is shrinking, firms with high operating leverage will experience A. larger decreases in profits than firms with low operating leverage. B. similar decreases in profits as firms with low operating leverage. C. smaller decreases in profits than firms with low operating leverage. D. no change in profits.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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12. If the economy is growing, firms with low operating leverage will experience A. higher increases in profits than firms with high operating leverage. B. similar increases in profits as firms with high operating leverage. C. smaller increases in profits than firms with high operating leverage. D. no change in profits.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
13. If the economy is shrinking, firms with low operating leverage will experience A. larger decreases in profits than firms with high operating leverage. B. similar decreases in profits as firms with high operating leverage. C. smaller decreases in profits than firms with high operating leverage. D. no change in profits.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
14. Industrial production refers to A. the amount of personal disposable income in the economy. B. the difference between government spending and government revenues. C. the total manufacturing output in the economy. D. the total production of goods and services in the economy.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-02 The Domestic Macroeconomy. Topic: 17-02 The Domestic Macroeconomy
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15. GDP refers to A. the amount of personal disposable income in the economy. B. the difference between government spending and government revenues. C. the total manufacturing output in the economy. D. the total production of goods and services in the economy. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-02 The Domestic Macroeconomy. Topic: 17-02 The Domestic Macroeconomy
16. A rapidly growing GDP indicates a(n) ______ economy with ______ opportunity for a firm to increase sales. A. stagnant; little B. stagnant; ample C. expanding; little D. expanding; ample E. stable; no
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-02 The Domestic Macroeconomy. Topic: 17-02 The Domestic Macroeconomy
17. A declining GDP indicates a(n) ______ economy with ______ opportunity for a firm to increase sales. A. stagnant; little B. stagnant; ample C. expanding; little D. expanding; ample E. stable; no
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-02 The Domestic Macroeconomy. Topic: 17-02 The Domestic Macroeconomy
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18. The average duration of unemployment and changes in the consumer price index for services are A. leading economic indicators. B. coincidental economic indicators. C. lagging economic indicators. D. composite economic indicators.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 17-05 Business Cycles. Topic: 17-05 Federal Government Policy
19. A firm in an industry that is very sensitive to the business cycle will likely have a stock beta A. greater than 1.0. B. equal to 1.0. C. less than 1.0 but greater than 0.0. D. equal to or less than 0.0. E. There is no relationship between beta and sensitivity to the business cycle.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 17-05 Business Cycles. Topic: 17-09 Business cycles
20. If the economy were going into a recession, an attractive industry to invest in would be the A. automobile industry. B. medical services industry. C. construction industry. D. automobile and construction industries. E. medical services and construction industries.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-05 Business Cycles. Topic: 17-09 Business cycles
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21. The stock price index and new orders for nondefense capital goods are A. leading economic indicators. B. coincidental economic indicators. C. lagging economic indicators. D. not useful as economic indicators.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 17-05 Business Cycles. Topic: 17-05 Federal Government Policy
22. A firm in the early stages of the industry life cycle will likely have A. high market penetration. B. high risk. C. rapid growth. D. high market penetration and rapid growth. E. high risk and rapid growth.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
23. Assume the Canadian government was to decide to increase the budget field. Holding all else constant, this will cause ______ to decrease. A. interest rates B. government borrowing C. unemployment D. interest rates and government borrowing E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
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24. Assume that the Bank of Canada decreases the money supply. This action will cause ________ to decrease. A. interest rates B. the unemployment rate C. investment in the economy D. trade balance E. inflation Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
25. If the currency of your country is depreciating, the result should be to ______ exports and to _______ imports. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease E. not affect; not affect
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 17-01 The Global Economy. Topic: 17-01 The Global Economy
26. If the currency of your country is appreciating, the result should be to ______ exports and to _______ imports. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease E. not affect; not affect
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 17-01 The Global Economy. Topic: 17-01 The Global Economy
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27. Increases in the money supply will cause demand for investment and consumption goods to _______ in the short run and cause prices to ________ in the long run. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; hold steady E. be unaffected; be unaffected
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
28. The North American Industry Classification System (NAICS) codes A. are for firms that operate in the NAFTA region. B. group firms by industry. C. are a perfect classification system for firms. D. are for firms that operate in the NAFTA region and group firms by industry. E. are for firms that operate in the NAFTA region and are a perfect classification system for firms.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
29. If interest rates increase, business investment expenditures are likely to ______, and consumer durable expenditures are likely to _________. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease E. be unaffected; be unaffected
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
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30. Fiscal policy generally has a _______ direct impact than monetary policy on the economy, and the formulation and implementation of fiscal policy is ______ than that of monetary policy. A. more; quicker B. more; slower C. less; quicker D. less; slower E. Cannot tell from the information given
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
31. Fiscal policy is difficult to implement quickly because A. it requires political negotiations. B. much of government spending is nondiscretionary and cannot be changed. C. increases in tax rates affect consumer spending gradually. D. it requires political negotiations, and much of government spending is nondiscretionary and cannot be changed. E. it requires political negotiations, and increases in tax rates affect consumer spending gradually.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
1-548
32. Inflation A. is the rate at which the general level of prices is increasing. B. rates are high when the economy is considered to be "overheated." C. is unrelated to unemployment rates. D. is the rate at which the general level of prices is increasing, and rates are high when the economy is considered to be "overheated." E. is the rate at which the general level of prices is increasing and is unrelated to unemployment rates.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
33. Two firms, A and B, both produce widgets. The price of widgets is $1 each. Firm A has total fixed costs of $500,000 and variable costs of 50 per widget. Firm B has total fixed costs of $240,000 and variable costs of 75 per widget. The corporate tax rate is 40%. If the economy is strong, each firm will sell 1,200,000 widgets. If the economy enters a recession, each firm will sell 1,100,000 widgets. If the economy enters a recession, the after-tax profit of Firm A will be A. $0. B. $6,000. C. $30,000. D. $60,000. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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34. Two firms, A and B, both produce widgets. The price of widgets is $1 each. Firm A has total fixed costs of $500,000 and variable costs of 50 per widget. Firm B has total fixed costs of $240,000 and variable costs of 75 per widget. The corporate tax rate is 40%. If the economy is strong, each firm will sell 1,200,000 widgets. If the economy enters a recession, each firm will sell 1,100,000 widgets. If the economy enters a recession, the after-tax profit of Firm B will be A. $0. B. $6,000. C. $36,000. D. $60,000. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
35. Two firms, A and B, both produce widgets. The price of widgets is $1 each. Firm A has total fixed costs of $500,000 and variable costs of 50 per widget. Firm B has total fixed costs of $240,000 and variable costs of 75 per widget. The corporate tax rate is 40%. If the economy is strong, each firm will sell 1,200,000 widgets. If the economy enters a recession, each firm will sell 1,100,000 widgets. If the economy is strong, the after-tax profit of Firm A will be A. $0. B. $6,000. C. $36,000. D. $60,000.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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36. Two firms, A and B, both produce widgets. The price of widgets is $1 each. Firm A has total fixed costs of $500,000 and variable costs of 50 per widget. Firm B has total fixed costs of $240,000 and variable costs of 75 per widget. The corporate tax rate is 40%. If the economy is strong, each firm will sell 1,200,000 widgets. If the economy enters a recession, each firm will sell 1,100,000 widgets. If the economy is strong, the after-tax profit of Firm B will be A. $0. B. $6,000. C. $36,000. D. $60,000.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
37. Two firms, A and B, both produce widgets. The price of widgets is $1 each. Firm A has total fixed costs of $500,000 and variable costs of 50 per widget. Firm B has total fixed costs of $240,000 and variable costs of 75 per widget. The corporate tax rate is 40%. If the economy is strong, each firm will sell 1,200,000 widgets. If the economy enters a recession, each firm will sell 1,100,000 widgets. Calculate firm A's degree of operating leverage. A. 11.0 B. 2.86 C. 9.09 D. 1.00
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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38. Two firms, A and B, both produce widgets. The price of widgets is $1 each. Firm A has total fixed costs of $500,000 and variable costs of 50 per widget. Firm B has total fixed costs of $240,000 and variable costs of 75 per widget. The corporate tax rate is 40%. If the economy is strong, each firm will sell 1,200,000 widgets. If the economy enters a recession, each firm will sell 1,100,000 widgets. Calculate firm B's degree of operating leverage. A. .714 B. 9.09 C. 7.86 D. 7.14
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
39. Classifying firms into groups, such as _________, provides an alternative to the industry life cycle. A. slow-growers B. stalwarts C. Counter-cyclicals D. slow-growers and stalwarts E. slow-growers and counter-cyclicals
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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40. Supply-side economists wishing to stimulate the economy are most likely to recommend A. a decrease in the money supply. B. a decrease in production output. C. an increase in the real interest rate. D. a decrease in the tax rate. E. an increase in mortgage rates.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
41. Which of the following are not examples of defensive industries? A. Food producers B. Durable goods producers C. Pharmaceutical firms D. Public utilities
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
42. Which of the following are examples of defensive industries? A. Food producers B. Durable goods producers C. Pharmaceutical firms D. Public utilities E. Food producers, pharmaceutical firms, and public utilities
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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43. ________ is a proposition that a strong proponent of supply-side economics would most likely stress. A. Higher marginal tax rates will lead to a reduction in the size of the budget deficit and lower interest rates as they depend on government revenues B. Higher marginal tax rates promote economic inefficiency and thereby retard aggregate output as they encourage investors to undertake low productivity projects with substantial tax shelter benefits C. Income redistribution payments will exert little impact on real aggregate supply as they do not consume resources directly D. A tax reduction will increase the disposable income of households, and thus, the primary impact of a tax reduction on aggregate supply will stem from the influence of the tax change on the size of the budget deficit or surplus E. None of the options is a likely statement for a supply-side proponent.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
44. The industry life cycle is described by which of the following stage(s)? A. Start-up B. Consolidation C. Absolute decline D. Start-up and consolidation E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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45. In the start-up stage of the industry life cycle, A. it is difficult to predict which firms will succeed and which firms will fail. B. industry growth is very rapid. C. firms pay a high level of dividends. D. it is difficult to predict which firms will succeed and which firms will fail, and industry growth is very rapid. E. industry growth is very rapid, and firms pay a high level of dividends.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
46. In the consolidation stage of the industry life cycle, A. it is difficult to predict which firms will succeed and which firms will fail. B. industry growth is very rapid. C. the performance of firms will more closely track the performance of the overall industry. D. it is difficult to predict which firms will succeed and which firms will fail, and industry growth is very rapid. E. industry growth is very rapid, and the performance of firms will more closely track the performance of the overall industry.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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47. In the maturity stage of the industry life cycle, A. the product has reached full potential. B. profit margins are narrower. C. producers are forced to compete on price to a greater extent. D. the product has reached full potential and profit margins are narrower. E. the product has reached full potential, profit margins are narrower, and producers are forced to compete on price to a greater extent.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
48. In the decline stage of the industry life cycle, A. the product may have reached obsolescence. B. the industry will grow at a rate less than the overall economy. C. the industry may experience negative growth. D. the product may have reached obsolescence, and the industry will grow at a rate less than the overall economy. E. the product may have reached obsolescence, the industry will grow at a rate less than the overall economy, and the industry may experience negative growth.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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49. A variety of factors relating to industry structure affect the performance of the firm, including A. threat of entry. B. rivalry between existing competitors. C. the state of the economy. D. threat of entry and the state of the economy. E. threat of entry and rivalry between existing competitors.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
50. The process of estimating the dividends and earnings that can be expected from the firm based on determinants of value is called A. business-cycle forecasting. B. macroeconomic forecasting. C. technical analysis. D. fundamental analysis. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-05 Business Cycles. Topic: 17-05 Federal Government Policy
51. The stock market exhibiting the highest U.S. dollar return in 2015 was A. Japan. B. Singapore. C. Greece. D. South Korea. E. China.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 17-01 The Global Economy. Topic: 17-01 The Global Economy
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52. The life cycle stage in which industry leaders are likely to emerge is the A. start-up stage. B. maturity stage. C. consolidation stage. D. relative decline stage. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-03 Demand and Supply Shocks. Topic: 17-06 Fiscal Policy
53. Investment manager Peter Lynch refers to firms that are in bankruptcy or soon might be as A. slow growers. B. stalwarts. C. cyclicals. D. asset plays. E. turnarounds.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-03 Demand and Supply Shocks. Topic: 17-06 Fiscal Policy
54. A top-down analysis of a firm's prospects starts with A. an examination of the firm's industry. B. an evaluation of the firm's position within its industry. C. a forecast of interest-rate movements. D. an assessment of the broad economic environment. E. the application of the CAPM to find the firm's theoretical return.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-03 Demand and Supply Shocks. Topic: 17-06 Fiscal Policy
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55. In recent years, P/E multiples for S&P 500 companies have A. ranged from -1 to -10. B. ranged from 1 to 8. C. ranged from 6 to 10. D. ranged from 12 to 25. E. ranged from 20 to more than 50.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
56. The industry with the highest ROE in 2015-2016 was A. major airlines. B. trucking. C. business software. D. computer systems. E. integrated oil and gas.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
57. The industry with the lowest ROE in 2015-2016 was A. money center banks. B. chemical products. C. business software. D. biotech. E. integrated oil and gas.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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58. The industry with the lowest return in 2016 was A. asset management. B. telecom services. C. health care. D. business software. E. money center banks.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
59. The industry with the highest return in 2016 was A. trucking. B. water utilities. C. health plans. D. asset management. E. money center banks.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
60. Investors can ______ invest in an industry with the highest expected return by purchasing ______. A. most easily; industry-specific iShares B. not; industry-specific iShares C. most easily; industry-specific ADRs D. not; individual stocks E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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61. Which of the following are key economic statistics that are used to describe the state of the macroeconomy? I) Gross domestic product II) The unemployment rate III) Inflation IV) Consumer sentiment V) The budget deficit A. I, II, and V B. I, III, and V C. I, II, and III D. I, II, III, and V E. I, II, III, IV, and V
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-05 Business Cycles. Topic: 17-05 Federal Government Policy
62. An example of a positive demand shock is A. a decrease in the money supply. B. a decrease in government spending. C. a decrease in foreign export demand. D. a decrease in the price of imported oil. E. a decrease in tax rates.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
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63. An example of a negative demand shock is A. a decrease in the money supply. B. a decrease in government spending. C. an increase in foreign export demand. D. a decrease in the price of imported oil. E. a decrease in the money supply and a decrease in government spending.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
64. During which stage of the industry life cycle would a firm experience stable growth in sales? A. Consolidation B. Relative decline C. Maturity D. Start-up E. Stabilization
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
65. The emerging stock market exhibiting the highest local currency return in 2015 was A. Russia B. China. C. Singapore. D. Mexico. E. Brazil.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 17-01 The Global Economy. Topic: 17-01 The Global Economy
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66. Sector rotation A. should always be carried out. B. is never worthwhile. C. is shifting the portfolio more heavily toward an industry or sector that is expected to perform well in the future. D. can be implemented without cost.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
67. According to Michael Porter, there are five determinants of competition. An example of _____ is the threat new competitors pose to existing competitors in an industry. A. threat of entry B. rivalry between existing competitors C. pressure from substitute products D. bargaining power of buyers E. bargaining power of suppliers
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
68. According to Michael Porter, there are five determinants of competition. An example of _____ is when competitors seek to expand their share of the market. A. threat of entry B. rivalry between existing competitors C. pressure from substitute products D. bargaining power of buyers E. bargaining power of suppliers
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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69. According to Michael Porter, there are five determinants of competition. An example of _____ is when the availability limits the prices that can be charged to customers. A. threat of entry B. rivalry between existing competitors C. pressure from substitute products D. bargaining power of buyers E. bargaining power of suppliers
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
70. According to Michael Porter, there are five determinants of competition. An example of _____ is when a buyer purchases a large fraction of an industry's output and can demand price concessions. A. threat of entry B. rivalry between existing competitors C. pressure from substitute products D. bargaining power of buyers E. bargaining power of suppliers
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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71. Assume the Canadian government was to decide to increase the budget field. Holding all else constant, this will cause ______ to increase. A. interest rates B. government borrowing C. unemployment D. interest rates and government borrowing E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
72. If interest rates decrease, business investment expenditures are likely to ______, and consumer durable expenditures are likely to _________. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease E. be unaffected; be unaffected
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 17-04 Federal Government Policy. Topic: 17-04 Demand and Supply Shocks
73. An example of a defensive industry is A. the automobile industry. B. the tobacco industry. C. the food industry. D. the automobile industry and the tobacco industry. E. the tobacco industry and the food industry.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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74. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy enters a recession, the total revenue of firm C will be A. $1,680,000. B. $1,400,000. C. $2,000,000. D. $0. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
75. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy enters a recession, the total cost of firm C will be A. $1,680,000. B. $1,170,000. C. $750,000. D. $420,000.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
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76. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy enters a recession, the before-tax profit of firm C will be A. $1,680,000. B. $1,170,000. C. $510,000. D. $204,000.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
77. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy enters a recession, the tax of firm C will be A. $1,680,000. B. $750,000. C. $510,000. D. $204,000.
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78. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy enters a recession, the after-tax profit of firm C will be A. $1,680,000. B. $750,000. C. $510,000. D. $204,000. E. $306,000.
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79. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy is strong, the total revenue of firm C will be A. $1,680,000. B. $1,400,000. C. $2,000,000. D. $2,400,000.
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80. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy is strong, the total cost of firm C will be A. $1,680,000. B. $1,170,000. C. $1,350,000. D. $420,000.
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81. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy is strong, the before-tax profit of firm C will be A. $1,680,000. B. $1,050,000. C. $510,000. D. $204,000.
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82. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy is strong, the tax of firm C will be A. $420,000. B. $750,000. C. $510,000. D. $204,000.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 17-06 Industry Analysis. Topic: 17-06 Fiscal Policy
83. Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50 per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy is strong, the after-tax profit of firm C will be A. $0. B. $6,000. C. $36,000. D. $60,000. E. $630,000.
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84. If a firm's sales decrease by 15%, and profits decrease by 20% during a recession, the firm's operating leverage is A. 1.33. B. 0.75. C. 5. D. -5.
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Chapter 18 Equity Valuation Models
Multiple Choice Questions 1. ________ is equal to the total market value of the firm's common stock divided by (the replacement cost of the firm's assets less liabilities). A. Book value per share B. Liquidation value per share C. Market value per share D. Tobin's Q E. None of the options are correct.
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2. High P/E ratios tend to indicate that a company will _______, ceteris paribus. A. grow quickly B. grow at the same speed as the average company C. grow slowly D. not grow E. None of the options are correct.
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3. _________ is equal to common shareholders' equity divided by common shares outstanding. A. Book value per share B. Liquidation value per share C. Market value per share D. Tobin's Q
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4. ________ are analysts who use information concerning current and prospective profitability of a firm to assess the firm's fair market value. A. Credit analysts B. Fundamental analysts C. Systems analysts D. Technical analysts E. Specialists Fundamentalists use all public information in an attempt to value stock (while hoping to identify undervalued securities).
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5. The _______ is defined as the present value of all cash proceeds to the investor in the stock. A. dividend-payout ratio B. intrinsic value C. market-capitalization rate D. plowback ratio
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6. _______ is the amount of money per common share that could be realized by breaking up the firm, selling the assets, repaying the debt, and distributing the remainder to shareholders. A. Book value per share B. Liquidation value per share C. Market value per share D. Tobin's Q
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7. Since 1955, Treasury bond yields and earnings yields on stocks have been A. identical. B. negatively correlated. C. positively correlated. D. uncorrelated.
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8. Historically, P/E ratios have tended to be A. higher when inflation has been high. B. lower when inflation has been high. C. uncorrelated with inflation rates but correlated with other macroeconomic variables. D. uncorrelated with any macroeconomic variables, including inflation rates.
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9. The ______ is a common term for the market consensus value of the required return on a stock. A. dividend payout ratio B. intrinsic value C. market capitalization rate D. plowback rate E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
10. The _________ is the fraction of earnings reinvested in the firm. A. dividend payout ratio B. retention rate C. plowback ratio D. dividend payout ratio and plowback ratio E. retention rate or plowback ratio
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11. The Gordon model A. is a generalization of the perpetuity formula to cover the case of a growing perpetuity. B. is valid only when g is less than k. C. is valid only when k is less than g. D. is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when g is less than k. E. is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when k is less than g. The Gordon model assumes constant growth indefinitely. Mathematically, gmust be less than k; otherwise, the intrinsic value is undefined.
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12. You wish to earn a return of 13% on each of two stocks, X and Y. Stock X is expected to pay a dividend of $3 in the upcoming year while stock Y is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock X A. will be greater than the intrinsic value of stock Y. B. will be the same as the intrinsic value of stock Y. C. will be less than the intrinsic value of stock Y. D. will be the same or greater than the intrinsic value of stock Y. E. None of the options are correct.
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13. You wish to earn a return of 11% on each of two stocks, C and D. Stock C is expected to pay a dividend of $3 in the upcoming year while stock D is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock C A. will be greater than the intrinsic value of stock D. B. will be the same as the intrinsic value of stock D. C. will be less than the intrinsic value of stock D. D. will be the same or greater than the intrinsic value of stock D. E. None of the options. PV0 = D1/(k-g); given k and g are equal, the stock with the larger dividend will have the higher value.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
14. You wish to earn a return of 12% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock A and 10% for stock B. The intrinsic value of stock A A. will be greater than the intrinsic value of stock B. B. will be the same as the intrinsic value of stock B. C. will be less than the intrinsic value of stock B. D. will be the same or greater than the intrinsic value of stock B. E. None of the options are correct.
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15. You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C A. will be greater than the intrinsic value of stock D. B. will be the same as the intrinsic value of stock D. C. will be less than the intrinsic value of stock D. D. will be the same or greater than the intrinsic value of stock D. E. None of the options are correct.
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16. Each of two stocks, A and B, are expected to pay a dividend of $5 in the upcoming year. The expected growth rate of dividends is 10% for both stocks. You require a rate of return of 11% on stock A and a return of 20% on stock B. The intrinsic value of stock A A. will be greater than the intrinsic value of stock B. B. will be the same as the intrinsic value of stock B. C. will be less than the intrinsic value of stock B. D. cannot be calculated without knowing the market rate of return. PV0 = D1/(k-g); given that dividends are equal, the stock with the larger required return will have the lower value.
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17. Each of two stocks, C and D, are expected to pay a dividend of $3 in the upcoming year. The expected growth rate of dividends is 9% for both stocks. You require a rate of return of 10% on stock C and a return of 13% on stock D. The intrinsic value of stock C A. will be greater than the intrinsic value of stock D. B. will be the same as the intrinsic value of stock D. C. will be less than the intrinsic value of stock D. D. cannot be calculated without knowing the market rate of return. PV0 = D1/(k-g); given that dividends are equal, the stock with the larger required return will have the lower value.
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18. If the expected ROE on reinvested earnings is equal to k, the multistage DDM reduces to A. V0 = (Expected dividend yield in year 1)/k. B. V0 = (Expected EPS in year 1)/k. C. V0 = (Treasury bond yield in year 1)/k. D. V0 = (Market return in year 1)/k. If ROE = k, no growth is occurring; b = 0; EPS = DPS.
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19. Low Tech Company has an expected ROE of 10%. The dividend growth rate will be ________ if the firm follows a policy of paying 40% of earnings in the form of dividends. A. 6.0% B. 4.8% C. 7.2% D. 3.0% 10% 0.60 = 6.0%.
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20. Music Doctors Company has an expected ROE of 14%. The dividend growth rate will be ________ if the firm follows a policy of paying 60% of earnings in the form of dividends. A. 4.8% B. 5.6% C. 7.2% D. 6.0% 14% 0.40 = 5.6%.
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21. Medtronic Company has an expected ROE of 16%. The dividend growth rate will be ________ if the firm follows a policy of paying 70% of earnings in the form of dividends. A. 3.0% B. 6.0% C. 7.2% D. 4.8% 16% 0.30 = 4.8%.
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22. High Speed Company has an expected ROE of 15%. The dividend growth rate will be ________ if the firm follows a policy of paying 50% of earnings in the form of dividends. A. 3.0% B. 4.8% C. 7.5% D. 6.0% 15% 0.50 = 7.5%.
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23. Light Construction Machinery Company has an expected ROE of 11%. The dividend growth rate will be _______ if the firm follows a policy of paying 25% of earnings in the form of dividends. A. 3.0% B. 4.8% C. 8.25% D. 9.0% 11% 0.75 = 8.25%.
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24. Xlink Company has an expected ROE of 15%. The dividend growth rate will be _______ if the firm follows a policy of plowing back 75% of earnings. A. 3.75% B. 11.25% C. 8.25% D. 15.0% 15% 0.75 = 11.25%.
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25. Think Tank Company has an expected ROE of 26%. The dividend growth rate will be _______ if the firm follows a policy of plowing back 90% of earnings. A. 2.6% B. 10% C. 23.4% D. 90% 26% 0.90 = 23.4%.
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26. Bubba Gumm Company has an expected ROE of 9%. The dividend growth rate will be _______ if the firm follows a policy of plowing back 10% of earnings. A. 90% B. 10% C. 9% D. 0.9% 9% 0.10 = 0.9%.
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27. A preferred stock will pay a dividend of $2.75 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $0.275 B. $27.50 C. $31.82 D. $56.25 2.75/.10 = 27.50.
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28. A preferred stock will pay a dividend of $3.00 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 9% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $33.33 B. $0.27 C. $31.82 D. $56.25 3.00/.09 = 33.33.
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29. A preferred stock will pay a dividend of $1.25 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 12% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $11.56 B. $9.65 C. $11.82 D. $10.42 1.25/.12 = 10.42.
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30. A preferred stock will pay a dividend of $3.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 11% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $0.39 B. $0.56 C. $31.82 D. $56.25 3.50/.11 = 31.82.
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31. A preferred stock will pay a dividend of $7.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $0.75 B. $7.50 C. $64.12 D. $56.25 E. None of the options are correct.
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32. A preferred stock will pay a dividend of $6.00 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $0.60 B. $6.00 C. $600 D. $60.00 E. None of the options are correct.
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33. You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return. A. $30.23 B. $24.11 C. $26.52 D. $27.50 E. None of the options are correct.
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34. You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $0.75 in dividends and $16 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 12% return. A. $23.91 B. $14.96 C. $26.52 D. $27.50 E. None of the options are correct.
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35. You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $2.50 in dividends and $28 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 15% return. A. $23.91 B. $24.11 C. $26.52 D. $27.50 E. None of the options are correct.
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36. You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $3.50 in dividends and $42 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return. A. $23.91 B. $24.11 C. $26.52 D. $27.50 E. None of the options are correct.
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37. Paper Express Company has a balance sheet which lists $85 million in assets, $40 million in liabilities, and $45 million in common shareholders' equity. It has 1,400,000 common shares outstanding. The replacement cost of the assets is $115 million. The market share price is $90. What is Paper Express's book value per share? A. $1.68 B. $2.60 C. $32.14 D. $60.71 E. None of the options are correct.
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38. Paper Express Company has a balance sheet which lists $85 million in assets, $40 million in liabilities, and $45 million in common shareholders' equity. It has 1,400,000 common shares outstanding. The replacement cost of the assets is $115 million. The market share price is $90. What is Paper Express's market value per share? A. $1.68 B. $2.60 C. $32.14 D. $60.71 E. None of the options are correct.
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39. One of the problems with attempting to forecast stock market values is that A. there are no variables that seem to predict market return. B. the earnings multiplier approach can only be used at the firm level. C. the level of uncertainty surrounding the forecast will always be quite high. D. dividend-payout ratios are highly variable. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-17 Free Cash Flow Valuation Approaches
40. The most popular approach to forecasting the overall stock market is to use A. the dividend multiplier. B. the aggregate return on assets. C. the historical ratio of book value to market value. D. the aggregate earnings multiplier. E. Tobin's Q. The earnings multiplier approach is the most popular approach to forecasting the overall stock market.
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41. Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The riskfree rate of return is 4%, and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25. The market's required rate of return on Sure's stock is A. 14.0%. B. 17.5%. C. 16.5%. D. 15.25%. E. None of the options are correct.
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42. Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The riskfree rate of return is 4%, and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25. What is the intrinsic value of Sure's stock today? A. $20.60 B. $20.00 C. $12.12 D. $22.00
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43. Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The riskfree rate of return is 4%, and the expected return on the market portfolio is 14%. The beta of Sure Tool Company's stock is 1.25. If Sure's intrinsic value is $21.00 today, what must be its growth rate? A. 0.0% B. 10% C. 4% D. 6% E. 7%
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44. Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2. What is the return you should require on Torque's stock? A. 12.0% B. 14.6% C. 15.6% D. 20% E. None of the options are correct.
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45. Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2. What is the intrinsic value of Torque's stock? A. $14.29 B. $14.60 C. $12.33 D. $11.62
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46. Midwest Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Midwest Airline has a beta of 3.00. The return you should require on the stock is A. 10%. B. 18%. C. 30%. D. 42%.
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47. Fools Gold Mining Company is expected to pay a dividend of $8 in the upcoming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Fools Gold Mining Company has a beta of -0.25. The return you should require on the stock is A. 2%. B. 4%. C. 6%. D. 8%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
48. High Tech Chip Company is expected to have EPS in the coming year of $2.50. The expected ROE is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 70%, the growth rate of dividends should be A. 5.00%. B. 6.25%. C. 6.60%. D. 7.50%. E. 8.75%. 12.5% 0.7 = 8.75%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
1-594
49. A company paid a dividend last year of $1.75. The expected ROE for next year is 14.5%. An appropriate required return on the stock is 10%. If the firm has a plowback ratio of 75%, the dividend in the coming year should be A. $1.80. B. $2.12. C. $1.77. D. $1.94. g = .145 .75 = 10.875%; $1.75(1.10875) = $1.94.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
50. High Tech Chip Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be A. $1.00. B. $2.50. C. $2.69. D. $2.81. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
1-595
51. Suppose that the average P/E multiple in the oil industry is 20. Dominion Oil is expected to have an EPS of $3.00 in the coming year. The intrinsic value of Dominion Oil stock should be A. $28.12. B. $35.55. C. $60.00. D. $72.00. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 18-01 Valuation by Comparables. Topic: 18-01 Valuation by Comparables
52. Suppose that the average P/E multiple in the oil industry is 22. Exxon is expected to have an EPS of $1.50 in the coming year. The intrinsic value of Exxon stock should be A. $33.00. B. $35.55. C. $63.00. D. $72.00. E. None of the options are correct.
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53. Suppose that the average P/E multiple in the oil industry is 16. Shell Oil is expected to have an EPS of $4.50 in the coming year. The intrinsic value of Shell Oil stock should be A. $28.12. B. $35.55. C. $63.00. D. $72.00. E. None of the options are correct.
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54. Suppose that the average P/E multiple in the gas industry is 17. KMP is expected to have an EPS of $5.50 in the coming year. The intrinsic value of KMP stock should be A. $28.12. B. $93.50. C. $63.00. D. $72.00. E. None of the options are correct.
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1-597
55. An analyst has determined that the intrinsic value of HPQ stock is $20 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 25, then it would be reasonable to assume the expected EPS of HPQ in the coming year is A. $3.63. B. $4.44. C. $0.80. D. $22.50. $20(1/25) = $0.80.
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56. An analyst has determined that the intrinsic value of Dell stock is $34 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 27, then it would be reasonable to assume the expected EPS of Dell in the coming year will be A. $3.63. B. $4.44. C. $14.40. D. $1.26. $34(1/27) = $1.26.
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57. An analyst has determined that the intrinsic value of IBM stock is $80 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 22, then it would be reasonable to assume the expected EPS of IBM in the coming year is A. $3.64. B. $4.44. C. $14.40. D. $22.50. $80(1/22) = $3.64.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 18-01 Valuation by Comparables. Topic: 18-01 Valuation by Comparables
58. Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the coming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Old Quartz Gold Mining Company has a beta of -0.25. The intrinsic value of the stock is A. $80.00. B. $133.33. C. $200.00. D. $400.00.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
1-599
59. Low Fly Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Low Fly Airline has a beta of 3.00. The intrinsic value of the stock is A. $46.67. B. $50.00. C. $56.00. D. $62.50.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
60. Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. The stock of Sunshine Corporation has a beta of 0.75. The intrinsic value of the stock is A. $10.71. B. $15.00. C. $17.75. D. $25.00.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
1-600
61. Low Tech Chip Company is expected to have EPS of $2.50 in the coming year. The expected ROE is 14%. An appropriate required return on the stock is 11%. If the firm has a dividend payout ratio of 40%, the intrinsic value of the stock should be A. $22.73. B. $27.50. C. $28.57. D. $38.46. g = 14% 0.6 = 8.4%; Expected DPS = $2.50(0.4) = $1.00; P = 1/(.11 - .084) = $38.46.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
62. Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year. Dividends are expected to grow at a rate of 10% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock is trading in the market today at a price of $90.00. What is the market-capitalization rate for Risk Metrics? A. 13.6% B. 13.9% C. 15.6% D. 16.9% E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
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63. Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year. Dividends are expected to grow at a rate of 10% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock is trading in the market today at a price of $90.00. What is the approximate beta of Risk Metrics's stock? A. 0.8 B. 1.0 C. 1.1 D. 1.4 E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
64. The market-capitalization rate on the stock of Flexsteel Company is 12%. The expected ROE is 13%, and the expected EPS are $3.60. If the firm's plowback ratio is 50%, the P/E ratio will be A. 7.69. B. 8.33. C. 9.09. D. 11.11. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-04 Price-Earnings Ratio. Topic: 18-04 Dividend Discount Models
1-602
65. The market-capitalization rate on the stock of Flexsteel Company is 12%. The expected ROE is 13%, and the expected EPS are $3.60. If the firm's plowback ratio is 75%, the P/E ratio will be A. 7.69. B. 8.33. C. 9.09. D. 11.11. E. None of the options are correct.
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66. The market-capitalization rate on the stock of Fast Growing Company is 20%. The expected ROE is 22%, and the expected EPS are $6.10. If the firm's plowback ratio is 90%, the P/E ratio will be A. 7.69. B. 8.33. C. 9.09. D. 11.11. E. 50.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-04 Price-Earnings Ratio. Topic: 18-04 Dividend Discount Models
1-603
67. JCPenney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year 2 of $1.97, and a dividend in year 3 of $2.54. After year 3, dividends are expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today. A. $33.00 B. $40.67 C. $71.80 D. $66.00 E. None of the options are correct.
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68. Exercise Bicycle Company is expected to pay a dividend in year 1 of $1.20, a dividend in year 2 of $1.50, and a dividend in year 3 of $2.00. After year 3, dividends are expected to grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The stock should be worth _______ today. A. $33.00 B. $39.86 C. $55.00 D. $66.00 E. $40.68
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
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69. Antiquated Products Corporation produces goods that are very mature in their product life cycles. Antiquated Products Corporation is expected to pay a dividend in year 1 of $1.00, a dividend of $0.90 in year 2, and a dividend of $0.85 in year 3. After year 3, dividends are expected to decline at a rate of 2% per year. An appropriate required rate of return for the stock is 8%. The stock should be worth A. $8.98. B. $10.57. C. $20.00. D. $22.22.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
70. Mature Products Corporation produces goods that are very mature in their product life cycles. Mature Products Corporation is expected to pay a dividend in year 1 of $2.00, a dividend of $1.50 in year 2, and a dividend of $1.00 in year 3. After year 3, dividends are expected to decline at a rate of 1% per year. An appropriate required rate of return for the stock is 10%. The stock should be worth A. $9.00. B. $10.57. C. $20.00. D. $22.22.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
1-605
71. Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market-capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The projected free cash flow of Utica Manufacturing Company for the coming year is A. $150,000. B. $180,000. C. $300,000. D. $380,000.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
72. Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The total value of the equity of Utica Manufacturing Company should be A. $1,000,000. B. $2,000,000. C. $3,000,000. D. $4,000,000.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
1-606
73. A firm's earnings per share increased from $10 to $12, dividends increased from $4.00 to $4.80, and the share price increased from $80 to $90. Given this information, it follows that A. the stock experienced a drop in the P/E ratio. B. the firm had a decrease in dividend-payout ratio. C. the firm increased the number of shares outstanding. D. the required rate of return decreased.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-01 Valuation by Comparables. Topic: 18-01 Valuation by Comparables
74. In the dividend discount model, which of the following are not incorporated into the discount rate? A. Real risk-free rate B. Risk premium for stocks C. Return on assets D. Expected inflation rate The real risk-free rate, risk premium for stocks, and expected inflation rate are incorporated into the discount rate used in the dividend discount model.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
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75. A company whose stock is selling at a P/E ratio greater than the P/E ratio of a market index most likely has A. an anticipated earnings growth rate which is less than that of the average firm. B. a dividend yield which is less than that of the average firm. C. less predictable earnings growth than that of the average firm. D. greater cyclicality of earnings growth than that of the average firm. Firms with lower than average dividend yields are usually growth firms, which have a higher P/E ratio than average.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
76. Other things being equal, a low ________ would be most consistent with a relatively high growth rate of firm earnings. A. dividend-payout ratio B. degree of financial leverage C. variability of earnings D. inflation rate
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
77. A firm has a return on equity of 14% and a dividend-payout ratio of 60%. The firm's anticipated growth rate is A. 5.6%. B. 10%. C. 14%. D. 20%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
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78. A firm has a return on equity of 20% and a dividend-payout ratio of 30%. The firm's anticipated growth rate is A. 6%. B. 10%. C. 14%. D. 20%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
79. Sales Company paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of earnings as dividends for the foreseeable future. If the firm is expected to generate a 10% return on equity in the future, and if you require a 12% return on the stock, the value of the stock is A. $17.67. B. $13.00. C. $16.67. D. $18.67. g = 10% 0.6 = 6%; P = 1 (1.06)/(.12 - .06) = $17.67.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-02 Intrinsic Value versus Market Price. Topic: 18-02 Limitations of Book Value
1-609
80. Assume that Bolton Company will pay a $2.00 dividend per share next year, an increase from the current dividend of $1.50 per share that was just paid. After that, the dividend is expected to increase at a constant rate of 5%. If you require a 12% return on the stock, the value of the stock is A. $28.57. B. $28.79. C. $30.00. D. $31.78. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-03 Dividend Discount Models. Topic: 18-04 Dividend discount models
81. The growth in dividends of Music Doctors, Inc. is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years. After this five-year period, the growth in dividends is expected to be 3% per year, indefinitely. The required rate of return on Music Doctors, Inc. is 11%. Last year's dividends per share were $2.75. What should the stock sell for today? A. $8.99 B. $25.21 C. $39.71 D. $110.00 E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
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82. The growth in dividends of ABC, Inc. is expected to be 15% per year for the next three years, followed by a growth rate of 8% per year for two years. After this five-year period, the growth in dividends is expected to be 3% per year, indefinitely. The required rate of return on ABC, Inc. is 13%. Last year's dividends per share were $1.85. What should the stock sell for today? A. $8.99 B. $25.21 C. $40.00 D. $27.74 E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
83. The growth in dividends of XYZ, Inc. is expected to be 10% per year for the next two years, followed by a growth rate of 5% per year for three years. After this five-year period, the growth in dividends is expected to be 2% per year, indefinitely. The required rate of return on XYZ, Inc. is 12%. Last year's dividends per share were $2.00. What should the stock sell for today? A. $8.99 B. $25.21 C. $40.00 D. $110.00 E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
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84. If a firm has a required rate of return equal to the ROE, A. the firm can increase market price and P/E by retaining more earnings. B. the firm can increase market price and P/E by increasing the growth rate. C. the amount of earnings retained by the firm does not affect market price or the P/E. D. the firm can increase market price and P/E by retaining more earnings and increasing the growth rate. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
85. According to James Tobin, the long-run value of Tobin's Q should move toward A. 0. B. 1. C. 2. D. infinity. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-01 Valuation by Comparables. Topic: 18-01 Valuation by Comparables
86. The goal of fundamental analysts is to find securities A. whose intrinsic value exceeds market price. B. with a positive present value of growth opportunities. C. with high market capitalization rates. D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-01 Valuation by Comparables. Topic: 18-01 Valuation by Comparables
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87. The dividend discount model A. ignores capital gains. B. incorporates the after-tax value of capital gains. C. includes capital gains implicitly. D. restricts capital gains to a minimum. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
88. Many stock analysts assume that a mispriced stock will A. immediately return to its intrinsic value. B. return to its intrinsic value within a few days. C. never return to its intrinsic value. D. gradually approach its intrinsic value over several years. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 18-01 Valuation by Comparables. Topic: 18-01 Valuation by Comparables
89. Investors want high plowback ratios A. for all firms. B. Whenever ROE >k. C. Whenever k>ROE. D. only when they are in low tax brackets. E. whenever bank interest rates are high. Investors prefer that firms reinvest earnings when ROE exceeds k.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
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90. Because the DDM requires multiple estimates, investors should A. carefully examine inputs to the model. B. performsensitivity analysis on price estimates. C. not use this model without expert assistance. D. feel confident that DDM estimates are correct. E. carefully examine inputs to the model and perform sensitivity analysis on price estimates. Small errors in input estimates can result in large pricing errors using the DDM. Therefore, investors should carefully examine input estimates and perform sensitivity analysis on the results.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
91. According to Peter Lynch, a rough rule of thumb for security analysis is that A. the growth rate should be equal to the plowback rate. B. the growth rate should be equal to the dividend-payout rate. C. the growth rate should be low for emerging industries. D. the growth rate should be equal to the P/E ratio. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 18-04 Price-Earnings Ratio. Topic: 18-04 Dividend Discount Models
1-614
92. Dividend discount models and P/E ratios are used by __________ to try to find mispriced securities. A. technical analysts B. statistical analysts C. fundamental analysts D. dividend analysts E. psychoanalysts Fundamental analysts look at the basic features of the firm to estimate firm value.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-01 Valuation by Comparables. Topic: 18-01 Valuation by Comparables
93. Which of the following is the best measure of the floor for a stock price? A. Book value B. Liquidation value C. Replacement cost D. Market value E. Tobin's Q If the firm's market value drops below the liquidation value the firm will be a possible takeover target. It would be worth more liquidated than as a going concern.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-01 Valuation by Comparables. Topic: 18-01 Valuation by Comparables
1-615
94. Who popularized the dividend discount model, which is sometimes referred to by his name? A. Burton Malkiel B. Frederick Macaulay C. Harry Markowitz D. Marshall Blume E. Myron Gordon The dividend discount model is also called the Gordon model.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
95. If a firm follows a low-investment-rate plan (applies a low plowback ratio), its dividends will be _______ now and _______ in the future than a firm that follows a high-reinvestmentrate plan. A. higher; higher B. lower; lower C. lower; higher D. higher; lower E. It is not possible to tell. By retaining less of its income for plowback, the firm is able to pay more dividends initially. But this will lead to a lower growth rate for dividends and a lower level of dividends in the future relative to a firm with a high-reinvestment-rate plan.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
1-616
96. The present value of growth opportunities (PVGO) is equal to I) the difference between a stock's price and its no-growth value per share. II) the stock's price. III) zero if its return on equity equals the discount rate. IV) the net present value of favorable investment opportunities. A. I and IV B. II and IV C. I, III, and IV D. II, III, and IV E. III and IV All are correct except II—the stock's price equals the no-growth value per share plus the PVGO.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 18-03 Dividend Discount Models. Topic: 18-03 Intrinsic Value versus Market Price
97. Low P/E ratios tend to indicate that a company will _______, ceteris paribus. A. grow quickly B. grow at the same speed as the average company C. grow slowly D. P/E ratios are unrelated to growth. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-04 Price-Earnings Ratio. Topic: 18-04 Dividend Discount Models
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98. Earnings management is A. when management makes changes in the operations of the firm to ensure that earnings do not increase or decrease too rapidly. B. when management makes changes in the operations of the firm to ensure that earnings do not increase too rapidly. C. when management makes changes in the operations of the firm to ensure that earnings do not decrease too rapidly. D. the practice of using flexible accounting rules to improve the apparent profitability of the firm. Earnings management is the practice of using flexible accounting rules to improve the apparent profitability of the firm.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-04 Price-Earnings Ratio. Topic: 18-04 Dividend Discount Models
99. A version of earnings management that became common in the 1990s was A. when management made changes in the operations of the firm to ensure that earnings did not increase or decrease too rapidly. B. reported "pro forma earnings." C. when management made changes in the operations of the firm to ensure that earnings did not increase too rapidly. D. when management made changes in the operations of the firm to ensure that earnings did not decrease too rapidly.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-04 Price-Earnings Ratio. Topic: 18-04 Dividend Discount Models
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100. GAAP allows A. no leeway to manage earnings. B. minimal leeway to manage earnings. C. considerable leeway to manage earnings. D. earnings management if it is beneficial in increasing stock price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-04 Price-Earnings Ratio. Topic: 18-04 Dividend Discount Models
101. The most appropriate discount rate to use when applying a FCFE valuation model is the A. required rate of return on equity. B. WACC. C. risk-free rate. D. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
102. WACC is the most appropriate discount rate to use when applying a ______ valuation model. A. FCFF B. FCFE C. DDM D. FCFF or DDM, depending on the debt level of the firm, E. P/E
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
1-619
103. The most appropriate discount rate to use when applying a FCFF valuation model is the A. required rate of return on equity. B. WACC. C. risk-free rate. D. required rate of return on equity or risk-free rate, depending on the debt level of the firm. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
104. The required rate of return on equity is the most appropriate discount rate to use when applying a ______ valuation model. A. FCFE B. FCEF C. DDM D. FCEF or DDM E. P/E The most appropriate discount rate to use when applying a FCFE valuation model is the required rate of return on equity.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
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105. Siri had a FCFE of $1.6M last year and has 3.2M shares outstanding. Siri's required return on equity is 12%, and WACC is 9.8%. If FCFE is expected to grow at 9% forever, the intrinsic value of Siri's shares is A. $68.13. B. $18.17. C. $26.35. D. $14.76. E. None of the options are correct.
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106. Zero had a FCFE of $4.5M last year and has 2.25M shares outstanding. Zero's required return on equity is 10%, and WACC is 8.2%. If FCFE is expected to grow at 8% forever, the intrinsic value of Zero's shares is A. $108.00. B. $1080.00. C. $26.35. D. $14.76. E. None of the options are correct.
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107. See Candy had a FCFE of $6.1M last year and has 2.32M shares outstanding. See's required return on equity is 10.6%, and WACC is 9.3%. If FCFE is expected to grow at 6.5% forever, the intrinsic value of See's shares is A. $108.00. B. $68.30. C. $26.35. D. $14.76.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
108. SI International had a FCFE of $122.1M last year and has 12.43M shares outstanding. SI's required return on equity is 11.3%, and WACC is 9.8%. If FCFE is expected to grow at 7.0% forever, the intrinsic value of SI's shares is A. $108.00. B. $68.29. C. $244.43. D. $14.76.
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109. Highpoint had a FCFE of $246M last year and has 123M shares outstanding. Highpoint's required return on equity is 10%, and WACC is 9%. If FCFE is expected to grow at 8.0% forever, the intrinsic value of Highpoint's shares is A. $21.60. B. $108. C. $244.42. D. $216.00.
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110. SGA Consulting had a FCFE of $3.2M last year and has 3.2M shares outstanding. SGA's required return on equity is 13%, and WACC is 11.5%. If FCFE is expected to grow at 8.5% forever, the intrinsic value of SGA's shares is A. $21.60. B. $26.56. C. $244.42. D. $24.11.
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111. Seaman had a FCFE of $4.6B last year and has 113.2M shares outstanding. Seaman's required return on equity is 11.6%, and WACC is 10.4%. If FCFE is expected to grow at 5% forever, the intrinsic value of Seaman's shares is A. $646.48. B. $64.66. C. $6,464.80 D. $6.46.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
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112. Consider the free cash flow approach to stock valuation. F&G Manufacturing Company is expected to have before-tax cash flow from operations of $750,000 in the coming year. The firm's corporate tax rate is 40%. It is expected that $250,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $125,000. After the coming year, cash flows are expected to grow at 7% per year. The appropriate market capitalization rate for unleveraged cash flow is 13% per year. The firm has no outstanding debt. The projected free cash flow of F&G Manufacturing Company for the coming year is A. $250,000. B. $180,000. C. $300,000. D. $380,000.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
113. Consider the free cash flow approach to stock valuation. F&G Manufacturing Company is expected to have before-tax cash flow from operations of $750,000 in the coming year. The firm's corporate tax rate is 40%. It is expected that $250,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $125,000. After the coming year, cash flows are expected to grow at 7% per year. The appropriate market capitalization rate for unleveraged cash flow is 13% per year. The firm has no outstanding debt. The total value of the equity of F&G Manufacturing Company should be A. $1,615,156.50. B. $2,479,168.95. C. $3,333,333.33. D. $4,166,666.67.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
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114. Boaters World is expected to have per share FCFE in year 1 of $1.65, per share FCFE in year 2 of $1.97, and per share FCFE in year 3 of $2.54. After year 3, per share FCFE is expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today. A. $77.53 B. $40.67 C. $82.16 D. $71.80 E. None of the options are correct.
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115. Smart Draw Company is expected to have per share FCFE in year 1 of $1.20, per share FCFE in year 2 of $1.50, and per share FCFE in year 3 of $2.00. After year 3, per share FCFE is expected to grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The stock should be worth _______ today. A. $33.00 B. $40.68 C. $55.00 D. $66.00 E. $12.16
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116. Old Style Corporation produces goods that are very mature in their product life cycles. Old Style Corporation is expected to have per share FCFE in year 1 of $1.00, per share FCFE of $0.90 in year 2, and per share FCFE of $0.85 in year 3. After year 3, per share FCFE is expected to decline at a rate of 2% per year. An appropriate required rate of return for the stock is 8%. The stock should be worth _______ today. A. $127.63 B. $10.57 C. $20.00 D. $22.22 E. $8.98
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117. Goodie Corporation produces goods that are very mature in their product life cycles. Goodie Corporation is expected to have per share FCFE in year 1 of $2.00, per share FCFE of $1.50 in year 2, and per share FCFE of $1.00 in year 3. After year 3, per share FCFE is expected to decline at a rate of 1% per year. An appropriate required rate of return for the stock is 10%. The stock should be worth __________ today. A. $9.00 B. $101.57 C. $10.57 D. $22.22 E. $47.23
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118. The growth in per share FCFE of SYNK, Inc. is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years. After this five-year period, the growth in per share FCFE is expected to be 3% per year, indefinitely. The required rate of return on SYNC, Inc. is 11%. Last year's per share FCFE was $2.75. What should the stock sell for today? A. $28.99 B. $35.21 C. $54.67 D. $56.37 E. $39.71
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119. The growth in per share FCFE of FOX, Inc. is expected to be 15% per year for the next three years, followed by a growth rate of 8% per year for two years. After this five-year period, the growth in per share FCFE is expected to be 3% per year, indefinitely. The required rate of return on FOX, Inc. is 13%. Last year's per share FCFE was $1.85. What should the stock sell for today? A. $28.99 B. $24.47 C. $26.84 D. $27.74 E. $19.18
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 18-05 Free Cash Flow Valuation Approaches. Topic: 18-05 The Constant-Growth DDM
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120. The growth in per share FCFE of CBS, Inc. is expected to be 10% per year for the next two years, followed by a growth rate of 5% per year for three years. After this five-year period, the growth in per share FCFE is expected to be 2% per year, indefinitely. The required rate of return on CBS, Inc. is 12%. Last year's per share FCFE was $2.00. What should the stock sell for today? A. $8.99 B. $22.51 C. $40.00 D. $25.21 E. $27.12
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121. Stingy Corporation is expected have EBIT of $1.2M this year. Stingy Corporation is in the 30% tax bracket, will report $133,000 in depreciation, will make $76,000 in capital expenditures, and will have a $24,000 increase in net working capital this year. What is Stingy's FCFF? A. 1,139,000 B. 1,200,000 C. 1,025,000 D. 921,000 E. 873,000 FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 1,200,000(.7) + 133,000 - 76,000 - 24,000 = 873,000.
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122. Fly Boy Corporation is expected have EBIT of $800k this year. Fly Boy Corporation is in the 30% tax bracket, will report $52,000 in depreciation, will make $86,000 in capital expenditures, and will have a $16,000 increase in net working capital this year. What is Fly Boy's FCFF? A. 510,000 B. 406,000 C. 542,000 D. 596,000 E. 682,000 FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 800,000(.7) + 52,000 - 86,000 - 16,000 = 510,000.
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123. Lamm Corporation is expected have EBIT of $6.2M this year. Lamm Corporation is in the 40% tax bracket, will report $1.2M in depreciation, will make $1.4M in capital expenditures, and will have a $160,000 increase in net working capital this year. What is Lamm's FCFF? A. 6,200,000 B. 6,160,000 C. 3,360,000 D. 3,680,000 E. 4,625,000 FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 6,200,000(.6) + 1,200,000 - 1,400,000 - 160,000 = 3,360,000.
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124. Rome Corporation is expected have EBIT of $2.3M this year. Rome Corporation is in the 30% tax bracket, will report $175,000 in depreciation, will make $175,000 in capital expenditures, and will have no change in net working capital this year. What is Rome's FCFF? A. 2,300,000 B. 1,785,000 C. 1,960,000 D. 1,610,000 E. 1,435,000 FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 2,300,000(.7) + 175,000 - 175,000 - 0 = 1,610,000.
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Chapter 19 Financial Statement Analysis
Multiple Choice Questions 1. A firm has a higher quick (or acid test) ratio than the industry average, which implies A. the firm has a higher P/E ratio than other firms in the industry. B. the firm is more likely to avoid insolvency in the short run than other firms in the industry. C. the firm may be less profitable than other firms in the industry. D. the firm has a higher P/E ratio than other firms in the industry, and the firm is more likely to avoid insolvency in the short run than other firms in the industry. E. the firm is more likely to avoid insolvency in the short run than other firms in the industry, and the firm may be less profitable than other firms in the industry.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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2. A firm has a lower quick (or acid test) ratio than the industry average, which implies A. the firm has a lower P/E ratio than other firms in the industry. B. the firm is less likely to avoid insolvency in the short run than other firms in the industry. C. the firm may be more profitable than other firms in the industry. D. the firm has a lower P/E ratio than other firms in the industry, and the firm is less likely to avoid insolvency in the short run than other firms in the industry. E. the firm is less likely to avoid insolvency in the short run than other firms in the industry, and the firm may be more profitable than other firms in the industry.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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3. An example of a liquidity ratio is A. fixed asset turnover. B. current ratio. C. acid test or quick ratio. D. fixed asset turnover and acid test or quick ratio. E. current ratio and acid test or quick ratio. Both current ratio and acid test or quick ratio are measures of liquidity; A relates to fixed assets.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
4. __________ provides a snapshot of the financial condition of the firm at a particular time. A. The balance sheet B. The income statement C. The statement of cash flows D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-01 The Major Financial Statements. Topic: 19-01 The Major Financial Statements
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5. __________ is a report of the cash flow generated by the firm's operations, investments, and financial activities. A. The balance sheet B. The income statement C. The statement of cash flows D. The auditor's statement of financial condition E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-01 The Major Financial Statements. Topic: 19-01 The Major Financial Statements
6. A firm has a higher asset turnover ratio than the industry average, which implies A. the firm has a higher P/E ratio than other firms in the industry. B. the firm is more likely to avoid insolvency in the short run than other firms in the industry. C. the firm is more profitable than other firms in the industry. D. the firm is utilizing assets more efficiently than other firms in the industry. E. the firm has higher spending on new fixed assets than other firms in the industry. The higher the asset turnover ratio, the more efficiently the firm is using assets.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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7. A firm has a lower asset turnover ratio than the industry average, which implies A. the firm has a lower P/E ratio than other firms in the industry. B. the firm is less likely to avoid insolvency in the short run than other firms in the industry. C. the firm is less profitable than other firms in the industry. D. the firm is utilizing assets less efficiently than other firms in the industry. E. the firm has lower spending on new fixed assets than other firms in the industry. The lower the asset turnover ratio the less efficiently the firm is using assets.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
8. If you wish to compute economic earnings and are trying to decide how to account for inventory, A. FIFO is better than LIFO. B. LIFO is better than FIFO. C. FIFO and LIFO are equally good. D. FIFO and LIFO are equally bad. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 19-06 Comparability Problems. Topic: 19-06 Profitability Measures
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9. __________ is a summary of the profitability of the firm over a period of time, such as a year. A. The balance sheet B. The income statement C. The statement of cash flows D. The audit report E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-01 The Major Financial Statements. Topic: 19-01 The Major Financial Statements
10. Over a period of 30 years or so, in managing investment funds, Benjamin Graham used the approach of investing in the stocks of companies where the stocks were trading at less than their working capital value. The average return from using this strategy was approximately A. 5%. B. 10%. C. 15%. D. 20%. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 19-07 Value Investing: The Graham Technique. Topic: 19-07 Return on Assets, ROA
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11. A study by Speidell and Bavishi (1992) found that when accounting statements of foreign firms were restated on a common accounting basis, A. the original and restated P/E ratios were quite similar. B. the original and restated P/E ratios varied considerably. C. most variation was explained by tax differences. D. most firms were consistent in their treatment of goodwill. This study found that restated P/E ratios varied considerably from those originally reported.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 19-06 Comparability Problems. Topic: 19-06 Profitability Measures
12. If the interest rate on debt is higher than ROA, a firm will __________ by increasing the use of debt in the capital structure. A. increase the ROE B. not change the ROE C. decrease the ROE D. change the ROE in an indeterminable manner If ROA is less than the interest rate, then ROE will decline by an amount that depends on the debt to equity ratio.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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13. If the interest rate on debt is lower than ROA, then a firm will __________ by increasing the use of debt in the capital structure. A. increase the ROE B. not change the ROE C. decrease the ROE D. change the ROE in an indeterminable manner If ROA is higher than the interest rate, then ROE will increase by an amount that depends on the debt to equity ratio.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 09-04 Ratio analysis
14. A firm has a market to book value ratio that is equivalent to the industry average and an ROE that is less than the industry average, which implies A. the firm has a higher P/E ratio than other firms in the industry. B. the firm is more likely to avoid insolvency in the short run than other firms in the industry. C. the firm is more profitable than other firms in the industry. D. the firm is utilizing its assets more efficiently than other firms in the industry. The relationship P/E = (P/B)/ROE indicates that A is possible.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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15. In periods of inflation, accounting depreciation is __________ relative to replacement cost, and real economic income is ________. A. overstated; overstated B. overstated; understated C. understated; overstated D. understated; understated E. correctly stated; correctly stated
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-06 Comparability Problems. Topic: 19-06 Profitability Measures
16. If a firm has a positive tax rate, a positive ROA, and the interest rate on debt is the same as ROA, then ROA will be A. greater than the ROE. B. equal to the ROE. C. less than the ROE. D. greater than zero, but it is impossible to determine how ROA will compare to ROE. E. negative in all cases.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
17. A firm has a P/E ratio of 12, an ROE of 13%, and a market-to-book value of A. 0.64. B. 0.92. C. 1.08. D. 1.56.
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18. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
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Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's current ratio for 2009 is A. 2.31. B. 1.87. C. 2.22. D. 2.46.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
19. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
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Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's quick ratio for 2009 is A. 1.69. B. 1.52. C. 1.23. D. 1.07. E. 1.00.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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20. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
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Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's leverage ratio for 2009 is A. 1.65. B. 1.89. C. 2.64. D. 1.31. E. 1.56.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
21. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
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Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's times interest earned ratio for 2009 is A. 8.86. B. 7.17. C. 9.66. D. 6.86. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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22. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
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Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's average collection period for 2009 is A. 59.31. B. 55.05. C. 61.31. D. 49.05. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
23. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
1-646
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's inventory turnover ratio for 2009 is A. 3.15. B. 3.63. C. 3.69. D. 2.58. E. 4.20.
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1-647
24. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
1-648
Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's fixed asset turnover ratio for 2009 is A. 2.04. B. 2.58. C. 2.97. D. 1.58. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
25. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
1-649
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's asset turnover ratio for 2009 is A. 1.79. B. 1.63. C. 1.34. D. 2.58. E. None of the options are correct.
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1-650
26. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
1-651
Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's return on sales ratio for 2009 is A. 15.5%. B. 14.6%. C. 14.0%. D. 15.0%. E. 16.5%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
27. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
1-652
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's return on equity ratio for 2009 is A. 16.88%. B. 15.63%. C. 14.00%. D. 15.00%. E. 16.24%.
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1-653
28. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
1-654
Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's P/E ratio for 2009 is A. 8.88. B. 7.63. C. 7.88. D. 7.32.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
29. The financial statements of Black Barn Company are given below.
Black Barn Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$8,000,000 5,260,000 2,740,000 1,500,000 1,240,000 140,000 1,100,000 440,000 $660,000
1-655
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$200,000 1,200,000 1,840,000 $3,240,000 3,200,000 $6,440,000
$50,000 950,000 1,500,000 $2,500,000 3,000,000 $5,500,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$800,000 600,000 $1,400,000 900,000 $2,300,000 $300,000 3,840,000 $6,440,000
$720,000 100,000 $820,000 1,000,000 $1,820,000 $300,000 3,380,000 $5,500,000
Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's market-to-book value for 2009 is A. 1.13. B. 1.62. C. 1.00. D. 1.26.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
1-656
30. A firm has a net profit/pretax profit ratio of 0.625, a leverage ratio of 1.2, a pretax profit/EBIT of 0.9, an ROE of 17.82%, a current ratio of 8, and a return on sales ratio of 8%. The firm's asset turnover is A. 0.3. B. 1.3. C. 2.3. D. 3.3. 17.82% = 0.625 0.9 8% asset turnover 1.2; asset turnover = 3.3.
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31. A firm has an ROA of 14%, a debt/equity ratio of 0.8, a tax rate of 35%, and the interest rate on the debt is 10%. The firm's ROE is A. 11.18%. B. 8.97%. C. 11.54%. D. 12.62%.
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1-657
32. A firm has an ROE of -2%, a debt/equity ratio of 1.0, a tax rate of 0%, and an interest rate on debt of 10%. The firm's ROA is A. 2%. B. 4%. C. 6%. D. 8%. E. None of the options are correct.
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33. A firm has a (net profit/pretax profit) ratio of 0.6, a leverage ratio of 2, a (pretax profit/EBIT) of 0.6, an asset turnover ratio of 2.5, a current ratio of 1.5, and a return on sales ratio of 4%. The firm's ROE is A. 4.2%. B. 5.2%. C. 6.2%. D. 7.2%. E. None of the options are correct.
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34. A measure of asset utilization is A. sales divided by working capital. B. return on total assets. C. return on equity capital. D. operating profit divided by sales. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
1-658
35. During periods of inflation, the use of FIFO (rather than LIFO) as the method of accounting for inventories causes A. higher reported sales. B. higher incomes taxes. C. lower ending inventory. D. higher incomes taxes and lower ending inventory. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-06 Comparability Problems. Topic: 19-04 The Statement of Cash Flows
36. Return on total assets is the product of A. interest rates and pre-tax profits. B. the debt-equity ratio and P/E ratio. C. the after-tax profit margin and the asset turnover ratio. D. sales and fixed assets. E. None of the options are correct.
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37. FOX Company has a ratio of (total debt/total assets) that is above the industry average, and a ratio of (long term debt/equity) that is below the industry average. These ratios suggest that the firm A. utilizes assets effectively. B. has too much equity in the capital structure. C. has relatively high current liabilities. D. has a relatively low dividend-payout ratio. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
1-659
38. A firm's current ratio is above the industry average. However, the firm's quick ratio is below the industry average. These ratios suggest that the firm A. has relatively more total current assets and even more inventory than other firms in the industry. B. is very efficient at managing inventories. C. has liquidity that is superior to the average firm in the industry. D. is near technical insolvency.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
39. Which of the following ratios gives information on the amount of profits reinvested in the firm over the years? A. Sales/total assets B. Debt/total assets C. Debt/equity D. Retained earnings/total assets Only retained earnings reflect profits reinvested over the years.
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1-660
40. Ferris Corp. wants to increase its current ratio from the present level of 1.5 when it closes the books next week. The action of __________ will have the desired effect. A. payment of current payables from cash B. sales of current marketable securities for cash C. write-down of impaired assets D. delay of next payroll E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
41. Assuming continued inflation, a firm that uses LIFO will tend to have a(n) ________current ratio than a firm using FIFO, and the difference will tend to __________ as time passes. A. higher; increase B. higher; decrease C. lower; decrease D. lower; increase E. identical; remain the same A firm using LIFO will have lower priced inventory, thus resulting in a lower current ratio. If inflation continues, these differences will increase over time.
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1-661
42. Fundamental analysis uses A. earnings and dividends prospects. B. relative strength. C. price momentum. D. earnings, dividend prospects, and relative strength. E. earnings, dividend prospects, and price momentum.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-02 Measuring Firm Performance. Topic: 19-02 The Income Statement
43. __________ is a true statement. A. During periods of inflation, LIFO makes the balance sheet less representative of the actual inventory values than if FIFO were used B. During periods of inflation, FIFO makes the balance sheet less representative of actual inventory values than if LIFO were used C. After inflation ends, distortion due to LIFO will disappear as inventory is sold D. During periods of inflation, LIFO overstates earnings relative to FIFO During periods of inflation, the use of LIFO results in lower priced inventory remaining in stock; thus the balance sheet understates the actual inventory values.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-06 Comparability Problems. Topic: 19-06 Profitability Measures
1-662
44. __________ is a false statement. A. During periods of inflation, LIFO makes the balance sheet less representative of the actual inventory values than if FIFO were used B. During periods of inflation, FIFO makes the balance sheet less representative of actual inventory values than if LIFO were used C. During periods of inflation, LIFO overstates earnings relative to FIFO D. During periods of inflation, FIFO makes the balance sheet less representative of actual inventory values than if LIFO were used, and LIFO overstates earnings relative to FIFO E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-06 Comparability Problems. Topic: 19-06 Profitability Measures
45. The level of real income of a firm can be distorted by the reporting of depreciation and interest expense. During periods of high inflation, the level of reported depreciation tends to __________ income, and the level of interest expense reported tends to __________ income. A. understate; overstate B. understate; understate C. overstate; understate D. overstate; overstate E. There is no discernible pattern.
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1-663
46. Which of the following would best explain a situation where the ratio of net income/total equity of a firm is higher than the industry average, while the ratio of net income/total assets is lower than the industry average? A. The firm's net profit margin is higher than the industry average. B. The firm's asset turnover is higher than the industry average. C. The firm's equity multiplier must be lower than the industry average. D. The firm's debt ratio is higher than the industry average. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
47. What best explains why a firm's ratio of long-term debt/total capital is lower than the industry average, while the ratio of income before interest and taxes/debt interest charges is higher than the industry average? A. The firm pays lower interest on long-term debt than the average firm. B. The firm has more short-term debt than average. C. The firm has a high ratio of current assets/current liabilities. D. The firm has a high ratio of total cash flow/long term debt. E. None of the options are correct.
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1-664
48. __________ best explains a ratio of sales/average net fixed assets that exceeds the industry average. A. The firm expanded plant and equipment in the past few years B. The firm makes less efficient use of assets than competing firms C. The firm has a substantial amount of old plant and equipment D. The firm uses straight-line depreciation If the firm has more old plant and equipment than competing firms, the denominator is deflated, thus producing a higher than average ratio.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-06 Comparability Problems. Topic: 19-06 Profitability Measures
49. Comparability problems arise because A. firms may use different generally accepted accounting principles. B. inflation may affect firms differently due to accounting conventions used. C. financial analysts do not know how to compare financial statements. D. firms may use different generally accepted accounting principles, and inflation may affect firms differently due to accounting conventions used. E. firms may use different generally accepted accounting principles, and financial analysts do not know how to compare financial statements.
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1-665
50. One problem with comparing financial ratios prepared by different reporting agencies is A. some agencies receive financial information later than others. B. agencies vary in their policies as to what is included in specific calculations. C. some agencies are careless in their reporting. D. some firms are more conservative in their accounting practices. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
51. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
1-666
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's current ratio for 2009 is A. 1.82. B. 1.03. C. 1.30. D. 1.65. E. None of the options are correct.
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1-667
52. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
1-668
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's quick ratio for 2009 is A. 1.71. B. 0.78. C. 0.85. D. 1.56.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
53. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
1-669
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's leverage ratio for 2009 is A. 1.62. B. 1.56. C. 2.00. D. 2.42. E. 2.17.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
1-670
54. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
1-671
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's times interest earned ratio for 2009 is A. 2.897. B. 2.719. C. 3.375. D. 3.462.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
55. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
1-672
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's average collection period for 2009 is A. 69.35. B. 69.73. C. 68.53. D. 67.77. E. 68.52.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
1-673
56. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
1-674
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's inventory turnover ratio for 2009 is A. 2.86. B. 1.23. C. 5.96. D. 4.42. E. 4.86.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
57. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
1-675
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's fixed asset turnover ratio for 2009 is A. 1.45. B. 1.63. C. 1.20. D. 1.58.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
1-676
58. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
1-677
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's asset turnover ratio for 2009 is A. 1.86. B. 0.63. C. 0.83. D. 1.63.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
59. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
1-678
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's return on sales ratio for 2009 is A. 20.2%. B. 21.6%. C. 22.4%. D. 18.0%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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60. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
1-680
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's return on equity ratio for 2009 is A. 12.24%. B. 14.63%. C. 15.50%. D. 14.50%. E. 16.9%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
61. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
1-681
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's P/E ratio for 2009 is A. 20.53. B. 6.63. C. 5.21. D. 5.00.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
1-682
62. The financial statements of Midwest Tours are given below.
Midwest Tours Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$2,500,000 1,260,000 1,240,000 700,000 540,000 160,000 380,000 152,000 $228,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 500,000 300,000 $860,000 2,180,000 $3,040,000
$50,000 450,000 270,000 $770,000 2,000,000 $2,770,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$200,000 460,000 660,000 860,000 $1,520,000 $120,000 1,400,000 $3,040,000
$170,000 440,000 $610,000 860,000 $1,470,000 $120,000 1,300,000 $2,890,000
1-683
Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's market-to-book value for 2009 is A. 0.24. B. 0.95. C. 0.71. D. 1.12.
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63. The financial statements of Snapit Company are given below.
Snapit Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$4,000,000 3,040,000 960,000 430,000 530,000 160,000 370,000 148,000 $222,000
1-684
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 550,000 690,000 $1,300,000 1,300,000 $2,600,000
$50,000 500,000 620,000 $1,170,000 1,230,000 $2,400,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$270,000 580,000 $850,000 900,000 $1,750,000 $250,000 600,000 $2,600,000
$250,000 500,000 $750,000 1,000,000 $1,750,000 $250,000 400,000 $2,400,000
Note: The common shares are trading in the stock market for $100 each. Refer to the financial statements of Snapit Company. The firm's fixed asset turnover ratio for 2009 is A. 4.60. B. 3.61. C. 3.16. D. 5.46.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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64. The financial statements of Snapit Company are given below.
Snapit Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$4,000,000 3,040,000 960,000 430,000 530,000 160,000 370,000 148,000 $222,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 550,000 690,000 $1,300,000 1,300,000 $2,600,000
$50,000 500,000 620,000 $1,170,000 1,230,000 $2,400,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$270,000 580,000 $850,000 900,000 $1,750,000 $250,000 600,000 $2,600,000
$250,000 500,000 $750,000 1,000,000 $1,750,000 $250,000 400,000 $2,400,000
1-686
Note: The common shares are trading in the stock market for $100 each. Refer to the financial statements of Snapit Company. The firm's asset turnover ratio for 2009 is A. 1.60. B. 3.16. C. 3.31. D. 4.64.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
65. The financial statements of Snapit Company are given below.
Snapit Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$4,000,000 3,040,000 960,000 430,000 530,000 160,000 370,000 148,000 $222,000
1-687
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 550,000 690,000 $1,300,000 1,300,000 $2,600,000
$50,000 500,000 620,000 $1,170,000 1,230,000 $2,400,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$270,000 580,000 $850,000 900,000 $1,750,000 $250,000 600,000 $2,600,000
$250,000 500,000 $750,000 1,000,000 $1,750,000 $250,000 400,000 $2,400,000
Note: The common shares are trading in the stock market for $100 each. Refer to the financial statements of Snapit Company. The firm's return on sales ratio for 2009 is A. 0.0133. B. 0.1325. C. 1.325. D. 1.260.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
1-688
66. The financial statements of Snapit Company are given below.
Snapit Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$4,000,000 3,040,000 960,000 430,000 530,000 160,000 370,000 148,000 $222,000
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 550,000 690,000 $1,300,000 1,300,000 $2,600,000
$50,000 500,000 620,000 $1,170,000 1,230,000 $2,400,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$270,000 580,000 $850,000 900,000 $1,750,000 $250,000 600,000 $2,600,000
$250,000 500,000 $750,000 1,000,000 $1,750,000 $250,000 400,000 $2,400,000
1-689
Note: The common shares are trading in the stock market for $100 each. Refer to the financial statements of Snapit Company. The firm's return on equity ratio for 2009 is A. 0.1235. B. 0.0296. C. 0.2960. D. 2.2960.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
67. The financial statements of Snapit Company are given below.
Snapit Company Income Statement (2009) Sales Cost of goods sold Gross profit Selling & administrative expenses Operating profit Interest expense Income before tax Tax expense Net income
$4,000,000 3,040,000 960,000 430,000 530,000 160,000 370,000 148,000 $222,000
1-690
Balance Sheet
2009
2008
Cash Accounts receivable Inventory Total current assets Fixed assets Total assets
$60,000 550,000 690,000 $1,300,000 1,300,000 $2,600,000
$50,000 500,000 620,000 $1,170,000 1,230,000 $2,400,000
Accounts Payable Bank loan Total current liabilities Bond payable Total liabilities Common stock (130,000 shares) Retained earnings Total liabilities & equity
$270,000 580,000 $850,000 900,000 $1,750,000 $250,000 600,000 $2,600,000
$250,000 500,000 $750,000 1,000,000 $1,750,000 $250,000 400,000 $2,400,000
Note: The common shares are trading in the stock market for $100 each. Refer to the financial statements of Snapit Company. The firm's market-to-book value for 2009 is A. 0.7256. B. 1.5294. C. 2.9400. D. 3.6142.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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68. ______ is a measure of what the firm would have earned if it didn't have any obligations to creditors or tax authorities. A. Net Sales B. Operating Income C. Net Income D. Non-operating Income E. Earnings before interest and taxes Taxes and interest expense are subtracted from EBIT to find Net Income. If there are no taxes and no interest expense EBIT would equal Net Income.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-03 Profitability Measures. Topic: 19-03 The Balance Sheet
69. Proceeds from a company's sale of stock to the public are included in A. par value. B. additional paid-in capital. C. retained earnings. D. par value and additional paid-in capital. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-01 The Major Financial Statements. Topic: 19-01 The Major Financial Statements
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70. Which of the financial statements recognizes only transactions in which cash changes hands? A. Balance sheet B. Income statement C. Statement of cash flows D. Balance sheet and income statement E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-01 The Major Financial Statements. Topic: 19-01 The Major Financial Statements
71. Suppose that Chicken Express, Inc. has an ROA of 7% and pays a 6% coupon on its debt. Chicken Express has a capital structure that is 70% equity and 30% debt. Relative to a firm that is 100% equity-financed, Chicken Express's net profit will be ________, and its ROE will be ________. A. lower; lower B. higher; higher C. higher; lower D. lower; higher E. It is impossible to predict.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
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72. The P/E ratio that is based on a firm's financial statements and reported in the newspaper stock listings is different from the P/E ratio derived from the dividend discount model (DDM) because A. the DDM uses a different price in the numerator. B. the DDM uses different earnings measures in the denominator. C. the prices reported are not accurate. D. the people who construct the ratio from financial statements have inside information. E. They are not different—this is a "trick" question.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-04 Ratio Analysis. Topic: 19-04 The Statement of Cash Flows
73. The dollar value of a firm's return in excess of its opportunity costs is called its A. profitability measure. B. excess return. C. economic value added. D. prospective capacity. E. return margin.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 19-03 Profitability Measures. Topic: 19-03 The Balance Sheet
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74. Economic value added (EVA) is also known as A. excess capacity. B. excess income. C. value of assets. D. accounting value added. E. residual income. Stern Stewart, a consulting firm that works extensively with EVA, introduced this term.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 19-03 Profitability Measures. Topic: 19-06 Profitability Measures
75. Which of the following are issues when dealing with the financial statements of international firms? I) Many countries allow firms to set aside larger contingency reserves than the amounts allowed for Canadian firms. II) Many firms outside Canada use accelerated depreciation methods for reporting purposes, whereas most U.S. firms use straight-line depreciation for reporting purposes. III) Intangibles, such as goodwill, may be amortized over different periods or may be expensed rather than capitalized. IV) There is no way to reconcile the financial statements of non-U.S. firms to GAAP. A. I and II B. II and IV C. I, II, and III D. I, III, and IV E. I, II, III, and IV
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-06 Comparability Problems. Topic: 19-06 Profitability Measures
1-695
76. Fair value accounting is also known as A. fundamental analysis. B. technical analysis. C. GAAP accounting. D. mark-to-market accounting. E. international accounting.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-06 Comparability Problems. Topic: 19-06 Profitability Measures
77. Critics of fair value accounting argue that: A. It ignores GAAP principles. B. It relies too much on ratio analysis. C. It ignores mark-to-market accounting. D. It relies too heavily on estimates. E. It relies too strongly on technical analysis.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-06 Comparability Problems. Topic: 19-06 Profitability Measures
78. Common size income statements make it easier to compare firms A. That use different inventory valuation methods ( FIFO vs. LIFO ). B. In different industries. C. With different degrees of leverage. D. Of different sizes.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 19-01 The Major Financial Statements. Topic: 19-02 The Income Statement
Chapter 20 Options Markets: Introduction
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Multiple Choice Questions 1. The price that the buyer of a call option pays to acquire the option is called the A. strike price. B. exercise price. C. execution price. D. acquisition price. E. premium. The price that the buyer of a call option pays to acquire the option is called the premium.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
2. The price that the writer of a call option receives to sell the option is called the A. strike price. B. exercise price. C. execution price. D. acquisition price. E. premium. The price that the writer of a call option receives to sell the option is called the premium.
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1-697
3. The price that the buyer of a put option pays to acquire the option is called the A. strike price. B. exercise price. C. execution price. D. acquisition price. E. premium. The price that the buyer of a put option pays to acquire the option is called the premium.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
4. The price that the writer of a put option receives to sell the option is called the A. premium. B. exercise price. C. execution price. D. acquisition price. E. strike price. The price that the writer of a put option receives to sell the option is called the premium.
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1-698
5. The price that the buyer of a call option pays for the underlying asset if she executes her option is called the A. strike price. B. exercise price. C. execution price. D. strike price or execution price. E. strike price or exercise price. The price that the buyer of a call option pays for the underlying asset if she executes her option is strike price or exercise price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
6. The price that the writer of a call option receives for the underlying asset if the buyer executes her option is called the A. strike price. B. exercise price. C. execution price. D. strike price or exercise price. E. strike price or execution price. The price that the writer of a call option receives for the underlying asset if the buyer executes her option is called the strike price or exercise price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
1-699
7. The price that the buyer of a put option receives for the underlying asset if she executes her option is called the A. strike price. B. exercise price. C. execution price. D. strike price or execution price. E. strike price or exercise price. The price that the buyer of a put option receives for the underlying asset if she executes her option is called the strike price or exercise price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
8. The price that the writer of a put option receives for the underlying asset if the option is exercised is called the A. strike price. B. exercise price. C. execution price. D. strike price or exercise price. E. None of the options are correct.
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1-700
9. An American 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. An American call option may be exercised (allowing the holder to buy the underlying asset) on or before expiration; the option contract also may be sold prior to expiration.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
10. A European call option allows the buyer to A. sell the underlying asset at the exercise price on 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. buy the underlying asset at the exercise price on the expiration date. E. sell the option in the open market prior to expiration and buy the underlying asset at the exercise price on the expiration date. A European call option may be exercised (allowing the holder to buy the underlying asset) on the expiration date; the option contract also may be sold prior to expiration.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
1-701
11. An American put option allows the holder to A. buy the underlying asset at the striking price on or before the expiration date. B. sell the underlying asset at the striking price on or before the expiration date. C. potentially benefit from a stock price increase. D. sell the underlying asset at the striking price on or before the expiration date and potentially benefit from a stock price increase. E. buy the underlying asset at the striking price on or before the expiration date and potentially benefit from a stock price increase. An American put option allows the buyer to sell the underlying asset at the striking price on or before the expiration date.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
12. A European put option allows the holder to A. buy the underlying asset at the striking price on or before the expiration date. B. sell the underlying asset at the striking price on or before the expiration date. C. potentially benefit from a stock price increase. D. sell the underlying asset at the striking price on the expiration date. E. potentially benefit from a stock price increase and sell the underlying asset at the striking price on the expiration date. A European put option allows the buyer to sell the underlying asset at the striking price only on the expiration date. The put option also allows the investor to benefit from an expected stock price decrease while risking only the amount invested in the contract.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
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13. An American put option can be exercised A. any time on or before the expiration date. B. only on the expiration date. C. any time in the indefinite future. D. only after dividends are paid. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
14. An American call option can be exercised A. any time on or before the expiration date. B. only on the expiration date. C. any time in the indefinite future. D. only after dividends are paid. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
15. A European call option can be exercised A. any time in the future. B. only on the expiration date. C. if the price of the underlying asset declines below the exercise price. D. immediately after dividends are paid. European options can be exercised at expiration only.
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16. A European put option can be exercised A. any time in the future. B. only on the expiration date. C. if the price of the underlying asset declines below the exercise price. D. immediately after dividends are paid. European options can be exercised at expiration only.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
17. To adjust for stock splits A. the exercise price of the option is reduced by the factor of the split, and the number of options held is increased by that factor. B. the exercise price of the option is increased by the factor of the split, and the number of options held is reduced by that factor. C. the exercise price of the option is reduced by the factor of the split, and the number of options held is reduced by that factor. D. the exercise price of the option is increased by the factor of the split, and the number of options held is increased by that factor.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
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18. All else equal, call option values are lower A. in the month of May. B. for low dividend-payout policies. C. for high dividend-payout policies. D. in the month of May and for low dividend-payout policies. E. in the month of May and for high dividend-payout policies.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
19. All else equal, call option values are higher A. in the month of May. B. for low dividend-payout policies. C. for high dividend-payout policies. D. in the month of May and for low dividend-payout policies. E. in the month of May and for high dividend-payout policies.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-705
20. The current market price of a share of AT&T stock is $50. If a call option on this stock has a strike price of $45, the call A. is out of the money. B. is in the money. C. sells for a higher price than if the market price of AT&T stock is $40. D. is out of the money and sells for a higher price than if the market price of AT&T stock is $40. E. is in the money and sells for a higher price than if the market price of AT&T stock is $40. If the striking price on a call option is less than the market price, the option is in the money and sells for more than an out of the money option.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
21. The current market price of a share of Boeing stock is $75. If a call option on this stock has a strike price of $70, the call A. is out of the money. B. is in the money. C. sells for a higher price than if the market price of Boeing stock is $70. D. is out of the money and sells for a higher price than if the market price of Boeing stock is $70. E. is in the money and sells for a higher price than if the market price of Boeing stock is $70. If the striking price on a call option is less than the market price, the option is in the money and sells for more than an at the money option.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
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22. The current market price of a share of CSCO stock is $22. If a call option on this stock has a strike price of $20, the call A. is out of the money. B. is in the money. C. sells for a higher price than if the market price of CSCO stock is $21. D. is out of the money and sells for a higher price than if the market price of CSCO stock is $21. E. is in the money and sells for a higher price than if the market price of CSCO stock is $21. If the striking price on a call option is less than the market price, the option is in the money and sells for more than a less in the money option.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
23. The current market price of a share of Disney stock is $60. If a call option on this stock has a strike price of $65, the call A. is out of the money. B. is in the money. C. can be exercised profitably. D. is out of the money and can be exercised profitably. E. is in the money and can be exercised profitably. If the striking price on a call option is more than the market price, the option is out of the money and cannot be exercised profitably.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-707
24. The current market price of a share of CAT stock is $76. If a call option on this stock has a strike price of $76, the call A. is out of the money. B. is in the money. C. is at the money. D. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
25. The current market price of a share of MSI stock is $24. If a call option on this stock has a strike price of $24, the call A. is out of the money. B. is in the money. C. is at the money. D. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
26. The current market price of a share of IBM stock is $195. If a call option on this stock has a strike price of $195, the call A. is out of the money. B. is in the money. C. is at the money. D. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-708
27. A put option on a stock is said to be out of the money if A. the exercise price is higher than the stock price. B. the exercise price is less than the stock price. C. the exercise price is equal to the stock price. D. the price of the put is higher than the price of the call. E. the price of the call is higher than the price of the put. An out of the money put option gives the owner the right to sell the shares for less than market price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
28. A put option on a stock is said to be in the money if A. the exercise price is higher than the stock price. B. the exercise price is less than the stock price. C. the exercise price is equal to the stock price. D. the price of the put is higher than the price of the call. E. the price of the call is higher than the price of the put. An in the money put option gives the owner the right to sell the shares for more than market price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-709
29. A put option on a stock is said to be at the money if A. the exercise price is higher than the stock price. B. the exercise price is less than the stock price. C. the exercise price is equal to the stock price. D. the price of the put is higher than the price of the call. E. the price of the call is higher than the price of the put. A put option on a stock is said to be at the money if the exercise price is equal to the stock price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
30. A call option on a stock is said to be out of the money if A. the exercise price is higher than the stock price. B. the exercise price is less than the stock price. C. the exercise price is equal to the stock price. D. the price of the put is higher than the price of the call. E. the price of the call is higher than the price of the put. An out of the money call option gives the owner the right to buy the shares for more than market price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-710
31. A call option on a stock is said to be in the money if A. the exercise price is higher than the stock price. B. the exercise price is less than the stock price. C. the exercise price is equal to the stock price. D. the price of the put is higher than the price of the call. E. the price of the call is higher than the price of the put. An in the money call option gives the owner the right to buy the shares for less than market price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
32. A call option on a stock is said to be at the money if A. the exercise price is higher than the stock price. B. the exercise price is less than the stock price. C. the exercise price is equal to the stock price. D. the price of the put is higher than the price of the call. E. the price of the call is higher than the price of the put. A call option on a stock is said to be at the money if the exercise price is equal to the stock price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-711
33. The current market price of a share of JNJ stock is $60. If a put option on this stock has a strike price of $55, the put A. is in the money. B. is out of the money. C. sells for a lower price than if the market price of JNJ stock is $50. D. is in the money and sells for a lower price than if the market price of JNJ stock is $50. E. is out of the money and sells for a lower price than if the market price of JNJ stock is $50. If the striking price on a put option is less than the market price, the option is out of the money and sells for less than an in the money option.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
34. The current market price of a share of a stock is $80. If a put option on this stock has a strike price of $75, the put A. is in the money. B. is out of the money. C. sells for a lower price than if the market price of the stock is $75. D. is in the money and sells for a lower price than if the market price of the stock is $75. E. is out of the money and sells for a lower price than if the market price of the stock is $75. If the striking price on a put option is less than the market price, the option is out of the money and sells for less than an at the money option.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-712
35. The current market price of a share of a stock is $20. If a put option on this stock has a strike price of $18, the put A. is out of the money. B. is in the money. C. sells for a higher price than if the strike price of the put option was $23. D. is out of the money and sells for a higher price than if the strike price of the put option was $23. E. is in the money and sells for a higher price than if the strike price of the put option was $23. If the striking price on a put option is less than the market price, the option is out of the money and sells for less than an in the money option.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
36. The current market price of a share of MSI stock is $15. If a put option on this stock has a strike price of $20, the put A. is out of the money. B. is in the money. C. can be exercised profitably. D. is out of the money and can be exercised profitably. E. is in the money and can be exercised profitably.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-713
37. The current market price of a share of TSCO stock is $75. If a put option on this stock has a strike price of $79, the put A. is out of the money. B. is in the money. C. can be exercised profitably. D. is out of the money and can be exercised profitably. E. is in the money and can be exercised profitably. If the striking price on a put option is more than the market price, the option is in the money and can be profitably exercised.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
38. The current market price of a share of AT&T stock is $50. If a put option on this stock has a strike price of $45, the put A. is out of the money. B. is in the money. C. sells for a lower price than if the market price of AT&T stock is $40. D. is out of the money and sells for a lower price than if the market price of AT&T stock is $40. E. is in the money and sells for a lower price than if the market price of AT&T stock is $40. If the striking price on a put option is less than the market price, the option is out of the money and sells for less than an in the money option.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-714
39. The current market price of a share of Boeing stock is $75. If a put option on this stock has a strike price of $70, the put A. is out of the money. B. is in the money. C. sells for a higher price than if the market price of Boeing stock is $70. D. is out of the money and sells for a higher price than if the market price of Boeing stock is $70. E. is in the money and sells for a higher price than if the market price of Boeing stock is $70. If the striking price on a put option is less than the market price, the option is out of the money and sells for less than an at the money option.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
40. The current market price of a share of CSCO stock is $22. If a put option on this stock has a strike price of $20, the put A. is out of the money. B. is in the money. C. sells for a higher price than if the strike price of the put option was $25. D. is out of the money and sells for a higher price than if the strike price of the put option was $25. E. is in the money and sells for a higher price than if the strike price of the put option was $25. If the striking price on a put option is less than the market price, the option is out of the money and sells for less than an in the money option.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-715
41. The current market price of a share of Disney stock is $60. If a put option on this stock has a strike price of $65, the put A. is out of the money. B. is in the money. C. can be exercised profitably. D. is out of the money and can be exercised profitably. E. is in the money and can be exercised profitably. If the striking price on a put option is more than the market price, the option is in the money and can be exercise profitably.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
42. The current market price of a share of CAT stock is $76. If a put option on this stock has a strike price of $80, the put A. is out of the money. B. is in the money. C. can be exercised profitably. D. is out of the money and can be exercised profitably. E. is in the money and can be exercised profitably. If the striking price on a put option is less than the market price, the option is in the money and can be profitably exercised.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-716
43. Lookback options have payoffs that A. depend in part on the minimum or maximum price of the underlying asset during the life of the option. B. only depend on the minimum price of the underlying asset during the life of the option. C. only depend on the maximum price of the underlying asset during the life of the option. D. are known in advance. Lookback options have payoffs that depend in part on the minimum or maximum price of the underlying asset during the life of the option.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-07 Exotic Options. Topic: 20-07 Values of Options at Expiration
44. Barrier options have payoffs that A. have payoffs that only depend on the minimum price of the underlying asset during the life of the option. B. depend both on the asset's price at expiration and on whether the underlying asset's price has crossed through some barrier. C. are known in advance. D. have payoffs that only depend on the maximum price of the underlying asset during the life of the option. Barrier options have payoffs that depend both on the asset's price at expiration and on whether the underlying asset's price has crossed through some barrier.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-07 Exotic Options. Topic: 20-07 Values of Options at Expiration
1-717
45. Currency-translated options have A. only asset prices denoted in a foreign currency. B. only exercise prices denoted in a foreign currency. C. payoffs that only depend on the maximum price of the underlying asset during the life of the option. D. either asset or exercise prices denoted in a foreign currency. Currency-translated options have either asset or exercise prices denoted in a foreign currency.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-07 Exotic Options. Topic: 20-07 Values of Options at Expiration
46. Binary options A. are based on two possible outcomes—yes or no. B. may make a payoff of a fixed amount if a specified event happens. C. may make a payoff of a fixed amount if a specified event does not happen. D. may make a payoff of a fixed amount if a specified event happens and are based on two possible outcomes—yes or no. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-07 Exotic Options. Topic: 20-07 Values of Options at Expiration
47. The maximum loss a buyer of a stock call option can suffer is equal to A. the striking price minus the stock price. B. the stock price minus the value of the call. C. the call premium. D. the stock price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
1-718
48. The maximum loss a buyer of a stock put option can suffer is equal to A. the striking price minus the stock price. B. the stock price minus the value of the call. C. the put premium. D. the stock price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
49. The lower bound on the market price of a convertible bond is A. its straight-bond value. B. its crooked-bond value. C. its conversion value. D. its straight-bond value and its conversion value. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-05 Option-Like Securities. Topic: 20-05 The Options Clearing Corporation
50. The potential loss for a writer of a naked call option on a stock is A. limited. B. unlimited. C. increasing when the stock price is decreasing. D. equal to the call premium. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
1-719
51. You write one JNJ February 70 put for a premium of $5. Ignoring transactions costs, what is the break-even price of this position? A. $65 B. $75 C. $5 D. $70
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
52. You purchase one JNJ 75 call option for a premium of $3. Ignoring transaction costs, the break-even price of the position is A. $75. B. $72. C. $3. D. $78. +75 + $3 = $78.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
53. You write one AT&T February 50 put for a premium of $5. Ignoring transactions costs, what is the break-even price of this position? A. $50 B. $55 C. $45 D. $40
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
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54. You purchase one IBM 200 call option for a premium of $6. Ignoring transaction costs, the break-even price of the position is A. $194. B. $228. C. $206. D. $211. +200 + $6 = $206.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
55. Call options on IBM-listed stock options are A. issued by IBM Corporation. B. created by investors. C. traded on various exchanges. D. issued by IBM Corporation and traded on various exchanges. E. created by investors and traded on various exchanges.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
56. Buyers of call options __________ required to post margin deposits, and sellers of put options __________ required to post margin deposits. A. are; are not B. are; are C. are not; are D. are not; are not E. are always; are sometimes
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
1-721
57. Buyers of put options anticipate the value of the underlying asset will __________, and sellers of call options anticipate the value of the underlying asset will ________. A. increase; increase B. decrease; increase C. increase; decrease D. decrease; decrease E. Cannot tell without further information
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
58. The Option Clearing Corporation is owned by A. the Federal Reserve System. B. the exchanges on which stock options are traded. C. the major U.S. banks. D. the Federal Deposit Insurance Corporation. The exchanges on which options are traded jointly own the Option Clearing Corporation in order to facilitate option trading.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
1-722
59. A covered call position is A. the simultaneous purchase of the call and the underlying asset. B. the purchase of a share of stock with a simultaneous sale of a put on that stock. C. the short sale of a share of stock with a simultaneous sale of a call on that stock. D. the purchase of a share of stock with a simultaneous sale of a call on that stock. E. the simultaneous purchase of a call and sale of a put on the same stock. Writing a covered call is a very safe strategy, as the writer owns the underlying stock. The only risk to the writer is that the stock will be called away, thus limiting the upside potential.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
60. According to the put-call parity theorem, the value of a European put option on a nondividend paying stock is equal to A. the call value plus the present value of the exercise price plus the stock price. B. the call value plus the present value of the exercise price minus the stock price. C. the present value of the stock price minus the exercise price minus the call price. D. the present value of the stock price plus the exercise price minus the call price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Hard Learning Objective: 20-04 The Put-Call Parity Relationship. Topic: 20-04 Adjustments in Option Contract Terms
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61. A protective put strategy is A. a long put plus a long position in the underlying asset. B. a long put plus a long call on the same underlying asset. C. a long call plus a short put on the same underlying asset. D. a long put plus a short call on the same underlying asset. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
62. Suppose the price of a share of Google stock is $500. An April call option on Google stock has a premium of $5 and an exercise price of $500. Ignoring commissions, the holder of the call option will earn a profit if the price of the share A. increases to $504. B. decreases to $490. C. increases to $506. D. decreases to $496. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-724
63. Suppose the price of a share of IBM stock is $200. An April call option on IBM stock has a premium of $5 and an exercise price of $200. Ignoring commissions, the holder of the call option will earn a profit if the price of the share A. increases to $204. B. decreases to $190. C. increases to $206. D. decreases to $196. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
64. You purchased one AT&T March 50 call and sold one AT&T March 55 call. Your strategy is known as A. a long straddle. B. a horizontal spread. C. a money spread. D. a short straddle. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
1-725
65. You purchased one AT&T March 50 put and sold one AT&T April 50 put. Your strategy is known as A. a vertical spread. B. a straddle. C. a time spread. D. a collar. A time spread involves the simultaneous purchase and sale of options with different expiration dates, same exercise price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
66. Before expiration, the time value of a call option is equal to A. zero. B. the actual call price minus the intrinsic value of the call. C. the intrinsic value of the call. D. the actual call price plus the intrinsic value of the call. The difference between the actual call price and the intrinsic value is the time value of the option, which should not be confused with the time value of money. The option's time value is the difference between the option's price and the value of the option were the option expiring immediately.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-726
67. Which of the following factors affect the price of a stock option? A. The risk-free rate B. The riskiness of the stock C. The time to expiration D. The expected rate of return on the stock E. The risk-free rate, riskiness of the stock, and time to expiration The risk-free rate, riskiness of the stock, and time to expiration are directly related to the price of the option; the expected rate of return on the stock does not affect the price of the option.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
68. All of the following factors affect the price of a stock option except A. the risk-free rate. B. the riskiness of the stock. C. the time to expiration. D. the expected rate of return on the stock. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
69. The value of a stock put option is positively related to the following factors except A. the time to expiration. B. the striking price. C. the stock price. D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-727
70. The value of a stock put option is positively related to A. the time to expiration. B. the striking price. C. the stock price. D. the time to expiration and the striking price. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
71. You purchase one September 50 put contract for a put premium of $2. What is the maximum profit that you could gain from this strategy? A. $4,800 B. $200 C. $5,000 D. $5,200 E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
72. You purchase one June 70 put contract for a put premium of $4. What is the maximum profit that you could gain from this strategy? A. $7,000 B. $400 C. $7,400 D. $6,600 E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
1-728
73. You purchase one IBM March 200 put contract for a put premium of $6. What is the maximum profit that you could gain from this strategy? A. $20,000 B. $20,600 C. $19,400 D. $19,000
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
74. The following price quotations were taken from the Wall Street Journal.
Stock Price 917/8 917/8 917/8
Strike Price 85 90 95
February 73/8 31/8 5/8
The premium on one February 90 call contract is A. $3.1250. B. $318.00. C. $312.50. D. $58.00.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
1-729
75. The following price quotations on WFM were taken from the Wall Street Journal.
Stock Price 917/8 917/8 917/8
Strike Price 85 90 95
February 73/8 31/8 5/8
The premium on one WFM February 90 call contract is A. $4.1250. B. $418.00. C. $412.50. D. $158.00.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
76. The following price quotations on WFM were taken from the Wall Street Journal.
Stock Price 917/8 917/8 917/8
Strike Price 85 90 95
February 73/8 31/8 5/8
1-730
The premium on one WFM February 85 call contract is A. $8.875. B. $887.50. C. $412.50. D. $158.00.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
77. Suppose you purchase one WFM May 100 call contract at $5 and write one WFM May 105 call contract at $2. The maximum potential profit of your strategy is ________, if both options are exercised. A. $600 B. $500 C. $200 D. $300 E. $100
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
1-731
78. Suppose you purchase one WFM May 100 call contract at $5 and write one WFM May 105 call contract at $2. If, at expiration, the price of a share of WFM stock is $103, your profit would be A. $500. B. $300. C. zero. D. $200.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
79. Suppose you purchase one WFM May 100 call contract at $5 and write one WFM May 105 call contract at $2. The maximum loss you could suffer from your strategy is A. $200. B. $300. C. zero. D. $500.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
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80. Suppose you purchase one WFM May 100 call contract at $5 and write one WFM May 105 call contract at $2. What is the lowest stock price at which you can break even? A. $101 B. $102 C. $103 D. $104 E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
81. You buy one Home Depot June 60 call contract and one June 60 put contract. The call premium is $5 and the put premium is $3. Your strategy is called A. a short straddle. B. a long straddle. C. a horizontal straddle. D. a covered call. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
1-733
82. You buy one Home Depot June 60 call contract and one June 60 put contract. The call premium is $5 and the put premium is $3. Your maximum loss from this position could be A. $500. B. $300. C. $800. D. $200. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
83. You buy one Home Depot June 60 call contract and one June 60 put contract. The call premium is $5 and the put premium is $3. At expiration, you break even if the stock price is equal to A. $52. B. $60. C. $68. D. either $52 or $68. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
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84. The put-call parity theorem A. represents the proper relationship between put and call prices. B. allows for arbitrage opportunities if violated. C. may be violated by small amounts, but not enough to earn arbitrage profits, once transaction costs are considered. D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-04 The Put-Call Parity Relationship. Topic: 20-04 Adjustments in Option Contract Terms
85. Some more "traditional" assets have option-like features; some of these instruments include A. callable bonds. B. convertible bonds. C. warrants. D. callable bonds and convertible bonds. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-05 Option-Like Securities. Topic: 20-05 The Options Clearing Corporation
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86. Financial engineering A. is the custom designing of securities or portfolios with desired patterns of exposure to the price of the underlying security. B. primarily takes place for the institutional investor. C. primarily takes places for the individual investor. D. is the custom designing of securities or portfolios with desired patterns of exposure to the price of the underlying security and primarily takes place for the institutional investor. E. is the custom designing of securities or portfolios with desired patterns of exposure to the price of the underlying security and primarily takes places for the individual investor.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-06 Financial Engineering. Topic: 20-06 Other Listed Options
87. A collar with a net outlay of approximately zero is an options strategy that A. combines a put and a call to lock in a price range for a security. B. uses the gains from sale of a call to purchase a put. C. uses the gains from sale of a put to purchase a call. D. combines a put and a call to lock in a price range for a security and uses the gains from sale of a call to purchase a put. E. combines a put and a call to lock in a price range for a security and uses the gains from sale of a put to purchase a call. The collar brackets the value of a portfolio between two bounds.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-03 Option Strategies. Topic: 20-03 American and European Options
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88. Top Flight Stock currently sells for $53. A one-year call option with strike price of $58 sells for $10, and the risk-free interest rate is 5.5%. What is the price of a one-year put with strike price of $58? A. $10.00 B. $12.12 C. $16.00 D. $11.98 E. $14.13
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-04 The Put-Call Parity Relationship. Topic: 20-04 Adjustments in Option Contract Terms
89. HighFlyer Stock currently sells for $48. A one-year call option with strike price of $55 sells for $9, and the risk-free interest rate is 6%. What is the price of a one-year put with strike price of $55? A. $9.00 B. $12.89 C. $16.00 D. $18.72 E. $15.60
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-04 The Put-Call Parity Relationship. Topic: 20-04 Adjustments in Option Contract Terms
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90. ING Stock currently sells for $38. A one-year call option with strike price of $45 sells for $9, and the risk-free interest rate is 4%. What is the price of a one-year put with strike price of $45? A. $9.00 B. $12.89 C. $16.00 D. $18.72 E. $14.27
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-04 The Put-Call Parity Relationship. Topic: 20-04 Adjustments in Option Contract Terms
91. A callable bond should be priced the same as A. a convertible bond. B. a straight bond plus a put option. C. a straight bond plus a call option. D. a straight bond plus warrants. E. a straight bond. A callable bond is the equivalent of a straight bond sale by the corporation and the concurrent issue of a call option by the bond buyer.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 20-05 Option-Like Securities. Topic: 20-05 The Options Clearing Corporation
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92. Asian options differ from American and European options in that A. they are only sold in Asian financial markets. B. they never expire. C. their payoff is based on the average price of the underlying asset. D. they are only sold in Asian financial markets and they never expire. E. they are only sold in Asian financial markets and their payoff is based on the average price of the underlying asset. Asian options have payoffs that depend on the average price of the underlying asset during some period of time.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-07 Exotic Options. Topic: 20-07 Values of Options at Expiration
93. Trading in "exotic options" takes place primarily A. on the New York Stock Exchange. B. in the over-the-counter market. C. on the American Stock Exchange. D. in the primary marketplace. E. None of the options.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 20-07 Exotic Options. Topic: 20-07 Values of Options at Expiration
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94. Consider a one-year maturity call option and a one-year put option on the same stock, both with striking price $45. If the risk-free rate is 4%, the stock price is $48, and the put sells for $1.50, what should be the price of the call? A. $4.38 B. $5.60 C. $6.23 D. $12.26 E. None of the options.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-04 The Put-Call Parity Relationship. Topic: 20-04 Adjustments in Option Contract Terms
95. Consider a one-year maturity call option and a one-year put option on the same stock, both with striking price $100. If the risk-free rate is 5%, the stock price is $103, and the put sells for $7.50, what should be the price of the call? A. $17.50 B. $15.26 C. $10.36 D. $12.26 E. None of the options.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 20-04 The Put-Call Parity Relationship. Topic: 20-04 Adjustments in Option Contract Terms
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96. Derivative securities are also called contingent claims because A. their owners may choose whether or not to exercise them. B. a large contingent of investors holds them. C. the writers may choose whether or not to exercise them. D. their payoffs depend on the prices of other assets. E. contingency management is used in adding them to portfolios. The values of derivatives depend on the values of the underlying stock, commodity, index, etc.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
97. You purchased a call option for $3.45 17 days ago. The call has a strike price of $45, and the stock is now trading for $51. If you exercise the call today, what will be your holdingperiod return? If you do not exercise the call today and it expires, what will be your holdingperiod return? A. 173.9%, -100% B. 73.9%, -100% C. 57.5%, -173.9% D. 73.9%, -57.5% E. 100%, -100%
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
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98. An option with an exercise price equal to the underlying asset's price is A. worthless. B. in the money. C. at the money. D. out of the money. E. theoretically impossible. This is the definition of "at the money." The option has a market value and may increase in value if there are favorable price movements in the underlying asset before the expiration date.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
99. To the option holder, put options are worth ______ when the exercise price is higher; call options are worth ______ when the exercise price is higher. A. more; more B. more; less C. less; more D. less; less E. It doesn't matter—they are too risky to be included in a reasonable person's portfolio. The holder of the put would prefer to sell the asset to the writer at a higher exercise price. The holder of the call would prefer to buy the asset from the writer at a lower exercise price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-02 Values of Options at Expiration. Topic: 20-02 Options Trading
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100. What happens to an option if the underlying stock has a 2-for-1 split? A. There is no change in either the exercise price or in the number of options held. B. The exercise price will adjust through normal market movements; the number of options will remain the same. C. The exercise price would become one-half of what it was, and the number of options held would double. D. The exercise price would double, and the number of options held would double. E. There is no standard rule—each corporation has its own policy.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
101. What happens to an option if the underlying stock has a 3-for-1 split? A. There is no change in either the exercise price or in the number of options held. B. The exercise price will adjust through normal market movements; the number of options will remain the same. C. The exercise price would become one-third of what it was, and the number of options held would triple. D. The exercise price would triple, and the number of options held would triple. E. There is no standard rule—each corporation has its own policy.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
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102. Suppose that you purchased a call option on the S&P 100 Index. The option has an exercise price of 1,680, and the index is now at 1,720. What will happen when you exercise the option? A. You will have to pay $1,680. B. You will receive $1,720. C. You will receive $1,680. D. You will receive $4,000. E. You will have to pay $4,000.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
103. Suppose that you purchased a call option on the S&P 100 Index. The option has an exercise price of 1,700, and the index is now at 1,760. What will happen when you exercise the option? A. You will have to pay $6,000. B. You will receive $6,000. C. You will receive $1,700. D. You will receive $1,760. E. You will have to pay $7,000.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 20-01 The Option Contract. Topic: 20-01 The Option Contract
Chapter 21 Option Valuation
Multiple Choice Questions
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1. Before expiration, the time value of an in-the-money call option is always A. equal to zero. B. positive. C. negative. D. equal to the stock price minus the exercise price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
2. Before expiration, the time value of an in-the-money put option is always A. equal to zero. B. negative. C. positive. D. equal to the stock price minus the exercise price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
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3. Before expiration, the time value of an at-the-money call option is usually A. positive. B. equal to zero. C. negative. D. equal to the stock price minus the exercise price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
4. Before expiration, the time value of an at-the-money put option is always A. equal to zero. B. equal to the stock price minus the exercise price. C. negative. D. positive. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
5. At expiration, the time value of an in-the-money call option is always A. equal to zero. B. positive. C. negative. D. equal to the stock price minus the exercise price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
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6. At expiration, the time value of an in-the-money put option is always A. equal to zero. B. negative. C. positive. D. equal to the stock price minus the exercise price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
7. At expiration, the time value of an at-the-money call option is always A. positive. B. equal to zero. C. negative. D. equal to the stock price minus the exercise price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
8. At expiration, the time value of an at-the-money put option is always A. equal to zero. B. equal to the stock price minus the exercise price. C. negative. D. positive.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
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9. A call option has an intrinsic value of zero if the option is A. at the money. B. out of the money. C. in the money. D. at the money and in the money. E. at the money or out of the money.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
10. A put option has an intrinsic value of zero if the option is A. at the money. B. out of the money. C. in the money. D. at the money and in the money. E. at the money or out of the money.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
11. Prior to expiration, A. the intrinsic value of a call option is greater than its actual value. B. the intrinsic value of a call option is always positive. C. the actual value of a call option is greater than the intrinsic value. D. the intrinsic value of a call option is always greater than its time value.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
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12. Prior to expiration, A. the intrinsic value of a put option is greater than its actual value. B. the intrinsic value of a put option is always positive. C. the actual value of a put option is greater than the intrinsic value. D. the intrinsic value of a put option is always greater than its time value.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
13. If the stock price increases, the price of a put option on that stock __________, and that of a call option __________. A. decreases; increases B. decreases; decreases C. increases; decreases D. increases; increases E. does not change; does not change
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
14. If the stock price decreases, the price of a put option on that stock __________, and that of a call option __________. A. decreases; increases B. decreases; decreases C. increases; decreases D. increases; increases E. does not change; does not change
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
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15. Other things equal, the price of a stock call option is positively correlated with the following factors except A. the stock price. B. the time to expiration. C. the stock volatility. D. the exercise price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
16. Other things equal, the price of a stock call option is positively correlated with which of the following factors? A. The stock price B. The time to expiration C. The stock volatility D. The exercise price E. The stock price, time to expiration, and stock volatility
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
17. Other things equal, the price of a stock call option is negatively correlated with which of the following factors? A. The stock price B. The time to expiration C. The stock volatility D. The exercise price E. The stock price, time to expiration, and stock volatility
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
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18. Other things equal, the price of a stock put option is positively correlated with the following factors except A. the stock price. B. the time to expiration. C. the stock volatility. D. the exercise price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
19. Other things equal, the price of a stock put option is positively correlated with which of the following factors? A. The stock price B. The time to expiration C. The stock volatility D. The exercise price E. The time to expiration, stock volatility, and exercise price
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
20. Other things equal, the price of a stock put option is negatively correlated with which of the following factors? A. The stock price B. The time to expiration C. The stock volatility D. The exercise price E. The time to expiration, stock volatility, and exercise price
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
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21. The price of a stock put option is __________ correlated with the stock price and __________ correlated with the strike price. A. positively; positively B. negatively; positively C. negatively; negatively D. positively; negatively E. not; not
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
22. The price of a stock call option is __________ correlated with the stock price and __________ correlated with the strike price. A. positively; positively B. negatively; positively C. negatively; negatively D. positively; negatively E. not; not
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
23. All the inputs in the Black-Scholes option pricing model are directly observable except A. the price of the underlying security. B. the risk-free rate of interest. C. the time to expiration. D. the variance of returns of the underlying asset return.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
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24. Which of the inputs in the Black-Scholes option pricing model are directly observable? A. The price of the underlying security B. The risk-free rate of interest C. The time to expiration D. The variance of returns of the underlying asset return E. The price of the underlying security, risk-free rate of interest, and time to expiration
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
25. Delta is defined as A. the change in the value of an option for a dollar change in the price of the underlying asset. B. the change in the value of the underlying asset for a dollar change in the call price. C. the percentage change in the value of an option for a 1% change in the value of the underlying asset. D. the change in the volatility of the underlying stock price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
26. A hedge ratio of 0.70 implies that a hedged portfolio should consist of A. long 0.70 calls for each short stock. B. short 0.70 calls for each long stock. C. long 0.70 shares for each short call. D. long 0.70 shares for each long call. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-03 Binomial Option Pricing. Topic: 21-03 Determinants of Option Values
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27. A hedge ratio of 0.85 implies that a hedged portfolio should consist of A. long 0.85 calls for each short stock. B. short 0.85 calls for each long stock. C. long 0.85 shares for each short call. D. long 0.85 shares for each long call. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-03 Binomial Option Pricing. Topic: 21-03 Determinants of Option Values
28. A hedge ratio for a call option is ________, and a hedge ratio for a put option is ______. A. negative; positive B. negative; negative C. positive; negative D. positive; positive E. zero; zero
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-03 Binomial Option Pricing. Topic: 21-03 Determinants of Option Values
29. A hedge ratio for a call is always A. equal to one. B. greater than one. C. between zero and one. D. between negative one and zero. E. of no restricted value.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-03 Binomial Option Pricing. Topic: 21-03 Determinants of Option Values
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30. A hedge ratio for a put is always A. equal to one. B. greater than one. C. between zero and one. D. between negative one and zero. E. of no restricted value.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-03 Binomial Option Pricing. Topic: 21-03 Determinants of Option Values
31. The dollar change in the value of a stock call option is always A. lower than the dollar change in the value of the stock. B. higher than the dollar change in the value of the stock. C. negatively correlated with the change in the value of the stock. D. higher than the dollar change in the value of the stock and negatively correlated with the change in the value of the stock. E. lower than the dollar change in the value of the stock and negatively correlated with the change in the value of the stock.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
32. The percentage change in the stock call-option price divided by the percentage change in the stock price is called A. the elasticity of the option. B. the delta of the option. C. the theta of the option. D. the gamma of the option.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
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33. The elasticity of an option is A. the volatility level for the stock that the option price implies. B. the continued updating of the hedge ratio as time passes. C. the percentage change in the stock call-option price divided by the percentage change in the stock price. D. the sensitivity of the delta to the stock price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
34. The elasticity of a stock call option is always A. greater than one. B. smaller than one. C. negative. D. infinite. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
35. The elasticity of a stock put option is always A. positive. B. smaller than one. C. negative. D. infinite.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
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36. The gamma of an option is A. the volatility level for the stock that the option price implies. B. the continued updating of the hedge ratio as time passes. C. the percentage change in the stock call-option price divided by the percentage change in the stock price. D. the sensitivity of the delta to the stock price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
37. Delta neutral A. is the volatility level for the stock that the option price implies. B. is the continued updating of the hedge ratio as time passes. C. is the percentage change in the stock call-option price divided by the percentage change in the stock price. D. means the portfolio has no tendency to change value as the underlying portfolio value changes.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
38. Dynamic hedging is A. the volatility level for the stock that the option price implies. B. the continued updating of the hedge ratio as time passes. C. the percentage change in the stock call-option price divided by the percentage change in the stock price. D. the sensitivity of the delta to the stock price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
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39. Volatility risk is A. the volatility level for the stock that the option price implies. B. the risk incurred from unpredictable changes in volatility. C. the percentage change in the stock call-option price divided by the percentage change in the stock price. D. the sensitivity of the delta to the stock price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
40. Portfolio A consists of 150 shares of stock and 300 calls on that stock. Portfolio B consists of 575 shares of stock. The call delta is 0.7. Which portfolio has a higher dollar exposure to a change in stock price? A. Portfolio B B. Portfolio A C. The two portfolios have the same exposure. D. Portfolio A if the stock price increases and portfolio B if it decreases E. Portfolio B if the stock price increases and portfolio A if it decreases
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
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41. Portfolio A consists of 500 shares of stock and 500 calls on that stock. Portfolio B consists of 800 shares of stock. The call delta is 0.6. Which portfolio has a higher dollar exposure to a change in stock price? A. Portfolio B B. Portfolio A C. The two portfolios have the same exposure. D. Portfolio A if the stock price increases and portfolio B if it decreases E. Portfolio B if the stock price increases and portfolio A if it decreases
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
42. Portfolio A consists of 400 shares of stock and 400 calls on that stock. Portfolio B consists of 500 shares of stock. The call delta is 0.5. Which portfolio has a higher dollar exposure to a change in stock price? A. Portfolio B B. Portfolio A C. The two portfolios have the same exposure. D. Portfolio A if the stock price increases and portfolio B if it decreases E. Portfolio B if the stock price increases and portfolio A if it decreases
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
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43. Portfolio A consists of 600 shares of stock and 300 calls on that stock. Portfolio B consists of 685 shares of stock. The call delta is 0.3. Which portfolio has a higher dollar exposure to a change in stock price? A. Portfolio B B. Portfolio A C. The two portfolios have the same exposure. D. Portfolio A if the stock price increases, and portfolio B if it decreases E. Portfolio B if the stock price increases, and portfolio A if it decreases
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
44. A portfolio consists of 100 shares of stock and 1500 calls on that stock. If the hedge ratio for the call is 0.7, what would be the dollar change in the value of the portfolio in response to a $1 decline in the stock price? A. +$700 B. +$500 C. -$1,150 D. -$520
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
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45. A portfolio consists of 800 shares of stock and 100 calls on that stock. If the hedge ratio for the call is 0.5, what would be the dollar change in the value of the portfolio in response to a $1 decline in the stock price? A. +$700 B. -$850 C. -$580 D. -$520
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
46. A portfolio consists of 225 shares of stock and 300 calls on that stock. If the hedge ratio for the call is 0.4, what would be the dollar change in the value of the portfolio in response to a $1 decline in the stock price? A. -$345 B. +$500 C. -$580 D. -$520
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
47. A portfolio consists of 400 shares of stock and 200 calls on that stock. If the hedge ratio for the call is 0.6, what would be the dollar change in the value of the portfolio in response to a $1 decline in the stock price? A. +$700 B. +$500 C. -$580 D. -$520
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
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48. If the hedge ratio for a stock call is 0.30, the hedge ratio for a put with the same expiration date and exercise price as the call would be A. 0.70. B. 0.30. C. -0.70. D. -0.30. E. -0.17.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
49. If the hedge ratio for a stock call is 0.50, the hedge ratio for a put with the same expiration date and exercise price as the call would be A. 0.30. B. 0.50. C. -0.60. D. -0.50. E. -0.17.
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50. If the hedge ratio for a stock call is 0.60, the hedge ratio for a put with the same expiration date and exercise price as the call would be A. 0.60. B. 0.40. C. -0.60. D. -0.40. E. -0.17.
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51. If the hedge ratio for a stock call is 0.70, the hedge ratio for a put with the same expiration date and exercise price as the call would be A. 0.70. B. 0.30. C. -0.70. D. -0.30. E. -0.17.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
52. A put option is currently selling for $6 with an exercise price of $50. If the hedge ratio for the put is -0.30, and the stock is currently selling for $46, what is the elasticity of the put? A. 2.76 B. 2.30 C. -7.67 D. -2.76 E. -2.30
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
53. A put option on the S&P 500 Index will best protect a portfolio A. of 100 shares of IBM stock. B. of 50 bonds. C. that corresponds to the S&P 500. D. of 50 shares of AT&T and 50 shares of Xerox stocks. E. that replicates the Dow.
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54. Higher dividend-payout policies have a __________ impact on the value of the call and a __________ impact on the value of the put compared to lower dividend-payout policies. A. negative; negative B. positive; positive C. positive; negative D. negative; positive E. zero; zero
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55. Lower dividend-payout policies have a __________ impact on the value of the call and a __________ impact on the value of the put compared to higher dividend-payout policies. A. negative; negative B. positive; positive C. positive; negative D. negative; positive E. zero; zero
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56. A $1 decrease in a call option's exercise price would result in a(n) __________ in the call option's value of __________ one dollar. A. increase; more than B. decrease; more than C. decrease; less than D. increase; less than E. increase; exactly
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
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57. Which one of the following variables influences the value of call options? I) Level of interest rates II) Time to expiration of the option III) Dividend yield of underlying stock IV) Stock price volatility A. I and IV only B. II and III only C. I, II, and IV only D. I, II, III, and IV E. I, II, and III only
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
58. Which one of the following variables influences the value of put options? I) Level of interest rates II) Time to expiration of the option III) Dividend yield of underlying stock IV) Stock price volatility A. I and IV only B. II and III only C. I, II, and IV only D. I, II, III, and IV E. I, II, and III only
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59. An American call-option buyer on a nondividend-paying stock will A. always exercise the call as soon as it is in the money. B. only exercise the call when the stock price exceeds the previous high. C. never exercise the call early. D. buy an offsetting put whenever the stock price drops below the strike price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-02 Restrictions on Option Values. Topic: 21-02 Intrinsic and Time Values
60. Relative to European puts, otherwise identical American put options A. are less valuable. B. are more valuable. C. are equal in value. D. will always be exercised earlier. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
61. Use the two-state put-option value in this problem. SO = $100; X = $120; the two possibilities for ST are $150 and $80. The range of P across the two states is _____, and the hedge ratio is _______. A. $0 and $40; -4/7 B. $0 and $50; +4/7 C. $0 and $40; +4/7 D. $0 and $50; -4/7 E. $20 and $40; +1/2
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-03 Binomial Option Pricing. Topic: 21-03 Determinants of Option Values
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62. Empirical tests of the Black-Scholes option pricing model A. show that the model generates values fairly close to the prices at which options trade. B. show that the model tends to overvalue deep in-the-money calls and undervalue deep outof-the-money calls. C. indicate that the mispricing that does occur is due to the possible early exercise of American options on dividend-paying stocks. D. show that the model generates values fairly close to the prices at which options trade and indicate that the mispricing that does occur is due to the possible early exercise of American options on dividend-paying stocks. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-06 Empirical Evidence on Option Pricing. Topic: 21-06 Early Exercise and Dividends
63. Options sellers who are delta-hedging would most likely A. sell when markets are falling. B. buy when markets are rising. C. sell when markets are falling and buy when markets are rising. D. sell whether markets are falling or rising. E. buy whether markets are falling or rising.
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64. An American-style call option with six months to maturity has a strike price of $35. The underlying stock now sells for $43. The call premium is $12. What is the intrinsic value of the call? A. $12 B. $8 C. $0 D. $23
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65. An American-style call option with six months to maturity has a strike price of $35. The underlying stock now sells for $43. The call premium is $12. What is the time value of the call? A. $8 B. $12 C. $0 D. $4 E. Cannot be determined without more information
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66. An American-style call option with six months to maturity has a strike price of $35. The underlying stock now sells for $43. The call premium is $12. If the option has delta of.5, what is its elasticity? A. 4.17 B. 2.32 C. 1.79 D. 0.5 E. 1.5
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
67. An American-style call option with six months to maturity has a strike price of $35. The underlying stock now sells for $43. The call premium is $12. If the company unexpectedly announces it will pay its first-ever dividend three months from today, you would expect that A. the call price would increase. B. the call price would decrease. C. the call price would not change. D. the put price would decrease. E. the put price would not change.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
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68. The intrinsic value of an out-of-the-money call option is equal to A. the call premium. B. zero. C. the stock price minus the exercise price. D. the striking price.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
69. Since deltas change as stock values change, portfolio hedge ratios must be constantly updated in active markets. This process is referred to as A. portfolio insurance. B. rebalancing. C. option elasticity. D. gamma hedging. E. dynamic hedging.
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70. In volatile markets, dynamic hedging may be difficult to implement because A. prices move too quickly for effective rebalancing. B. as volatility increases, historical deltas are too low. C. price quotes may be delayed so that correct hedge ratios cannot be computed. D. volatile markets may cause trading halts. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
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71. Rubinstein (1994) observed that the performance of the Black-Scholes model had deteriorated in recent years, and he attributed this to A. investor fears of another market crash. B. higher-than-normal dividend payouts. C. early exercise of American call options. D. decreases in transaction costs. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-06 Empirical Evidence on Option Pricing. Topic: 21-06 Early Exercise and Dividends
72. The time value of a call option is I) the difference between the option's price and the value it would have if it were expiring immediately. II) the same as the present value of the option's expected future cash flows. III) the difference between the option's price and its expected future value. IV) different from the usual time value of money concept. A. I B. I and II C. II and III D. II E. I and IV
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
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73. The time value of a put option is I) the difference between the option's price and the value it would have if it were expiring immediately. II) the same as the present value of the option's expected future cash flows. III) the difference between the option's price and its expected future value. IV) different from the usual time value of money concept. A. I B. I and II C. II and III D. II E. I and IV
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74. The intrinsic value of an at-the-money call option is equal to A. the call premium. B. zero. C. the stock price plus the exercise price. D. the striking price. E. None of the options are correct.
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75. As the underlying stock's price increased, the call option valuation function's slope approaches A. zero. B. one. C. two times the value of the stock. D. one-half the value of the stock. E. infinity.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-02 Restrictions on Option Values. Topic: 21-02 Intrinsic and Time Values
76. The intrinsic value of an in-of-the-money call option is equal to A. the call premium. B. zero. C. the stock price minus the exercise price. D. the striking price. E. None of the options are correct.
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77. The Black-Scholes formula assumes that I) the risk-free interest rate is constant over the life of the option. II) the stock price volatility is constant over the life of the option. III) the expected rate of return on the stock is constant over the life of the option. IV) there will be no sudden extreme jumps in stock prices. A. I and II B. I and III C. II and II D. I, II, and IV E. I, II, III, and IV
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
78. The intrinsic value of an in-the-money put option is equal to A. the stock price minus the exercise price. B. the put premium. C. zero. D. the exercise price minus the stock price. E. None of the options are correct.
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79. The hedge ratio of an option is also called the option's A. alpha. B. beta. C. sigma. D. delta. E. rho.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
80. The intrinsic value of an at-the-money put option is equal to A. the stock price minus the exercise price. B. the put premium. C. zero. D. the exercise price minus the stock price. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
81. An American-style call option with six months to maturity has a strike price of $42. The underlying stock now sells for $50. The call premium is $14. What is the intrinsic value of the call? A. $12 B. $10 C. $8 D. $23
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82. An American-style call option with six months to maturity has a strike price of $42. The underlying stock now sells for $50. The call premium is $14. What is the time value of the call? A. $8 B. $12 C. $6 D. $4 E. Cannot be determined without more information
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83. An American-style call option with six months to maturity has a strike price of $42. The underlying stock now sells for $50. The call premium is $14. If the company unexpectedly announces it will pay its first-ever dividend four months from today, you would expect that A. the call price would increase. B. the call price would decrease. C. the call price would not change. D. the put price would decrease. E. the put price would not change.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 21-04 Black-Scholes Option Valuation. Topic: 21-04 Restrictions on Option Values
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84. The intrinsic value of an out-of-the-money put option is equal to A. the stock price minus the exercise price. B. the put premium. C. zero. D. the exercise price minus the stock price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-01 Option Valuation: Introduction. Topic: 21-01 Option Valuation: Introduction
85. Vega is defined as A. the change in the value of an option for a dollar change in the price of the underlying asset. B. the change in the value of the underlying asset for a dollar change in the call price. C. the percentage change in the value of an option for a 1% change in the value of the underlying asset. D. the change in the volatility of the underlying stock price. E. the sensitivity of an option's price to changes in volatility.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 21-05 Using the Black-Scholes Formula. Topic: 21-05 Restrictions on the Value of a Call Option
Chapter 22 Futures Markets
Multiple Choice Questions
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1. A futures contract A. is an agreement to buy or sell a specified amount of an asset at the spot price on the expiration date of the contract. B. is an agreement to buy or sell a specified amount of an asset at a predetermined price on the expiration date of the contract. C. gives the buyer the right, but not the obligation, to buy an asset sometime in the future. D. is a contract to be signed in the future by the buyer and the seller of the commodity. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
2. The terms of futures contracts __________ standardized, and the terms of forward contracts __________ standardized. A. are; are B. are not; are C. are; are not D. are not; are not E. are; may or may not be
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3. Futures contracts __________ traded on an organized exchange, and forward contracts __________ traded on an organized exchange. A. are not; are B. are; are C. are not; are not D. are; are not E. are; may or may not be
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
4. In a futures contract, the futures price is A. determined by the buyer and the seller when the delivery of the commodity takes place. B. determined by the futures exchange. C. determined by the buyer and the seller when they initiate the contract. D. determined independently by the provider of the underlying asset. E. None of the options are correct.
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5. The buyer of a futures contract is said to have a __________ position, and the seller of a futures contract is said to have a __________ position in futures. A. long; short B. long; long C. short; short D. short; long E. margined; long
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6. Investors who take long positions in futures agree to __________ of the commodity on the delivery date, and those who take the short positions agree to __________ of the commodity. A. make delivery; take delivery B. take delivery; make delivery C. take delivery; take delivery D. make delivery; make delivery E. negotiate the price; pay the price
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
7. The terms of futures contracts, such as the quality and quantity of the commodity and the delivery date, are A. specified by the buyers and sellers. B. specified only by the buyers. C. specified by the futures exchanges. D. specified by brokers and dealers. E. None of the options are correct.
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8. A trader who has a __________ position in wheat futures believes the price of wheat will __________ in the future. A. long; increase B. long; decrease C. short; increase D. long; stay the same E. short; stay the same
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9. A trader who has a __________ position in gold futures wants the price of gold to __________ in the future. A. long; decrease B. short; decrease C. short; stay the same D. short; increase E. long; stay the same
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10. The open interest on silver futures at a particular time is the A. number of silver futures contracts traded during the day. B. number of outstanding silver futures contracts for delivery within the next month. C. number of silver futures contracts traded the previous day. D. number of all long or short silver futures contracts outstanding.
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11. Which one of the following statements regarding delivery is true? A. Most futures contracts result in actual delivery. B. Only 1% to 3% of futures contracts result in actual delivery. C. Only 15% of futures contracts result in actual delivery. D. Approximately 50% of futures contracts result in actual delivery. E. Futures contracts never result in actual delivery.
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12. Which of the following statements regarding delivery is false? I) Most futures contracts result in actual delivery. II) Only 1% to 3% of futures contracts result in actual delivery. III) Only 15% of futures contracts result in actual delivery. A. I only B. II only C. III only D. I and II E. I and III
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13. You hold one long corn futures contract that expires in April. To close your position in corn futures before the delivery date you must A. buy one May corn futures contract. B. buy two April corn futures contract. C. sell one April corn futures contract. D. sell one May corn futures contract.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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14. Which one of the following statements is true? A. The maintenance margin is the amount of money you post with your broker when you buy or sell a futures contract. B. If the value of the margin account falls below the maintenance-margin requirement, the holder of the contract will receive a margin call. C. A margin deposit can only be met with cash. D. All futures contracts require the same margin deposit. E. The maintenance margin is set by the producer of the underlying asset.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-02 Trading Mechanics. Topic: 22-02 The Basics of Futures Contracts
15. Which of the following statements is false? I) The maintenance-margin is the amount of money you post with your broker when you buy or sell a futures contract. II) If the value of the margin account falls below the maintenance-margin requirement, the holder of the contract will receive a margin call. III) A margin deposit can only be met with cash. IV) All futures contracts require the same margin deposit. A. I only B. II only C. III only D. IV only E. I, III, and IV
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-02 Trading Mechanics. Topic: 22-02 The Basics of Futures Contracts
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16. Financial futures contracts are actively traded on the following indices except A. the S&P 500 Index. B. the New York Stock Exchange Index. C. the Nikkei Index. D. the Dow Jones Industrial Index. E. All are actively traded.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
17. Financial futures contracts are actively traded on which of the following indices? A. The S&P 500 Index B. The New York Stock Exchange Index C. The Nikkei Index D. The Dow Jones Industrial Index E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
18. Agricultural futures contracts are actively traded on A. corn. B. oats. C. pork bellies. D. corn and oats. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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19. Agricultural futures contracts are actively traded on A. soybeans. B. oats. C. wheat. D. soybeans and oats. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
20. Agricultural futures contracts are actively traded on A. milk. B. orange juice. C. lumber. D. milk and orange juice. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
21. Agricultural futures contracts are actively traded on A. rice. B. sugar. C. canola. D. rice and sugar. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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22. Foreign currency futures contracts are actively traded on the A. euro. B. British pound. C. drachma. D. euro and British pound. E. All of the options are correct.
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23. Foreign currency futures contracts are actively traded on the A. Japanese yen. B. Australian dollar. C. Brazilian real. D. Japanese yen and Australian dollar. E. All of the options are correct.
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24. Metals and energy currency futures contracts are actively traded on A. gold. B. silver. C. propane. D. gold and silver. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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25. Metals and energy currency futures contracts are actively traded on A. copper. B. platinum. C. weather. D. copper and platinum. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
26. Interest rate futures contracts are actively traded on the A. eurodollars. B. euroyen. C. sterling. D. eurodollars and euroyen. E. All of the options are correct.
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27. To exploit an expected increase in interest rates, an investor would most likely A. sell Treasury bond futures. B. take a long position in wheat futures. C. buy S&P 500 Index futures. D. take a long position in Treasury bond futures. E. None of the options are correct.
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28. An investor with a long position in Treasury notes futures will profit if A. interest rates decline. B. interest rates increase. C. the prices of Treasury notes decrease. D. the price of the S&P 500 Index increases. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
29. To hedge a long position in Treasury bonds, an investor would most likely A. buy interest rate futures. B. sell S&P futures. C. sell interest rate futures. D. buy Treasury bonds in the spot market. E. None of the options are correct.
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30. An increase in the basis will __________ a long hedger and __________ a short hedger. A. hurt; benefit B. hurt; hurt C. benefit; hurt D. benefit; benefit E. benefit; have no effect upon
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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31. Which one of the following statements regarding "basis" is not true? A. The basis is the difference between the futures price and the spot price. B. The basis risk is borne by the hedger. C. A short hedger suffers losses when the basis decreases. D. The basis increases when the futures price increases by more than the spot price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
32. Which one of the following statements regarding "basis" is true? A. The basis is the difference between the futures price and the spot price. B. The basis risk is borne by the hedger. C. A short hedger suffers losses when the basis decreases. D. The basis increases when the futures price increases by more than the spot price. E. The basis is the difference between the futures price and the spot price, basis risk is borne by the hedger, and basis increases when the futures price increases by more than the spot price.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
33. If you determine that the S&P 500 Index futures is overpriced relative to the spot S&P 500 Index, you could make an arbitrage profit by A. buying all the stocks in the S&P 500 and selling put options on the S&P 500 Index. B. selling short all the stocks in the S&P 500 and buying S&P Index futures. C. selling all the stocks in the S&P 500 and buying call options on the S&P 500 Index. D. selling S&P 500 Index futures and buying all the stocks in the S&P 500. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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34. On January 1, the listed spot and futures prices of a Treasury bond were 93.8 and 93.13. You purchased $100,000 par value Treasury bonds and sold one Treasury bond futures contract. One month later, the listed spot price and futures prices were 94 and 94.09, respectively. If you were to liquidate your position, your profits would be a A. $125 loss. B. $125 profit. C. $12.50 loss. D. $1,250 loss. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
35. You purchased one silver future contract at $3 per ounce. What would be your profit (loss) at maturity if the silver spot price at that time is $4.10 per ounce? Assume the contract size is 5,000 ounces and there are no transactions costs. A. $5.50 profit B. $5,500 profit C. $5.50 loss D. $5,500 loss
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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36. You sold one silver future contract at $3 per ounce. What would be your profit (loss) at maturity if the silver spot price at that time is $4.10 per ounce? Assume the contract size is 5,000 ounces and there are no transactions costs. A. $5.50 profit B. $5,500 profit C. $5.50 loss D. $5,500 loss E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
37. You purchased one corn future contract at $2.29 per bushel. What would be your profit (loss) at maturity if the corn spot price at that time were $2.10 per bushel? Assume the contract size is 5,000 bushels and there are no transactions costs. A. $950 profit B. $95 profit C. $950 loss D. $95 loss E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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38. You sold one corn future contract at $2.29 per bushel. What would be your profit (loss) at maturity if the corn spot price at that time were $2.10 per bushel? Assume the contract size is 5,000 bushels and there are no transactions costs. A. $950 profit B. $95 profit C. $950 loss D. $95 loss E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
39. You sold one wheat future contract at $3.04 per bushel. What would be your profit (loss) at maturity if the wheat spot price at that time were $2.98 per bushel? Assume the contract size is 5,000 bushels and there are no transactions costs. A. $30 profit B. $300 profit C. $300 loss D. $30 loss
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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40. You purchased one wheat future contract at $3.04 per bushel. What would be your profit (loss) at maturity if the wheat spot price at that time were $2.98 per bushel? Assume the contract size is 5,000 bushels and there are no transactions costs. A. $30 profit B. $300 profit C. $300 loss D. $30 loss
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
41. On January 1, you sold one April S&P 500 Index futures contract at a futures price of 1,420. If, on February 1, the April futures price was 1,430, what would be your profit (loss) if you closed your position (without considering transactions costs)? A. $2,500 loss B. $10 loss C. $2,500 profit D. $10 profit
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
42. On January 1, you bought one April S&P 500 index futures contract at a futures price of 1,420. If, on February 1, the April futures price was 1,430, what would be your profit (loss) if you closed your position (without considering transactions costs)? A. $2,500 loss B. $10 loss C. $2,500 profit D. $10 profit
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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43. You sold one soybean future contract at $5.13 per bushel. What would be your profit (loss) at maturity if the wheat spot price at that time were $5.26 per bushel? Assume the contract size is 5,000 bushels and there are no transactions costs. A. $65 profit B. $650 profit C. $650 loss D. $65 loss
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
44. You bought one soybean future contract at $5.13 per bushel. What would be your profit (loss) at maturity if the wheat spot price at that time were $5.26 per bushel? Assume the contract size is 5,000 bushels and there are no transactions costs. A. $65 profit B. $650 profit C. $650 loss D. $65 loss
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
45. On April 1, you bought one S&P 500 Index futures contract at a futures price of 1,550. If, on June 15, the futures price was 1,612, what would be your profit (loss) if you closed your position (without considering transactions costs)? A. $1,550 loss B. $15,550 loss C. $15,550 profit D. $1,550 profit
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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46. On April 1, you sold one S&P 500 Index futures contract at a futures price of 1,550. If, on June 15, the futures price was 1,612, what would be your profit (loss) if you closed your position (without considering transactions costs)? A. $1,550 loss B. $15,550 loss C. $15,550 profit D. $1,550 profit
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
47. The expectations hypothesis of futures pricing A. is the simplest theory of futures pricing. B. states that the futures price equals the expected value of the future spot price of the asset. C. is not a zero-sum game. D. is the simplest theory of futures pricing and states that the futures price equals the expected value of the future spot price of the asset. E. is the simplest theory of futures pricing and is not a zero-sum game.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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48. Normal backwardation A. maintains that, for most commodities, there are natural hedgers who desire to shed risk. B. maintains that speculators will enter the long side of the contract only if the futures price is below the expected spot price. C. assumes that risk premiums in the futures markets are based on systematic risk. D. maintains that, for most commodities, there are natural hedgers who desire to shed risk, and that speculators will enter the long side of the contract only if the futures price is below the expected spot price. E. maintains that speculators will enter the long side of the contract only if the futures price is below the expected spot price and assumes that risk premiums in the futures markets are based on systematic risk.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-05 Futures Prices versus Expected Spot Prices. Topic: 22-05 The Clearinghouse and Open Interest
49. Contango A. holds that the natural hedgers are the purchasers of a commodity, not the suppliers. B. is a hypothesis polar to backwardation. C. holds that FO must be less than (PT). D. holds that the natural hedgers are the purchasers of a commodity, not the suppliers, and holds that FO must be less than (PT). E. holds that the natural hedgers are the purchasers of a commodity, not the suppliers, and is a hypothesis polar to backwardation.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-05 Futures Prices versus Expected Spot Prices. Topic: 22-05 The Clearinghouse and Open Interest
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50. Delivery of stock index futures A. is never made. B. is made by a cash settlement based on the index value. C. requires delivery of 1 share of each stock in the index. D. is made by delivering 100 shares of each stock in the index. E. is made by delivering a value-weighted basket of stocks.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
51. The establishment of a futures market in a commodity should not have a major impact on spot prices because A. the futures market is small relative to the spot market. B. the futures market is illiquid. C. futures are a zero-sum game. D. the futures market is large relative to the spot market. E. most futures contracts do not take delivery.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
52. Given a stock index with a value of $1,500, an anticipated dividend of $62 and a risk-free rate of 5.75%, what should be the value of one futures contract on the index? A. $1,343.40 B. $62.00 C. $1,418.44 D. $1,524.25
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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53. If a trader holding a long position in corn futures fails to meet the obligations of a futures contract, the party that is hurt by the failure is A. the offsetting short trader. B. the corn farmer. C. the clearinghouse. D. the broker. E. the commodities dealer.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
54. Open interest includes A. only contracts with a specified delivery date. B. the sum of short and long positions. C. the sum of short, long, and clearinghouse positions. D. the sum of long or short positions and clearinghouse positions. E. only long or short positions but not both.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
55. The process of marking to market A. posts gains or losses to each account daily. B. may result in margin calls. C. impacts only long positions. D. posts gains or losses to each account daily and may result in margin calls. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-02 Trading Mechanics. Topic: 22-02 The Basics of Futures Contracts
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56. Futures contracts are regulated by A. the Commodities Futures Trading Corporation. B. the Chicago Board of Trade. C. the Chicago Mercantile Exchange. D. the Federal Reserve. E. the Securities and Exchange Commission.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
57. Taxation of futures trading gains and losses A. is based on cumulative year-end profits or losses. B. occurs based on the date contracts are sold or closed. C. can be timed to offset stock-portfolio gains and losses. D. is based on the contract holding period. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-02 Trading Mechanics. Topic: 22-02 The Basics of Futures Contracts
58. Speculators may use futures markets rather than spot markets because A. transaction costs are lower in futures markets. B. futures markets provide leverage. C. spot markets are less efficient. D. futures markets are less efficient. E. transaction costs are lower in futures markets, and futures markets provide leverage.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-05 Futures Prices versus Expected Spot Prices. Topic: 22-05 The Clearinghouse and Open Interest
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59. Given a stock index with a value of $1,000, an anticipated dividend of $30, and a risk-free rate of 6%, what should be the value of one futures contract on the index? A. $943.40 B. $970.00 C. $1,030.00 D. $915.09 E. $1,000.00
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
60. Given a stock index with a value of $1,125, an anticipated dividend of $33, and a risk-free rate of 4%, what should be the value of one futures contract on the index? A. $1137.00 B. $1070.00 C. $993.40 D. $995.09 E. $1000.00
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
61. Given a stock index with a value of $1,100, an anticipated dividend of $27, and a risk-free rate of 3%, what should be the value of one futures contract on the index? A. $943.40 B. $970.00 C. $913.40 D. $1,106.00 E. $1,000.00
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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62. Given a stock index with a value of $1,200, an anticipated dividend of $45, and a risk-free rate of 6%, what should be the value of one futures contract on the index? A. $1,227.00 B. $1,070.00 C. $993.40 D. $995.09 E. $1,000.00
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
63. Which of the following items is specified in a futures contract? I) The contract size II) The maximum acceptable price range during the life of the contract III) The acceptable grade of the commodity on which the contract is held IV) The market price at expiration V) The settlement price A. I, II, and IV B. I, III, and V C. I and V D. I, IV, and V E. I, II, III, IV, and V
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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64. Which of the following items is not specified in a futures contract? I) The contract size II) The maximum acceptable price range during the life of the contract III) The acceptable grade of the commodity on which the contract is held IV) The market price at expiration V) The settlement price A. II and IV B. I, III, and V C. I and V D. I, IV, and V E. I, II, III, IV, and V
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
65. With regard to futures contracts, what does the word "margin" mean? A. It is the amount of the money borrowed from the broker when you buy the contract. B. It is the maximum percentage that the price of the contract can change before it is marked to market. C. It is the maximum percentage that the price of the underlying asset can change before it is marked to market. D. It is a good-faith deposit made at the time of the contract's purchase or sale. E. It is the amount by which the contract is marked to market.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-02 Trading Mechanics. Topic: 22-02 The Basics of Futures Contracts
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66. Which of the following is true about profits from futures contracts? A. The person with the long position gets to decide whether to exercise the futures contract and will only do so if there is a profit to be made. B. It is possible for both the holder of the long position and the holder of the short position to earn a profit. C. The clearinghouse makes most of the profit. D. The amount that the holder of the long position gains must equal the amount that the holder of the short position loses. E. Holders of short positions can recognize profits by making delivery early.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
67. Which of the following is false about profits from futures contracts? I) The person with the long position gets to decide whether to exercise the futures contract and will only do so if there is a profit to be made. II) It is possible for both the holder of the long position and the holder of the short position to earn a profit. III) The clearinghouse makes most of the profit. IV) The amount that the holder of the long position gains must equal the amount that the holder of the short position loses. A. I only B. II only C. III only D. IV only E. I, II, and III
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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68. Some of the newer futures contracts include I) fashion futures. II) weather futures. III) electricity futures. IV) entertainment futures. A. I and II B. II and III C. III and IV D. I, II, and III E. I, III, and IV
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
69. Who guarantees that a futures contract will be fulfilled? A. The buyer B. The seller C. The broker D. The clearinghouse E. Nobody
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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70. If you took a long position in a pork bellies futures contract and then forgot about it, what would happen at the expiration of the contract? A. Nothing—the seller understands that these things happen. B. You would wake up to find the pork bellies on your front lawn. C. Your broker would send you a nasty letter. D. You would be notified that you owe the holder of the short position a certain amount of cash. E. You would be notified that you have to pay a penalty in addition to the regular cost of the pork bellies.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
71. If a trader holding a long position in oil futures fails to meet the obligations of a futures contract, the party that is hurt by the failure is A. the offsetting short trader. B. the oil producer. C. the clearinghouse. D. the broker. E. the commodities dealer.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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72. A trader who has a __________ position in oil futures believes the price of oil will __________ in the future. A. short; increase B. long; increase C. short; stay the same D. long; stay the same
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
73. You hold one long oil futures contract that expires in April. To close your position in oil futures before the delivery date, you must A. buy one May oil futures contract. B. buy two April oil futures contracts. C. sell one April oil futures contract. D. sell one May oil futures contract. E. None of the options are correct. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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74. Financial futures contracts are actively traded on the following indices except A. the All ordinary index. B. the DAX 30 Index. C. the CAC 40 Index. D. the Toronto 35 Index. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
75. Financial futures contracts are actively traded on which of the following indices? A. The All ordinary index B. The DAX 30 Index C. The CAC 40 Index D. The Toronto 35 Index E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
76. To exploit an expected decrease in interest rates, an investor would most likely A. buy Treasury bond futures. B. take a long position in wheat futures. C. buy S&P 500 Index futures. D. take a short position in Treasury bond futures. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
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77. An investor with a short position in Treasury notes futures will profit if A. interest rates decline. B. interest rates increase. C. the prices of Treasury notes increase. D. the price of the long bond increases. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
78. To hedge a short position in Treasury bonds, an investor would most likely A. ignore interest rate futures. B. buy S&P futures. C. buy interest rate futures. D. sell Treasury bonds in the spot market.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 22-01 The Futures Contract. Topic: 22-01 The Futures Contract
79. A decrease in the basis will __________ a long hedger and __________ a short hedger. A. hurt; benefit B. hurt; hurt C. benefit; hurt D. benefit; benefit E. benefit; have no effect upon
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-05 Futures Prices versus Expected Spot Prices. Topic: 22-05 The Clearinghouse and Open Interest
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80. Which one of the following statements regarding "basis" is true? I) The basis is the difference between the futures price and the spot price. II) The basis risk is borne by the hedger. III) A short hedger suffers losses when the basis decreases. IV) The basis increases when the futures price increases by more than the spot price. A. I only B. II only C. III only D. IV only E. I, II, and IV.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-05 Futures Prices versus Expected Spot Prices. Topic: 22-05 The Clearinghouse and Open Interest
81. If you determine that the DAX-30 Index futures is overpriced relative to the spot DAX-30 Index, you could make an arbitrage profit by A. buying all the stocks in the DAX-30 and selling put options on the DAX-30 Index. B. selling short all the stocks in the DAX-30 and buying DAX-30 futures. C. selling all the stocks in the DAX-30 and buying call options on the DAX-30 Index. D. selling DAX-30 Index futures and buying all the stocks in the DAX-30.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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82. If you determine that the DAX-30 Index futures is underpriced relative to the spot DAX30 Index, you could make an arbitrage profit by A. buying all the stocks in the DAX-30 and selling put options on the DAX-30 Index. B. selling short all the stocks in the DAX-30 and buying DAX-30 futures. C. selling all the stocks in the DAX-30 and buying call options on the DAX-30 Index. D. buying DAX-30 Index futures and selling all the stocks in the DAX-30. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
83. On January 1, the listed spot and futures prices of a Treasury bond were 95.4 and 95.6. You sold $100,000 par value Treasury bonds and purchased one Treasury bond futures contract. One month later, the listed spot price and futures prices were 95 and 94.4, respectively. If you were to liquidate your position, your profits would be a A. $125 loss. B. $125 profit. C. $1,060.50 loss. D. $1,062.50 profit. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
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84. You purchased one oil future contract at $70 per barrel. What would be your profit (loss) at maturity if the oil spot price at that time is $73.12 per barrel? Assume the contract size is 1,000 barrels and there are no transactions costs. A. $3.12 profit B. $31.20 profit C. $3.12 loss D. $31.20 loss E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
85. You sold one oil future contract at $70 per barrel. What would be your profit (loss) at maturity if the oil spot price at that time is $73.12 per barrel? Assume the contract size is 1,000 barrels and there are no transactions costs. A. $3.12 profit B. $31.20 profit C. $3.12 loss D. $31.20 loss E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 22-04 Futures Prices. Topic: 22-04 Trading Mechanics
Chapter 23 Futures, Swaps, and Risk Management
Multiple Choice Questions
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1. Which one of the following stock index futures has a multiplier of $50 times the index value? A. Russell 2000 B. S&P 500 (E-mini) C. Nikkei D. DAX-30 E. NASDAQ 100
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
2. Which one of the following stock index futures has a multiplier of $10 times the index value? A. Russell 2000 B. Dow Jones Industrial Average C. Nikkei D. DAX-30 E. NASDAQ 100
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
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3. Which one of the following stock index futures has a multiplier of $50 times the index value? A. Russell 2000 B. FTSE 100 C. Nikkei D. NASDAQ 100 E. Mini-Russell 2000 and NASDAQ 100
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
4. Which one of the following stock index futures has a multiplier of $50 times the index value? A. Mini-Russell 2000 B. FTSE 100 C. S&P Mid-Cap D. DAX-30 E. Russell 2000 and S&P Mid-Cap
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
5. Which one of the following stock index futures has a multiplier of $100 times the index value? A. CAC 40 B. S&P 500 Index C. Nikkei D. DAX-30 E. NASDAQ 100
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
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6. Which one of the following stock index futures has a multiplier of 10 euros times the index? A. CAC 40 B. Hang Seng C. Nikkei D. DAX-30 E. CAC 40 and Hang Seng
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
7. Which one of the following stock index futures has a multiplier of 50 Hong Kong dollars times the index? A. FTSE 100 B. Hang Seng C. Nikkei D. DAX-30 E. FTSE 100 and Hang Seng
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
8. Which one of the following stock index futures has a multiplier of 25 euros times the index? A. FTSE 100 B. Hang Seng C. Nikkei D. DAX-30 E. FTSE 100 and Hang Seng
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
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9. If you purchased one S&P 500 Index futures contract at a price of 1,550 and closed your position when the index futures was 1,547, you incurred A. a loss of $1,500. B. a gain of $1,500. C. a loss of $750. D. a gain of $750. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
10. If you took a short position in two S&P 500 futures contracts at a price of 1,510 and closed the position when the index futures was 1,492, you incurred A. a gain of $9,000. B. a loss of $9,000. C. a loss of $18,000. D. a gain of $18,000. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
11. If a stock index futures contract is overpriced, you would exploit this situation by A. selling both the stock index futures and the stocks in the index. B. selling the stock index futures and simultaneously buying the stocks in the index. C. buying both the stock index futures and the stocks in the index. D. buying the stock index futures and selling the stocks in the index. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
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12. Foreign exchange futures markets are __________, and the foreign exchange forward markets are __________. A. informal; formal B. formal; formal C. formal; informal D. informal; informal E. organized; unorganized
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-01 Foreign Exchange Futures. Topic: 23-01 Foreign Exchange Futures
13. Suppose that the risk-free rates in the United States and in the United Kingdom are 4% and 6%, respectively. The spot exchange rate between the dollar and the pound is $1.60/BP. What should the futures price of the pound for a one-year contract be to prevent arbitrage opportunities, ignoring transactions costs? A. $1.60/BP B. $1.70/BP C. $1.66/BP D. $1.63/BP E. $1.57/BP
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
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14. Suppose that the risk-free rates in the United States and in the United Kingdom are 5% and 4%, respectively. The spot exchange rate between the dollar and the pound is $1.80/BP. What should the futures price of the pound for a one-year contract be to prevent arbitrage opportunities, ignoring transactions costs? A. $1.62/BP B. $1.72/BP C. $1.82/BP D. $1.92/BP
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
15. Suppose that the risk-free rates in the United States and in Japan are 5.25% and 4.5%, respectively. The spot exchange rate between the dollar and the yen is $0.008828/yen. What should the futures price of the yen for a one-year contract be to prevent arbitrage opportunities, ignoring transactions costs? A. $0.009999/yen B. $0.009981/yen C. $0.008981/yen D. $0.008891/yen
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
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16. Let RUS be the annual risk-free rate in the United States, RUK be the risk-free rate in the United Kingdom, F be the futures price of $/BP for a 1-year contract, and E the spot exchange rate of $/BP. Which one of the following is true? A. If RUS>RUK, then E>F. B. If RUS<RUK, then E<F. C. If RUS>RUK, then E<F. D. If RUS<RUK, then F = E. E. There is no consistent relationship that can be predicted.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
17. Let RUS be the annual risk-free rate in the United States, RJ be the risk-free rate in Japan, F be the futures price of $/yen for a 1-year contract, and E the spot exchange rate of $/yen. Which one of the following is true? A. If RUS>RJ, then E<F. B. If RUS<RJ, then E<F. C. If RUS>RJ, then E>F. D. If RUS<RJ, then F = E. E. There is no consistent relationship that can be predicted.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
18. Consider the following:
Risk-free rate in the United States Risk-free rate in Australia Spot exchange rate
CF Now 0.04/year 0.03/year 1.67 A$/$
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What should be the proper futures price for a 1-year contract? A. 1.703 A$/$ B. 1.654 A$/$ C. 1.638 A$/$ D. 1.778 A$/$ E. 1.686 A$/$
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
19. Consider the following:
Risk-free rate in the United States Risk-free rate in Canada Spot exchange rate
CF Now 0.04/year 0.03/year 1.67 A$/$
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If the futures market price is 1.63 A$/$, how could you arbitrage? A. Borrow Australian dollars in Canada convert them to dollars, lend the proceeds in the United States, and enter futures positions to purchase Canadian dollars at the current futures price. B. Borrow U.S. dollars in the United States, convert them to Canadian dollars, lend the proceeds in Canada, and enter futures positions to sell Australian dollars at the current futures price. C. Borrow U.S. dollars in the United States, invest them in the U.S., and enter futures positions to purchase Canadian dollars at the current futures price. D. Borrow Canadian dollars in Canada and invest them there, then convert back to U.S. dollars at the spot price. E. There is no arbitrage opportunity.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
20. Consider the following:
Risk-free rate in the United States Risk-free rate in Canada Spot exchange rate
CF Now 0.04/year 0.03/year 1.67 A$/$
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If the market futures price is 1.69 A$/$, how could you arbitrage? A. Borrow Canadian dollars in Canada, convert them to dollars, lend the proceeds in the United States, and enter futures positions to purchase Canadian dollars at the current futures price. B. Borrow U.S. dollars in the United States, convert them to Canadian dollars, lend the proceeds in Canada, and enter futures positions to sell Canadian dollars at the current futures price. C. Borrow U.S. dollars in the United States, invest them in the U.S., and enter futures positions to purchase Canadian dollars at the current futures price. D. Borrow Canadian dollars in Canada and invest them there, then convert back to U.S. dollars at the spot price. E. There is no arbitrage opportunity.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
21. Consider the following:
Risk-free rate in the United States Risk-free rate in Canada Spot exchange rate
CF Now 0.04/year 0.03/year 1.67 A$/$
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Assume the current market futures price is 1.66 CAD$/$. You borrow 167,000 CAD$, convert the proceeds to U.S. dollars, and invest them in the U.S. at the risk-free rate. You simultaneously enter a contract to purchase 170,340 CAD$ at the current futures price (maturity of 1 year). What would be your profit (loss)? A. Profit of 630 CAD$ B. Loss of 2300 CAD$ C. Profit of 2300 CAD$ D. Loss of 630 CAD$
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
22. Which of the following is(are) example(s) of interest rate futures contracts? A. Corporate bonds B. Treasury bonds C. Eurodollars D. Treasury bonds and Eurodollars E. Corporate bonds and Treasury bonds
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-03 Interest Rate Futures. Topic: 23-03 Interest Rate Parity
1-822
23. A swap A. obligates two counterparties to exchange cash flows at one or more future dates. B. allows participants to restructure their balance sheets. C. allows a firm to convert outstanding fixed rate debt to floating rate debt. D. obligates two counterparties to exchange cash flows at one or more future dates and allows participants to restructure their balance sheets. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-04 Swaps. Topic: 23-04 Direct versus Indirect Quotes
24. Credit risk in the swap market A. is extensive. B. is limited to the difference between the values of the fixed rate and floating rate obligations. C. is equal to the total value of the payments that the floating rate payer was obligated to make. D. is extensive and equal to the total value of the payments that the floating rate payer was obligated to make. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-04 Swaps. Topic: 23-04 Direct versus Indirect Quotes
1-823
25. Trading in stock index futures A. now exceeds buying and selling of shares in most markets. B. reduces transactions costs as compared to trading in stocks. C. increases leverage as compared to trading in stocks. D. generally results in faster execution than trading in stocks. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
26. Commodity futures pricing A. must be related to spot prices. B. includes cost of carry. C. converges to spot prices at maturity. D. All of the options are correct. E. None of the options.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
27. Arbitrage proofs in futures market pricing relationships A. rely on the CAPM. B. demonstrate how investors can exploit misalignments. C. incorporate transactions costs. D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Hard Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
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28. One reason swaps are desirable is that A. they are free of credit risk. B. they have no transactions costs. C. they increase interest rate volatility. D. they increase interest rate risk. E. they offer participants easy ways to restructure their balance sheets.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 23-04 Swaps. Topic: 23-04 Direct versus Indirect Quotes
29. Which two indices had the lowest correlation between them during the 2008-2012 period? A. S&P and DJIA; the correlation was 0.979 B. S&P and NASDAQ 100; the correlation was 0.928 C. DJIA and Russell 2000; the correlation was 0.908 D. S&P and Russell 2000; the correlation was 0.948 E. NASDAQ 100 and DJIA; the correlation was 0.876
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
30. Which two indices had the highest correlation between them during the 2008-2012 period? A. S&P and DJIA; the correlation was 0.979 B. S&P and Russell 2000; the correlation was 0.948 C. DJIA and Russell 2000; the correlation was 0.908 D. S&P and NASDAQ 100; the correlation was 0.928 E. NASDAQ 100 and DJIA; the correlation was 0.876
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
1-825
31. The value of a futures contract for storable commodities can be determined by the _______, and the model __________ consistent with parity relationships. A. CAPM; will be B. CAPM; will not be C. APT; will not be D. APT; will be E. CAPM and APT; will be
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
32. In the equation Profits = a + b ($/₤ exchange rate), b is a measure of A. the firm's beta when measured in terms of the foreign currency. B. the ratio of the firm's beta in terms of dollars to the firm's beta in terms of pounds. C. the sensitivity of profits to the exchange rate. D. the sensitivity of the exchange rate to profits. E. the frequency with which the exchange rate changes.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 23-01 Foreign Exchange Futures. Topic: 23-01 Foreign Exchange Futures
33. Hedging one commodity by using a futures contract on another commodity is called A. surrogate hedging. B. cross hedging. C. alternative hedging. D. correlative hedging. E. proxy hedging.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-03 Interest Rate Futures. Topic: 23-03 Interest Rate Parity
1-826
34. You are given the following information about a portfolio you are to manage. For the long term, you are bullish, but you think the market may fall over the next month.
Portfolio Value Portfolio's Beta Current S&P500 Value Anticipated S&P500 Value
$1 million 0.60 1400 1200
If the anticipated market value materializes, what will be your expected loss on the portfolio? A. 14.29% B. 16.67% C. 15.43% D. 8.57% E. 6.42%
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
35. You are given the following information about a portfolio you are to manage. For the long term, you are bullish, but you think the market may fall over the next month.
Portfolio Value Portfolio's Beta Current S&P500 Value Anticipated S&P500 Value
$1 million 0.60 1400 1200
1-827
What is the dollar value of your expected loss? A. $142,900 B. $16,670 C. $85,700 D. $30,000 E. $64,200
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
36. You are given the following information about a portfolio you are to manage. For the long term, you are bullish, but you think the market may fall over the next month.
Portfolio Value Portfolio's Beta Current S&P500 Value Anticipated S&P500 Value
$1 million 0.60 1400 1200
For a 200-point drop in the S&P 500, by how much does the value of the futures position change? A. $200,000 B. $50,000 C. $250,000 D. $500,000 E. $100,000
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
1-828
37. You are given the following information about a portfolio you are to manage. For the long term, you are bullish, but you think the market may fall over the next month.
Portfolio Value Portfolio's Beta Current S&P500 Value Anticipated S&P500 Value
$1 million 0.60 1400 1200
How many contracts should you buy or sell to hedge your position? Allow fractions of contracts in your answer. A. sell 1.714 B. buy 1.714 C. sell 4.236 D. buy 4.236 E. sell 11.235
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-03 Interest Rate Futures. Topic: 23-03 Interest Rate Parity
1-829
38. If you sold an S&P 500 Index futures contract at a price of 950 and closed your position when the index futures was 947, you incurred A. a loss of $1,500. B. a gain of $1,500. C. a loss of $750. D. a gain of $750. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
39. If you took a short position in three S&P 500 futures contracts at a price of 900 and closed the position when the index futures was 885, you incurred A. a gain of $11,250. B. a loss of $11,250. C. a loss of $8,000. D. a gain of $8,000. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
1-830
40. Suppose that the risk-free rates in the United States and in Canada are 3% and 5%, respectively. The spot exchange rate between the dollar and the Canadian dollar (C$) is $0.80/C$. What should the futures price of the C$ for a one-year contract be to prevent arbitrage opportunities, ignoring transactions costs. A. $1.00/C$ B. $1.70/C$ C. $0.88/C$ D. $0.78/C$ E. $1.22/C$
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
41. Suppose that the risk-free rates in the United States and in Canada are 5% and 3%, respectively. The spot exchange rate between the dollar and the Canadian dollar (C$) is $0.80/C$. What should the futures price of the C$ for a one-year contract be to prevent arbitrage opportunities, ignoring transactions costs. A. $1.00/C$ B. $0.82/C$ C. $0.88/C$ D. $0.78/C$ E. $1.22/C$
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
1-831
42. Suppose that the risk-free rates in the United States and in the United Kingdom are 6% and 4%, respectively. The spot exchange rate between the dollar and the pound is $1.60/BP. What should the futures price of the pound for a one-year contract be to prevent arbitrage opportunities, ignoring transactions costs. A. $1.60/BP B. $1.70/BP C. $1.66/BP D. $1.63/BP E. $1.57/BP
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
43. You are given the following information about a portfolio you are to manage. For the long term, you are bullish, but you think the market may fall over the next month.
Portfolio Value Portfolio's Beta Current S&P500 Value Anticipated S&P500 Value
$1 million 0.86 990 915
1-832
If the anticipated market value materializes, what will be your expected loss on the portfolio? A. 7.58% B. 6.52% C. 15.43% D. 8.57% E. 6.42%
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
44. You are given the following information about a portfolio you are to manage. For the long term, you are bullish, but you think the market may fall over the next month.
Portfolio Value Portfolio's Beta Current S&P500 Value Anticipated S&P500 Value
$1 million 0.86 990 915
What is the dollar value of your expected loss? A. $142,900 B. $65,200 C. $85,700 D. $30,000 E. $64,200
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
1-833
45. You are given the following information about a portfolio you are to manage. For the long term, you are bullish, but you think the market may fall over the next month.
Portfolio Value Portfolio's Beta Current S&P500 Value Anticipated S&P500 Value
$1 million 0.86 990 915
For a 75-point drop in the S&P 500, by how much does the futures position change? A. $200,000 B. $50,000 C. $250,000 D. $500,000 E. $18,750
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
46. You are given the following information about a portfolio you are to manage. For the long term, you are bullish, but you think the market may fall over the next month.
Portfolio Value Portfolio's Beta Current S&P500 Value Anticipated S&P500 Value
$1 million 0.86 990 915
1-834
How many contracts should you buy or sell to hedge your position? Allow fractions of contracts in your answer. A. Sell 3.477 B. Buy 3.477 C. Sell 4.236 D. Buy 4.236 E. Sell 11.235
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
47. Covered interest arbitrage A. ensures that currency futures prices are set correctly. B. ensures that commodity futures prices are set correctly. C. ensures that interest rate futures prices are set correctly. D. ensures that currency futures prices and commodity futures prices are set correctly. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-01 Foreign Exchange Futures. Topic: 23-01 Foreign Exchange Futures
1-835
48. A hedge ratio can be computed as A. profit derived from one futures position for a given change in the exchange rate divided by the change in value of the unprotected position for the same exchange rate. B. the change in value of the unprotected position for a given change in the exchange rate divided by the profit derived from one futures position for the same exchange rate. C. profit derived from one futures position for a given change in the exchange rate plus the change in value of the unprotected position for the same exchange rate. D. the change in value of the unprotected position for a given change in the exchange rate plus by the profit derived from one futures position for the same exchange rate.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 23-02 Stock-Index Futures. Topic: 23-02 The Markets
49. The most common short-term interest rate used in the swap market is A. the U.S. discount rate. B. the U.S. prime rate. C. the U.S. fed funds rate. D. LIBOR. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
1-836
50. If interest rate parity holds, A. covered interest arbitrage opportunities will exist. B. covered interest arbitrage opportunities will not exist. C. arbitragers will be able to make risk-free profits. D. covered interest arbitrage opportunities will exist, and arbitragers will be able to make riskfree profits. E. covered interest arbitrage opportunities will not exist, and arbitragers will be able to make risk-free profits.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
51. If interest rate parity does not hold, A. covered interest arbitrage opportunities will exist. B. covered interest arbitrage opportunities will not exist. C. arbitragers will be able to make risk-free profits. D. covered interest arbitrage opportunities will exist, and arbitragers will be able to make riskfree profits. E. covered interest arbitrage opportunities will not exist, and arbitragers will be able to make risk-free profits.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
1-837
52. If covered interest arbitrage opportunities do not exist, A. interest rate parity does not hold. B. interest rate parity holds. C. arbitragers will be able to make risk-free profits. D. interest rate parity does not hold, and arbitragers will be able to make risk-free profits. E. interest rate parity holds, and arbitragers will be able to make risk-free profits.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
53. If covered interest arbitrage opportunities exist, A. interest rate parity does not hold. B. interest rate parity holds. C. arbitragers will be able to make risk-free profits. D. interest rate parity does not hold, and arbitragers will be able to make risk-free profits. E. interest rate parity holds, and arbitragers will be able to make risk-free profits.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 23-05 Commodity Futures Pricing. Topic: 23-05 Using Futures to Manage Exchange Rate Risk
Chapter 24 Portfolio Performance Evaluation
Multiple Choice Questions
1-838
1. Hedge funds I) are appropriate as a sole investment vehicle for an investor. II) should only be added to an already well-diversified portfolio. III) pose performance-evaluation issues due to nonlinear factor exposures. IV) have down-market betas that are typically larger than up-market betas. V) have symmetrical betas. A. I only B. II and V C. I, III, and IV D. II, III, and IV E. I, III, and V
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
2. Mutual funds show ____________ evidence of serial correlation, and hedge funds show ____________ evidence of serial correlation. A. almost no; almost no B. almost no; substantial C. substantial; substantial D. substantial; almost no E. modest; modest
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
1-839
3. The comparison universe is A. a concept found only in astronomy. B. the set of all mutual funds in the world. C. the set of all mutual funds in the U.S. D. a set of mutual funds with similar risk characteristics to your mutual fund. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
4. The comparison universe is not A. a concept found only in astronomy. B. the set of all mutual funds in the world. C. the set of all mutual funds in the U.S. D. a set of mutual funds with similar risk characteristics to your mutual fund. E. a concept found only in astronomy, the set of all mutual funds in the world, or the set of all mutual funds in the U.S.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
5. __________ developed a popular method for risk-adjusted performance evaluation of mutual funds. A. Eugene Fama B. Michael Jensen C. William Sharpe D. Jack Treynor E. Michael Jensen, William Sharpe, and Jack Treynor
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
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6. Henriksson (1984) found that, on average, betas of funds __________ during market advances. A. increased very significantly B. increased slightly C. decreased slightly D. decreased very significantly E. did not change
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 24-04 Market Timing. Topic: 24-04 The Sharpe Ratio for Overall Portfolios
7. Most professionally managed equity funds generally A. outperform the S&P 500 Index on both raw and risk-adjusted return measures. B. underperform the S&P 500 Index on both raw and risk-adjusted return measures. C. outperform the S&P 500 Index on raw return measures and underperform the S&P 500 Index on risk-adjusted return measures. D. underperform the S&P 500 Index on raw return measures and outperform the S&P 500 Index on risk-adjusted return measures. E. match the performance of the S&P 500 Index on both raw and risk-adjusted return measures.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
1-841
8. Suppose two portfolios have the same average return and the same standard deviation of returns, but portfolio A has a higher beta than portfolio B. According to the Sharpe measure, the performance of portfolio A A. is better than the performance of portfolio B. B. is the same as the performance of portfolio B. C. is poorer than the performance of portfolio B. D. cannot be measured as there are no data on the alpha of the portfolio. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
9. Suppose two portfolios have the same average return and the same standard deviation of returns, but portfolio A has a higher beta than portfolio B. According to the Treynor measure, the performance of portfolio A A. is better than the performance of portfolio B. B. is the same as the performance of portfolio B. C. is poorer than the performance of portfolio B. D. cannot be measured as there are no data on the alpha of the portfolio. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
1-842
10. Suppose two portfolios have the same average return and the same standard deviation of returns, but portfolio A has a lower beta than portfolio B. According to the Treynor measure, the performance of portfolio A A. is better than the performance of portfolio B. B. is the same as the performance of portfolio B. C. is poorer than the performance of portfolio B. D. cannot be measured as there are no data on the alpha of the portfolio. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
11. Suppose two portfolios have the same average return and the same standard deviation of returns, but Aggie Fund has a higher beta than Raider Fund. According to the Sharpe measure, the performance of Aggie Fund A. is better than the performance of Raider Fund. B. is the same as the performance of Raider Fund. C. is poorer than the performance of Raider Fund. D. cannot be measured as there are no data on the alpha of the portfolio.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
1-843
12. Suppose two portfolios have the same average return and the same standard deviation of returns, but Aggie Fund has a higher beta than Raider Fund. According to the Treynor measure, the performance of Aggie Fund A. is better than the performance of Raider Fund. B. is the same as the performance of Raider Fund. C. is poorer than the performance of Raider Fund. D. cannot be measured as there are no data on the alpha of the portfolio.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
13. Suppose two portfolios have the same average return and the same standard deviation of returns, but Aggie Fund has a lower beta than Raider Fund. According to the Treynor measure, the performance of Aggie Fund A. is better than the performance of Raider Fund. B. is the same as the performance of Raider Fund. C. is poorer than the performance of Raider Fund. D. cannot be measured as there are no data on the alpha of the portfolio.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
14. Suppose two portfolios have the same average return and the same standard deviation of returns, but Buckeye Fund has a higher beta than Gator Fund. According to the Sharpe measure, the performance of Buckeye Fund A. is better than the performance of Gator Fund. B. is the same as the performance of Gator Fund. C. is poorer than the performance of Gator Fund. D. cannot be measured as there are no data on the alpha of the portfolio.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
1-844
15. Suppose two portfolios have the same average return and the same standard deviation of returns, but Buckeye Fund has a lower beta than Gator Fund. According to the Sharpe measure, the performance of Buckeye Fund A. is better than the performance of Gator Fund. B. is the same as the performance of Gator Fund. C. is poorer than the performance of Gator Fund. D. cannot be measured as there are no data on the alpha of the portfolio.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 24-01 The Conventional Theory of Performance Evaluation. Topic: 24-01 The Conventional Theory of Performance Evaluation
16. Suppose two portfolios have the same average return and the same standard deviation of returns, but Buckeye Fund has a lower beta than Gator Fund. According to the Treynor measure, the performance of Buckeye Fund A. is better than the performance of Gator Fund. B. is the same as the performance of Gator Fund. C. is poorer than the performance of Gator Fund. D. cannot be measured as there are no data on the alpha of the portfolio. E. None of the options are correct.
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1-845
17. Suppose two portfolios have the same average return and the same standard deviation of returns, but Buckeye Fund has a higher beta than Gator Fund. According to the Treynor measure, the performance of Buckeye Fund A. is better than the performance of Gator Fund. B. is the same as the performance of Gator Fund. C. is poorer than the performance of Gator Fund. D. cannot be measured as there are no data on the alpha of the portfolio. E. None of the options are correct.
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18. Morningstar's RAR method I) is one of the most widely-used performance measures. II) indicates poor performance by placing up to 5 darts next to the fund's name. III) computes fund returns adjusted for loads. IV) computes fund returns adjusted for risk. V) produces ranking results that are the same as those produced with the Sharpe measure. A. I, II, and IV B. I, III, and IV C. I, IV, and V D. I, II, IV, and V E. I, II, III, IV, and V
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1-846
19. Suppose you purchase 100 shares of GM stock at the beginning of year 1 and purchase another 100 shares at the end of year 1. You sell all 200 shares at the end of year 2. Assume that the price of GM stock is $50 at the beginning of year 1, $55 at the end of year 1, and $65 at the end of year 2. Assume no dividends were paid on GM stock. Your dollar-weighted return on the stock will be __________ your time-weighted return on the stock. A. higher than B. the same as C. less than D. exactly proportional to E. More information is necessary to answer this question.
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20. Suppose the risk-free return is 4%. The beta of a managed portfolio is 1.2, the alpha is 1%, and the average return is 14%. Based on Jensen's measure of portfolio performance, you would calculate the return on the market portfolio as A. 11.5%. B. 14%. C. 15%. D. 16%.
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1-847
21. Suppose the risk-free return is 3%. The beta of a managed portfolio is 1.75, the alpha is 0%, and the average return is 16%. Based on Jensen's measure of portfolio performance, you would calculate the return on the market portfolio as A. 12.3%. B. 10.4%. C. 15.1%. D. 16.7%.
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22. Suppose the risk-free return is 6%. The beta of a managed portfolio is 1.5, the alpha is 3%, and the average return is 18%. Based on Jensen's measure of portfolio performance, you would calculate the return on the market portfolio as A. 12%. B. 14%. C. 15%. D. 16%.
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23. Suppose a particular investment earns an arithmetic return of 10% in year 1, 20% in year 2, and 30% in year 3. The geometric average return for the period will be A. greater than the arithmetic average return. B. equal to the arithmetic average return. C. less than the arithmetic average return. D. equal to the market return. E. It cannot be determined from the information given.
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1-848
24. Suppose you buy 100 shares of Abolishing Dividend Corporation at the beginning of year 1 for $80. Abolishing Dividend Corporation pays no dividends. The stock price at the end of year 1 is $100, $120 at the end of year 2, and $150 at the end of year 3. The stock price declines to $100 at the end of year 4, and you sell your 100 shares. For the four years, your geometric average return is A. 0.0%. B. 1.0%. C. 5.7%. D. 9.2%. E. 34.5%.
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25. You want to evaluate three mutual funds using the information ratio measure for performance evaluation. The risk-free return during the sample period is 6%, and the average return on the market portfolio is 19%. The average returns, residual standard deviations, and betas for the three funds are given below.
Fund A Fund B Fund C
Average Return 20%
Residual Standard Deviation Beta 4.00 % 0.8
21%
1.25
%
1.0
23%
1.20
%
1.2
1-849
The fund with the highest information ratio measure is A. Fund A. B. Fund B. C. Fund C. D. Funds A and B (tied for highest). E. Funds A and C (tied for highest).
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26. You want to evaluate three mutual funds using the Sharpe measure for performance evaluation. The risk-free return during the sample period is 6%. The average returns, standard deviations, and betas for the three funds are given below, as are the data for the S&P 500 Index.
Fund A Fund B Fund C S&P 500
Average Return 24 % 12 % 22 % 18 %
Standard Deviation 30 % 10 % 20 % 16 %
1-850
Beta 1.5 0.5 1.0 1.0
The fund with the highest Sharpe measure is A. Fund A. B. Fund B. C. Fund C. D. Funds A and B (tied for highest). E. Funds A and C (tied for highest).
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27. You want to evaluate three mutual funds using the Sharpe measure for performance evaluation. The risk-free return during the sample period is 4%. The average returns, standard deviations, and betas for the three funds are given below, as are the data for the S&P 500 Index.
Fund A Fund B Fund C S&P 500
Average Return 18 % 15 % 11 % 10 %
Standard Deviation 38 % 27 % 24 % 22 %
1-851
Beta 1.6 1.3 1.0 1.0
The fund with the highest Sharpe measure is A. Fund A. B. Fund B. C. Fund C. D. Funds A and B (tied for highest). E. Funds A and C (tied for highest).
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28. You want to evaluate three mutual funds using the Sharpe measure for performance evaluation. The risk-free return during the sample period is 5%. The average returns, standard deviations, and betas for the three funds are given below, as are the data for the S&P 500 Index.
Fund A Fund B Fund C S&P 500
Average Return 23 % 20 % 19 % 18 %
Residual Standard Deviation 30 % 19 % 17 % 15 %
1-852
Beta 1.3 1.2 1.1 1.0
The investment with the highest Sharpe measure is A. Fund A. B. Fund B. C. Fund C. D. the index. E. Funds A and C (tied for highest).
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29. You want to evaluate three mutual funds using the Treynor measure for performance evaluation. The risk-free return during the sample period is 6%. The average returns, standard deviations, and betas for the three funds are given below, in addition to information regarding the S&P 500 Index.
Fund A Fund B Fund C S&P 500
Average Return 13 % 19 % 25 % 18 %
Standard Deviation Beta 10 % 0.5 20 % 1.0 30 % 1.5 16 % 1.0
1-853
The fund with the highest Treynor measure is A. Fund A. B. Fund B. C. Fund C. D. Funds A and B (tied for highest). E. Funds A and C (tied for highest).
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30. You want to evaluate three mutual funds using the Jensen measure for performance evaluation. The risk-free return during the sample period is 6%, and the average return on the market portfolio is 18%. The average returns, standard deviations, and betas for the three funds are given below.
Fund A Fund B Fund C
Average Return 17.6 %
Residual Standard Deviation Beta 10 % 1.2
17.5
%
20
%
1.0
17.4
%
30
%
0.8
1-854
The fund with the highest Jensen measure is A. Fund A. B. Fund B. C. Fund C. D. Funds A and B (tied for highest). E. Funds A and C (tied for highest).
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31. Suppose you purchase one share of the stock of Volatile Engineering Corporation at the beginning of year 1 for $36. At the end of year 1, you receive a $2 dividend and buy one more share for $30. At the end of year 2, you receive total dividends of $4 (i.e., $2 for each share) and sell the shares for $36.45 each. The time-weighted return on your investment is A. -1.75%. B. 4.08%. C. 6.74%. D. 11.46%. E. 12.35%.
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1-855
32. Suppose you purchase one share of the stock of Volatile Engineering Corporation at the beginning of year 1 for $36. At the end of year 1, you receive a $2 dividend and buy one more share for $30. At the end of year 2, you receive total dividends of $4 (i.e., $2 for each share) and sell the shares for $36.45 each. The dollar-weighted return on your investment is A. -1.75%. B. 4.08%. C. 8.53%. D. 8.00%. E. 12.35%.
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33. Suppose you purchase one share of the stock of Cereal Correlation Company at the beginning of year 1 for $50. At the end of year 1, you receive a $1 dividend and buy one more share for $72. At the end of year 2, you receive total dividends of $2 (i.e., $1 for each share) and sell the shares for $67.20 each. The time-weighted return on your investment is A. 10.0%. B. 8.7%. C. 19.7%. D. 17.6%.
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1-856
34. Suppose you purchase one share of the stock of Cereal Correlation Company at the beginning of year 1 for $50. At the end of year 1, you receive a $1 dividend and buy one more share for $72. At the end of year 2, you receive total dividends of $2 (i.e., $1 for each share) and sell the shares for $67.20 each. The dollar-weighted return on your investment is A. 10.00%. B. 8.78%. C. 19.71%. D. 20.36%.
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35. Suppose you own two stocks, A and B. In year 1, stock A earns a 2% return and stock B earns a 9% return. In year 2, stock A earns an 18% return and stock B earns an 11% return. __________ has the higher arithmetic average return. A. Stock A B. Stock B C. The two stocks have the same arithmetic average return. D. At least three periods are needed to calculate the arithmetic average return.
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1-857
36. Suppose you own two stocks, A and B. In year 1, stock A earns a 2% return and stock B earns a 9% return. In year 2, stock A earns an 18% return and stock B earns an 11% return. Which stock has the higher geometric average return? A. Stock A B. Stock B C. The two stocks have the same geometric average return. D. At least three periods are needed to calculate the geometric average return.
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37. The following data are available relating to the performance of Sooner Stock Fund and the market portfolio:
Sooner Average return Standard deviations of returns Beta Residual standard deviation
20 44
1.8 2.0
% %
Market Portfolio 11 % 19 %
%
1.0 0.0
%
1-858
The risk-free return during the sample period was 3%. What is the Sharpe measure of performance evaluation for Sooner Stock Fund? A. 1.33% B. 4.00% C. 8.67% D. 38.6% E. 37.14%
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38. The following data are available relating to the performance of Sooner Stock Fund and the market portfolio:
Sooner Average return Standard deviations of returns Beta Residual standard deviation
20 44
1.8 2.0
% %
Market Portfolio 11 % 19 %
%
1.0 0.0
%
1-859
The risk-free return during the sample period was 3%. What is the Treynor measure of performance evaluation for Sooner Stock Fund? A. 1.33% B. 4.00% C. 8.67% D. 9.44% E. 37.14%
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39. The following data are available relating to the performance of Sooner Stock Fund and the market portfolio:
Sooner Average return Standard deviations of returns Beta Residual standard deviation
20 44
1.8 2.0
% %
Market Portfolio 11 % 19 %
%
1.0 0.0
%
1-860
The risk-free return during the sample period was 3%. Calculate the Jensen measure of performance evaluation for Sooner Stock Fund. A. 2.6% B. 4.00% C. 8.67% D. 31.43% E. 37.14%
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40. The following data are available relating to the performance of Sooner Stock Fund and the market portfolio:
Sooner Average return Standard deviations of returns Beta Residual standard deviation
20 44
1.8 2.0
% %
Market Portfolio 11 % 19 %
%
1.0 0.0
%
1-861
The risk-free return during the sample period was 3%. Calculate the information ratio for Sooner Stock Fund. A. 1.53 B. 1.30 C. 8.67 D. 31.43 E. 37.14
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41. The following data are available relating to the performance of Monarch Stock Fund and the market portfolio:
Monarch Average return Standard deviations of returns Beta Residual standard deviation
16 26
1.15 1
% %
Market Portfolio 12 % 22 %
%
1.00 0
%
1-862
The risk-free return during the sample period was 4%. What is the information ratio measure of performance evaluation for Monarch Stock Fund? A. 1.00% B. 280.00% C. 44.00% D. 50.00% E. None of the options are correct.
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42. The following data are available relating to the performance of Monarch Stock Fund and the market portfolio:
Monarch Average return Standard deviations of returns Beta Residual standard deviation
16 26
1.15 1
% %
%
Market Portfolio 12 % 22 %
1.00 0
%
1-863
The risk-free return during the sample period was 4%. Calculate Sharpe's measure of performance for Monarch Stock Fund. A. 1% B. 46% C. 44% D. 50% E. None of the options are correct.
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43. The following data are available relating to the performance of Monarch Stock Fund and the market portfolio:
Monarch Average return Standard deviations of returns Beta Residual standard deviation
16 26
1.15 1
% %
Market Portfolio 12 % 22 %
1.00 % 0
%
1-864
The risk-free return during the sample period was 4%. Calculate Treynor's measure of performance for Monarch Stock Fund. A. 10.40% B. 8.80% C. 44.00% D. 50.00%
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44. The following data are available relating to the performance of Monarch Stock Fund and the market portfolio:
Monarch Average return Standard deviations of returns Beta Residual standard deviation
16 26
1.15 1
% %
Market Portfolio 12 % 22 %
%
1.00 0
%
1-865
The risk-free return during the sample period was 4%. Calculate Jensen's measure of performance for Monarch Stock Fund. A. 1.00% B. 2.80% C. 44.00% D. 50.00%
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45. The following data are available relating to the performance of Seminole Fund and the market portfolio:
Seminole Average return Standard deviations of returns Beta Residual standard deviation
18 30
1.4 4.0
% %
Market Portfolio 14 % 22 %
%
1.0 0.0
%
1-866
The risk-free return during the sample period was 6%. If you wanted to evaluate the Seminole Fund using theM2measure, what percent of the adjusted portfolio would need to be invested in T-Bills? A. -36% (borrow) B. 50% C. 8% D. 36% E. 27%
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46. The following data are available relating to the performance of Seminole Fund and the market portfolio:
Seminole Average return Standard deviations of returns Beta Residual standard deviation
18 30
1.4 4.0
% %
Market Portfolio 14 % 22 %
%
1.0 0.0
%
1-867
The risk-free return during the sample period was 6%. Calculate the M2 measure for the Seminole Fund. A. 4.0% B. 20.0% C. 2.86% D. 0.8% E. 40.0%
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47. If an investor has a portfolio that has constant proportions in T-bills and the market portfolio, the portfolio's characteristic line will plot as a line with ___________. If the investor can time bull markets, the characteristic line will plot as a line with ___________. A. a positive slope; a negative slope B. a negative slope; a positive slope C. a constant slope; a negative slope D. a negative slope; a constant slope E. a constant slope; a positive slope
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1-868
48. Studies of style analysis have found that ________ of fund returns can be explained by asset allocation alone. A. between 50% and 70% B. less than 10% C. between 40 and 50% D. between 75% and 90% E. over 90%
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49. The following data are available relating to the performance of Wildcat Fund and the market portfolio:
Wildcat Average return Standard deviations of returns Beta Residual standard deviation
18 25
1.25 2
% %
Market Portfolio 15 % 20 %
1.00 % 0
%
1-869
The risk-free return during the sample period was 7%. What is the information ratio measure of performance evaluation for Wildcat Fund? A. 1.00% B. 8.80% C. 44.00% D. 50.00%
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50. The following data are available relating to the performance of Wildcat Fund and the market portfolio:
Wildcat Average return Standard deviations of returns Beta Residual standard deviation
18 25
1.25 2
% %
Market Portfolio 15 % 20 %
%
1.00 0
1-870
%
The risk-free return during the sample period was 7%. Calculate Sharpe's measure of performance for Wildcat Fund. A. 1.00% B. 8.80% C. 44.00% D. 50.00%
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51. The following data are available relating to the performance of Wildcat Fund and the market portfolio:
Wildcat Average return Standard deviations of returns Beta Residual standard deviation
18 25
1.25 2
% %
Market Portfolio 15 % 20 %
1.00 % 0
%
1-871
The risk-free return during the sample period was 7%. Calculate Treynor's measure of performance for Wildcat Fund. A. 1.00% B. 8.80% C. 44.00% D. 50.00%
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52. The following data are available relating to the performance of Wildcat Fund and the market portfolio:
Wildcat Average return Standard deviations of returns Beta Residual standard deviation
18 25
1.25 2
% %
Market Portfolio 15 % 20 %
%
1.00 0 %
1-872
The risk-free return during the sample period was 7%. Calculate Jensen's measure of performance for Wildcat Fund. A. 1.00% B. 8.80% C. 44.00% D. 50.00%
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53. The following data are available relating to the performance of Long Horn Stock Fund and the market portfolio:
Average return Standard deviations of returns Beta Residual standard deviation
Long Horn 19 % 35 %
Market Portfolio 12 % 15 %
1.5 3.0
1.0 0.0
%
%
1-873
The risk-free return during the sample period was 6%. What is the Sharpe measure of performance evaluation for Long Horn Stock Fund? A. 1.33% B. 4.00% C. 8.67% D. 31.43% E. 37.14%
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54. The following data are available relating to the performance of Long Horn Stock Fund and the market portfolio:
Average return Standard deviations of returns Beta Residual standard deviation
Long Horn 19 % 35 %
1.5 3.0
%
Market Portfolio 12 % 15 %
1.0 0.0 %
1-874
The risk-free return during the sample period was 6%. What is the Treynor measure of performance evaluation for Long Horn Stock Fund? A. 1.33% B. 4.00% C. 8.67% D. 31.43% E. 37.14%
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55. The following data are available relating to the performance of Long Horn Stock Fund and the market portfolio:
Average return Standard deviations of returns Beta Residual standard deviation
Long Market Horn Portfolio 19 % 12 % 35 % 15 %
1.5 3.0
%
1.0 0.0
%
1-875
The risk-free return during the sample period was 6%. Calculate the Jensen measure of performance evaluation for Long Horn Stock Fund. A. 1.33% B. 4.00% C. 8.67% D. 31.43% E. 37.14%
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56. The following data are available relating to the performance of Long Horn Stock Fund and the market portfolio:
Average return Standard deviations of returns Beta Residual standard deviation
Long Horn 19 % 35 %
Market Portfolio 12 % 15 %
1.5 3.0
1.0 0.0
%
%
1-876
The risk-free return during the sample period was 6%. Calculate the information ratio for Long Horn Stock Fund. A. 1.33 B. 4.00 C. 8.67 D. 31.43 E. 37.14
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57. In a particular year, Razorback Mutual Fund earned a return of 1% by making the following investments in asset classes:
Bonds Stocks
Weight 20 % 80 %
Return 5 % 0 %
The return on a bogey portfolio was 2%, calculated from the following information.
Bonds (Lehman Brother Index) Stocks (S&P 500 Index)
Weight 50 %
Return 5 %
50
-1
%
%
1-877
The total excess return on the Razorback Fund's managed portfolio was A. -1.80%. B. -1.00%. C. 0.80%. D. 1.00%.
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58. In a particular year, Razorback Mutual Fund earned a return of 1% by making the following investments in asset classes:
Bonds Stocks
Weight 20 % 80 %
Return 5 % 0 %
The return on a bogey portfolio was 2%, calculated from the following information.
Bonds (Lehman Brother Index) Stocks (S&P 500 Index)
Weight 50 %
Return 5 %
50
-1
%
%
1-878
The contribution of asset allocation across markets to the Razorback Fund's total excess return was A. -1.80%. B. -1.00%. C. 0.80%. D. 1.00%.
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59. In a particular year, Razorback Mutual Fund earned a return of 1% by making the following investments in asset classes:
Bonds Stocks
Weight 20 % 80 %
Return 5 % 0 %
The return on a bogey portfolio was 2%, calculated from the following information.
Bonds (Lehman Brother Index) Stocks (S&P 500 Index)
Weight 50 %
Return 5 %
50
-1
%
%
1-879
The contribution of selection within markets to the Razorback Fund's total excess return was A. -1.80%. B. -1.00%. C. 0.80%. D. 1.00%.
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60. In a particular year, Aggie Mutual Fund earned a return of 15% by making the following investments in the following asset classes:
Bonds Stocks
Weight 10 % 90 %
Return 6 % 16 %
The return on a bogey portfolio was 10%, calculated as follows:
Bonds (Lehman Brothers Index) Stocks (S&P 500 Index)
Weight 50 %
Return 5 %
50
15
%
%
1-880
The total excess return on the Aggie managed portfolio was A. 1%. B. 3%. C. 4%. D. 5%.
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61. In a particular year, Aggie Mutual Fund earned a return of 15% by making the following investments in the following asset classes:
Bonds Stocks
Weight 10 % 90 %
Return 6 % 16 %
The return on a bogey portfolio was 10%, calculated as follows:
Bonds (Lehman Brothers Index) Stocks (S&P 500 Index)
Weight 50 %
Return 5 %
50
15
%
%
1-881
The contribution of asset allocation across markets to the total excess return was A. 1%. B. 3%. C. 4%. D. 5%.
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62. In a particular year, Aggie Mutual Fund earned a return of 15% by making the following investments in the following asset classes:
Bonds Stocks
Weight 10 % 90 %
Return 6 % 16 %
The return on a bogey portfolio was 10%, calculated as follows:
Bonds (Lehman Brothers Index) Stocks (S&P 500 Index)
Weight Return 50 % 5 % 50 % 15
%
1-882
The contribution of selection within markets to total excess return was A. 1%. B. 3%. C. 4%. D. 5%.
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63. In measuring the comparative performance of different fund managers, the preferred method of calculating rate of return is A. internal rate of return. B. arithmetic average. C. dollar weighted. D. time weighted. E. None of the options are correct.
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64. The __________ measures the reward to volatility trade-off by dividing the average portfolio excess return by the standard deviation of returns. A. Sharpe measure B. Treynor measure C. Jensen measure D. information ratio E. None of the options are correct.
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1-883
65. A pension fund that begins with $500,000 earns 15% the first year and 10% the second year. At the beginning of the second year, the sponsor contributes another $300,000. The dollar-weighted and time-weighted rates of return, respectively, were A. 11.7% and 12.5%. B. 12.1% and 12.5%. C. 12.5% and 11.7%. D. 12.5% and 12.1%.
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66. The Value Line Index is an equally-weighted geometric average of the returns of about 1,700 firms. The value of an index based on the geometric average returns of three stocks where the returns on the three stocks during a given period were 32%, 5%, and-10%, respectively, is A. 4.3%. B. 7.6%. C. 9.0%. D. 13.4%. E. 5.0%.
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1-884
67. Risk-adjusted mutual fund performance measures have decreased in popularity because A. in nearly efficient markets, it is extremely difficult for portfolio managers to outperform the market. B. the measures usually result in negative performance results for the portfolio managers. C. the high rates of return earned by the mutual funds have made the measures useless. D. in nearly efficient markets, it is extremely difficult for portfolio managers to outperform the market, and the measures usually result in negative performance results for the portfolio managers. E. None of the options are correct.
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68. The Sharpe, Treynor, and Jensen portfolio performance measures are derived from the CAPM, A. therefore, it does not matter which measure is used to evaluate a portfolio manager. B. however, the Sharpe and Treynor measures use different risk measures. Therefore, the measures vary as to whether or not they are appropriate, depending on the investment scenario. C. therefore, all measure the same attributes. D. therefore, it does not matter which measure is used to evaluate a portfolio manager. However, the Sharpe and Treynor measures use different risk measures, so therefore, the measures vary as to whether or not they are appropriate, depending on the investment scenario. E. None of the options are correct.
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1-885
69. The Jensen portfolio evaluation measure A. is a measure of return per unit of risk, as measured by standard deviation. B. is an absolute measure of return over and above that predicted by the CAPM. C. is a measure of return per unit of risk, as measured by beta. D. is a measure of return per unit of risk, as measured by standard deviation, and is an absolute measure of return over and above that predicted by the CAPM. E. is an absolute measure of return over and above that predicted by the CAPM, and is a measure of return per unit of risk, as measured by beta.
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70. The M-squared measure considers A. only the return when evaluating mutual funds. B. the risk-adjusted return when evaluating mutual funds. C. only the total risk when evaluating mutual funds. D. only the market risk when evaluating mutual funds. E. None of the options are correct.
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71. The dollar-weighted return on a portfolio is equivalent to A. the time-weighted return. B. the geometric average return. C. the arithmetic average return. D. the portfolio's internal rate of return. E. None of the options are correct.
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1-886
72. A portfolio manager's ranking within a comparison universe may not provide a good measure of performance because A. portfolio returns may not be calculated in the same way. B. portfolio durations can vary across managers. C. if managers follow a particular style or subgroup, portfolios may not be comparable. D. portfolio durations can vary across managers and if managers follow a particular style or subgroup, portfolios may not be comparable. E. All of the options are correct.
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73. The geometric average rate of return is based on A. the market's volatility. B. the concept of expected return. C. the standard deviation of returns. D. the CAPM. E. the principle of compounding.
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74. The M2 measure was developed by A. Merton and Miller. B. Miller and Miller. C. Modigliani and Miller. D. Modigliani and Modigliani. E. the M&M Mars Company.
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1-887
75. Rodney holds a portfolio of risky assets that represents his entire risky investment. To evaluate the performance of Rodney's portfolio, in which order would you complete the steps listed? I) Compare the Sharpe measure of Rodney's portfolio to the Sharpe measure of the best portfolio. II) State your conclusions. III) Assume that past security performance is representative of expected performance. IV) Determine the benchmark portfolio that Rodney would have held if he had chosen a passive strategy. A. I, III, IV, II B. III, IV, I, II C. IV, III, I, II D. III, II, I, IV E. III, I, IV, II
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76. The Modigliani M2 measure and the Treynor T2 measure A. are identical. B. are nearly identical and will rank portfolios the same way. C. are nearly identical, but might rank portfolios differently. D. are somewhat different; M2can be used to rank portfolios, butT2cannot. E. are somewhat different; T2can be used to rank portfolios, butM2cannot.
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1-888
77. To determine whether portfolio performance is statistically significant requires A. a very long observation period due to the high variance of stock returns. B. a short observation period due to the high variance of stock returns. C. a very long observation period due to the low variance of stock returns. D. a short observation period due to the low variance of stock returns. E. a low variance of returns over any observation period.
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Chapter 25 International Diversification
Multiple Choice Questions 1. Shares of several foreign firms are traded in the U.S. markets in the form of A. ADRs. B. ECUs. C. single-country funds. D. All of the options are correct. E. None of the options are correct.
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1-889
2. __________ refers to the possibility of expropriation of assets, changes in tax policy, and the possibility of restrictions on foreign exchange transactions. A. Default risk B. Foreign exchange risk C. Market risk D. Political risk E. None of the options are correct.
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1-890
3. __________ are mutual funds that invest in one country only. A. ADRs B. ECUs C. Single-country funds D. All of the options are correct. E. None of the options are correct.
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4. The performance of an internationally-diversified portfolio may be affected by A. country selection. B. currency selection. C. stock selection. D. All of the options are correct. E. None of the options are correct.
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5. Over the period 2011-2016, most correlations between the U.S. stock index and stock-index portfolios of other countries were A. negative. B. positive but less than.9. C. approximately zero. D. .9 or above. E. None of the options are correct.
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1-891
6. The __________ index is a widely used index of non-U.S. stocks. A. CBOE B. Dow Jones C. EAFE D. All of the options are correct. E. None of the options are correct.
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7. According to PRS, in 2015, which country had the highest composite risk rating on a scale of 0 (most risky) to 100 (least risky)? A. Switzerland B. Canada C. Germany D. U.S.
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8. Which country has the highest in GDP per capita? A. Luxembourg B. Canada C. Germany D. U.S.
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1-892
9. Which country has the largest stock market compared to GDP? A. Japan B. Germany C. Hong Kong D. U.S.
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10. Using local currency returns, the S&P 500 has the highest correlation with A. Euronext. B. FTSE. C. Nikkei. D. Toronto.
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11. In 2015, the U.S. equity market represented __________ of the world equity market. A. 19% B. 60% C. 43% D. 41%
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1-893
12. The straightforward generalization of the simple CAPM to international stocks is problematic because A. inflation-risk perceptions by different investors in different countries will differ as consumption baskets differ. B. investors in different countries view exchange-rate risk from the perspective of different domestic currencies. C. taxes, transaction costs, and capital barriers across countries make it difficult for investors to hold a world-index portfolio. D. All of the options are correct. E. None of the options are correct.
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13. The yield on a 1-year bill in the U.K. is 8%, and the present exchange rate is 1 pound = Cad. $1.60. If you expect the exchange rate to be 1 pound = Cadf. $1.50 a year from now, the return a Canadian investor can expect to earn by investing in U.K. bills is A. -6.7%. B. 0%. C. 8%. D. 1.25%. E. None of the options are correct.
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1-894
14. Suppose the 1-year risk-free rate of return in Canada is 5%. The current exchange rate is 1 pound = Cad $1.60. The 1-year forward rate is 1 pound = $1.57. What is the minimum yield on a 1-year risk-free security in Britain that would induce a Canadian investor to invest in the British security? A. 2.44% B. 2.50% C. 7.00% D. 7.62% E. None of the options are correct.
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15. The interest rate on a 1-year Canadian security is 8%. The current exchange rate is C$ = US $0.78. The 1-year forward rate is C$ = US $0.76. The return (denominated in U.S. $) that a U.S. investor can earn by investing in the Canadian security is A. 3.59%. B. 4.00%. C. 5.23%. D. 8.46%. E. None of the options are correct.
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1-895
16. Suppose the 1-year risk-free rate of return in Canada is 4%, and the 1-year risk-free rate of return in Britain is 7%. The current exchange rate is 1 pound = Cad. $1.65. A 1-year future exchange rate of __________ for the pound would make a Canadian investor indifferent between investing in the Canadian security and investing in the British security. A. 1.6037 B. 2.0411 C. 1.7500 D. 2.3369
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17. The present exchange rate is C$ = U.S. $0.78. The 1-year future rate is C$ = U.S. $0.76. The yield on a 1-year U.S. bill is 4%. A yield of __________ on a 1-year Canadian bill will make an investor indifferent between investing in the U.S. bill and the Canadian bill. A. 2.4% B. 1.3% C. 6.4% D. 6.7% E. None of the options are correct.
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1-896
18. Assume there is a fixed exchange rate between the Canadian and U.S. dollar. The expected return and standard deviation of return on the U.S. stock market are 18% and 15%, respectively. The expected return and standard deviation on the Canadian stock market are 13% and 20%, respectively. The covariance of returns between the U.S. and Canadian stock markets is 1.5%. If you invested 50% of your money in the Canadian stock market and 50% in the U.S. stock market, the expected return on your portfolio would be A. 12.0%. B. 12.5%. C. 13.0%. D. 15.5%.
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19. Assume there is a fixed exchange rate between the Canadian and U.S. dollar. The expected return and standard deviation of return on the U.S. stock market are 18% and 15%, respectively. The expected return and standard deviation on the Canadian stock market are 13% and 20%, respectively. The covariance of returns between the U.S. and Canadian stock markets is 1.5%. If you invested 50% of your money in the Canadian stock market and 50% in the U.S. stock market, the standard deviation of return of your portfolio would be A. 12.53%. B. 15.21%. C. 17.50%. D. 18.75%.
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1-897
20. The major concern that has been raised with respect to the weighting of countries within the EAFE index is A. currency volatilities are not considered in the weighting. B. cross-correlations are not considered in the weighting. C. inflation is not represented in the weighting. D. the weights are not proportional to the asset bases of the respective countries. E. None of the options are correct.
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21. You are a Canadian investor who purchased British securities for 2,000 pounds, one year ago when the British pound cost $1.50. No dividends were paid on the British securities in the past year. Your total return based on Canadian dollars was __________ if the value of the securities is now 2,400 pounds and the pound is worth $1.60. A. 16.7% B. 20.0% C. 28.0% D. 40.0% E. None of the options are correct.
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1-898
22. Canadian investors A. can trade derivative securities based on prices in foreign security markets. B. cannot trade foreign derivative securities. C. can trade options and futures on the Nikkei stock index of 225 stocks traded on the Tokyo stock exchange and on FTSE (Financial Times Share Exchange) indexes of U.K. and European stocks. D. can trade derivative securities based on prices in foreign security markets and can trade options and futures on the Nikkei stock index of 225 stocks traded on the Tokyo stock exchange and on FTSE (Financial Times Share Exchange) indexes of U.K. and European stocks. E. None of the options are correct.
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23. Exchange-rate risk A. results from changes in the exchange rates between the currency of the investor and the country in which the investment is made. B. can be hedged by using a forward or futures contract in foreign exchange. C. cannot be eliminated. D. results from changes in the exchange rates between the currency of the investor and the country in which the investment is made and cannot be eliminated. E. results from changes in the exchange rates between the currency of the investor and the country in which the investment is made and can be hedged by using a forward or futures contract in foreign exchange.
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1-899
24. International investing A. cannot be measured against a passive benchmark, such as the S&P 500. B. can be measured against a widely-used index of non-U.S. stocks, the EAFE Index (Europe, Australia, Far East). C. can be measured against international indexes. D. can be measured against a widely-used index of non-U.S. stocks, the EAFE Index (Europe, Australia, Far East), and against international indexes. E. None of the options are correct.
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25. The manager of Quantitative International Fund uses EAFE as a benchmark. Last year's performance for the fund and the benchmark were as follows:
EAFE Weight
Eur Aus FE
0.30 0.10 0.60
Return on Equity Index 10% 5% 15%
Currency Application E1/E0-1
Quantitative's Weight
Manager's Return
10% -10% 30%
0.25 0.25 0.50
9% 8% 16%
1-900
] Calculate Quantitative's currency selection return contribution. A. +20% B. -5% C. +15% D. +5% E. -10%
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26. The manager of Quantitative International Fund uses EAFE as a benchmark. Last year's performance for the fund and the benchmark were as follows:
EAFE Weight
Eur Aus FE
0.30 0.10 0.60
Return on Equity Index 10% 5% 15%
Currency Application E1/E0-1
Quantitative's Weight
Manager's Return
10% -10% 30%
0.25 0.25 0.50
9% 8% 16%
Calculate Quantitative's country selection return contribution. A. 12.5% B. -12.5% C. 11.25% D. -1.25% E. 1.25%
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1-901
27. The manager of Quantitative International Fund uses EAFE as a benchmark. Last year's performance for the fund and the benchmark were as follows:
Eur Aus FE
EAFE Return Weight on Equity Index 0.30 10% 0.10 5% 0.60 15%
Currency Application E1/E0-1
Quantitative's Weight
Manager's Return
10% -10% 30%
0.25 0.25 0.50
9% 8% 16%
Calculate Quantitative's stock selection return contribution. A. 1.0% B. -1.0% C. 3.0% D. 0.25%
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28. Using the S&P 500 portfolio as a proxy of the market portfolio A. is appropriate because U.S. securities represent more than 60% of world equities. B. is appropriate because most U.S. investors are primarily interested in U.S. securities. C. is appropriate because most U.S. and non-U.S. investors are primarily interested in U.S. securities. D. is inappropriate because U.S. securities make up less than 41% of world equities. E. is inappropriate because the average U.S. investor has less than 20% of his or her portfolio in non-U.S. equities.
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1-902
29. When an investor adds international stocks to his or her Canadian stock portfolio, A. it will raise his or her risk relative to the risk he or she would face just holding U.S. stocks. B. he or she can reduce the risk of his or her portfolio. C. he or she will increase his or her expected return but must also take on more risk. D. it will have no impact on either the risk or the return of his or her portfolio. E. he or she needs to seek professional management because he or she doesn't have access to international investments on his or her own.
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30. "ADRs" stands for ___________, and "WEBS" stands for ____________. A. additional dollar returns; weekly equity and bond survey B. additional daily returns; world equity and bond survey C. American dollar returns; world equity and bond statistics D. American depository receipts; world equity benchmark shares E. adjusted dollar returns; weighted equity benchmark shares
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31. WEBS portfolios A. are passively managed. B. are shares that can be sold by investors. C. are free from brokerage commissions. D. are passively managed and are shares that can be sold by investors. E. All of the options are correct.
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1-903
32. The EAFE is A. the East Asia Foreign Equity index. B. the Economic Advisor's Foreign Estimator index. C. the European and Asian Foreign Equity index. D. the European, Asian, French Equity index. E. the European, Australian, Far East index.
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33. Home bias refers to A. the tendency to vacation in your home country instead of traveling abroad. B. the tendency to believe that your home country is better than other countries. C. the tendency to give preferential treatment to people from your home country. D. the tendency to overweight investments in your home country. E. None of the options are correct.
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34. The possibility of experiencing a drop in revenue or an increase in cost in an international transaction due to a change in foreign exchange rates is called A. foreign exchange risk. B. political risk. C. translation exposure. D. hedging risk.
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1-904
35. As exchange rates change, they A. change the relative purchasing power between countries. B. can affect imports and exports between countries. C. will affect the flow of funds between countries. D. All of the options are true.
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36. When Country A's currency strengthens against Country B's, citizens of Country A will A. pay less to buy Country B's products. B. pay more to buy Country B's products. C. pay more to buy domestically-produced products. D. not be affected by the change in their currency's value.
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37. The interplay between interest rate differentials and exchange rates, such that each adjusts until the foreign exchange market and the money market reach equilibrium, is called the A. Purchasing Power Parity Theory. B. Balance of Payments. C. Interest Rate Parity Theory. D. None of the options are correct.
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1-905
38. Which equity index had the highest volatility in terms of U.S. dollar-denominated returns for the period of five years ending in October 2016? A. Shanghai B. India C. Nikkei D. U.S.
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39. Which equity index had the lowest volatility in terms of U.S. dollar-denominated returns for the period of five years ending in October 2016? A. Korea B. U.S. C. Toronto D. Nikkei
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40. The possibility of experiencing a drop in revenue or an increase in cost in an international transaction due to a change in foreign exchange rates is called A. foreign exchange risk. B. political risk. C. translation exposure. D. hedging risk.
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1-906
41. The yield on a 1-year bill in the U.K. is 7%, and the present exchange rate is 1 pound = Cad $1.65. If you expect the exchange rate to be 1 pound = Cad $1.45 a year from now, the return a Canadian investor can expect to earn by investing in U.K. bills is A. -6.7%. B. 3.2%. C. 8%. D. -5.97%. E. None of the options
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42. Suppose the 1-year risk-free rate of return in Canada. is 6%. The current exchange rate is 1 pound = Cad $1.62. The 1-year forward rate is 1 pound = $1.53. What is the minimum yield on a 1-year risk-free security in Britain that would induce a Canadian investor to invest in the British security? A. 15.44% B. 13.50% C. 12.24% D. 7.62% E. None of the options
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1-907
43. The interest rate on a 1-year Canadian security is 7.8%. The current exchange rate is C$ = US $0.79. The 1-year forward rate is C$ = US $0.77. The return (denominated in U.S. $) that a U.S. investor can earn by investing in the Canadian security is A. 3.59%. B. 4.00%. C. 5.07%. D. 8.46%. E. None of the options
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44. Suppose the 1-year risk-free rate of return in Canada. is 4.5% and the 1-year risk-free rate of return in Britain is 7.7%. The current exchange rate is 1 pound = Cad. $1.60. A 1-year future exchange rate of __________ for the pound would make a Canadian investor indifferent between investing in the Canadian security and investing in the British security. A. 1.5525 B. 2.0411 C. 1.7500 D. 2.3369
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1-908
45. You are a Canadian investor who purchased British securities for 2,200 pounds one year ago when the British pound cost $1.50. No dividends were paid on the British securities in the past year. Your total return based on Canadian dollars was __________ if the value of the securities is now 2,560 pounds and the pound is worth $1.60. A. 16.7% B. 20.3% C. 24.1% D. 41.4% E. None of the options
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46. The present exchange rate is C$ = U.S. $0.78. The 1-year future rate is C$ = U.S. $0.75. The yield on a 1-year U.S. bill is 5%. A yield of __________ on a 1-year Canadian bill will make investor indifferent between investing in the U.S. bill and the Canadian bill. A. 9.2% B. 8.3% C. 6.4% D. 11.3% E. None of the options
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47. You are a Canadian investor who purchased British securities for 4,000 pounds one year ago when the British pound cost $1.50. No dividends were paid on the British securities in the past year. Your total return based on Canadian dollars was __________ if the value of the securities is now 4,400 pounds and the pound is worth $1.62. A. 16.7% B. 18.8% C. 28.0% D. 40.0% E. None of the options
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48. Suppose the 1-year risk-free rate of return in Canada is 4% and the 1-year risk-free rate of return in Britain is 6%. The current exchange rate is 1 pound = Cad. $1.67. A 1-year future exchange rate of __________ for the pound would make a Canadian investor indifferent between investing in the Canadian security and investing in the British security. A. 1.6385 B. 2.0411 C. 1.7500 D. 2.3369
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Chapter 26 Hedge Funds
Multiple Choice Questions
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1. ______ are the dominant form of investing in securities markets for most individuals, but ______ have enjoyed a far greater growth rate in the last decade. A. Hedge Funds; hedge funds B. Mutual funds; hedge funds C. Hedge Funds; mutual funds D. Mutual funds; mutual funds E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 26-01 Hedge Funds versus Mutual Funds. Topic: 26-01 Hedge Funds versus Mutual Funds
2. Like mutual funds, hedge funds A. allow private investors to pool assets to be managed by a fund manager. B. are commonly organized as private partnerships. C. are subject to extensive SEC regulations. D. are typically only open to wealthy or institutional investors. E. are commonly organized as private partnerships and are typically only open to wealthy or institutional investors.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 26-01 Hedge Funds versus Mutual Funds. Topic: 26-01 Hedge Funds versus Mutual Funds
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3. Unlike mutual funds, hedge funds A. allow private investors to pool assets to be managed by a fund manager. B. are commonly organized as private partnerships. C. are subject to extensive SEC regulations. D. are typically only open to wealthy or institutional investors. E. are commonly organized as private partnerships and are typically only open to wealthy or institutional investors.
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4. Alpha-seeking hedge funds typically ______ relative mispricing of specific securities and ______ broad market exposure. A. bet on; bet on B. hedge; hedge C. hedge; bet on D. bet on; hedge E. None of the options are correct.
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5. Hedge funds ______ engage in market timing ______ take extensive derivative positions. A. cannot; and cannot B. cannot; but can C. can; and can D. can; but cannot E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
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6. The risk profile of hedge funds ______, making performance evaluation ______. A. can shift rapidly and substantially; challenging B. can shift rapidly and substantially; straightforward C. is stable; challenging D. is stable; straightforward E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-05 Performance Management for Hedge Funds. Topic: 26-05 Portable Alpha
7. Shares in hedge funds are priced A. at NAV. B. a significant premium to NAV. C. a significant discount from NAV. D. a significant premium to NAV or a significant discount from NAV. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 26-06 Fee Structure in Hedge Funds. Topic: 26-06 An Example of a Pure Play
8. Hedge funds are typically set up as ______ and provide ______ information about portfolio composition and strategy to their investors. A. limited liability partnerships; minimal B. limited liability partnerships; extensive C. investment trusts; minimal D. investment trusts; extensive
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-01 Hedge Funds versus Mutual Funds. Topic: 26-01 Hedge Funds versus Mutual Funds
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9. Hedge funds are ______ transparent than mutual funds because of ______ strict SEC regulation on hedge funds. A. more; more B. more; less C. less; less D. less; more
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-01 Hedge Funds versus Mutual Funds. Topic: 26-01 Hedge Funds versus Mutual Funds
10. ______ must periodically provide the public with information on portfolio composition. A. Hedge funds B. Mutual funds C. ADRs D. Hedge funds and ADRs E. Hedge funds and mutual funds
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11. ______ are subject to the Securities Act of 1933 and the Investment Company Act of 1940 to protect unsophisticated investors. A. Hedge funds B. Mutual funds C. ADRs D. Hedge funds and ADRs E. Mutual funds and ADRs
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12. Hedge funds traditionally have ______ than 100 investors and ______ to the general public. A. more; advertise B. more; do not advertise C. less; advertise D. less; do not advertise
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-01 Hedge Funds versus Mutual Funds. Topic: 26-01 Hedge Funds versus Mutual Funds
13. Hedge funds differ from mutual funds in terms of A. transparency. B. investors. C. investment strategy. D. liquidity. E. All of the options are correct.
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14. Hedge funds may invest or engage in A. distressed firms. B. convertible bonds. C. currency speculation. D. merger arbitrage. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-01 Hedge Funds versus Mutual Funds. Topic: 26-01 Hedge Funds versus Mutual Funds
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15. Hedge funds are prohibited from investing or engaging in A. distressed firms. B. convertible bonds. C. currency speculation. D. merger arbitrage. E. None of the options are correct.
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16. Hedge funds often have ______ provisions as long as ______, which preclude redemption. A. crackdown; 2 months B. lock-up; 2 months C. crackdown; several years D. lock-up; several years E. None of the options are correct.
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17. Hedge fund strategies can be classified as A. directional or nondirectional. B. stock or bond. C. arbitrage or speculation. D. stock or bond and arbitrage or speculation. E. directional or nondirectional and stock or bond.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
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18. A hedge fund pursuing a ______ strategy is betting one sector of the economy will outperform other sectors. A. directional B. nondirectional C. stock or bond D. arbitrage or speculation E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
19. A hedge fund pursuing a ______ strategy is attempting to exploit temporary misalignments in relative pricing. A. directional B. nondirectional C. stock or bond D. arbitrage or speculation E. None of the options are correct.
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20. A hedge fund pursuing a ______ strategy is trying to exploit relative mispricing within a market but is hedged to avoid taking a stance on the direction of the broad market. A. directional B. nondirectional C. market neutral D. arbitrage or speculation E. nondirectional and market neutral
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
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21. An example of a ______ strategy is the mispricing of a futures contract that must be corrected by contract expiration. A. market neutral B. directional C. relative value D. divergence E. convergence
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22. A hedge fund attempting to profit from a change in the spread between mortgages and Treasuries is using a ______ strategy. A. market neutral B. directional C. relative value D. divergence E. convergence
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
23. If the yield on mortgage-backed securities was abnormally high compared to Treasury bonds, a hedge fund pursuing a relative value strategy would A. short sell the Treasury bonds and short sell the mortgage-backed securities. B. short sell the Treasury bonds and buy the mortgage-backed securities. C. buy the Treasury bonds and buy the mortgage-backed securities. D. buy the Treasury bonds and short sell the mortgage-backed securities. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
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24. Assume newly-issued 30-year on-the-run bonds sell at higher yields (lower prices) than 29½-year bonds with a nearly identical duration. A hedge fund that sells 29½-year bonds and buys 30-year bonds is taking a A. market neutral position. B. conservative position. C. bullish position. D. bearish position.
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25. A bet on particular mispricing across two or more securities with extraneous sources of risk, such as general market exposure hedged away, is a A. pure play. B. relative play. C. long shot. D. sure thing. E. relative play and sure thing.
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26. If the yield on mortgage-backed securities was abnormally low compared to Treasury bonds, a hedge fund pursuing a relative value strategy would A. short sell the Treasury bonds and short sell the mortgage-backed securities. B. short sell the Treasury bonds and buy the mortgage-backed securities. C. buy the Treasury bonds and buy the mortgage-backed securities. D. buy the Treasury bonds and short sell the mortgage-backed securities.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
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27. Statistical arbitrage is a version of a ______ strategy. A. market neutral B. directional C. relative value D. divergence E. convergence
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
28. ______ uses quantitative techniques, and often automated trading systems, to seek out many temporary misalignments among securities. A. Covered interest arbitrage B. Locational arbitrage C. Triangular arbitrage D. Statistical arbitrage E. All arbitrage
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
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29. Assume that you manage a $3 million portfolio that pays no dividends and has a beta of 1.45 and an alpha of 1.5% per month. Also, assume that the risk-free rate is 0.025% (per month) and the S&P 500 is at 1,220. If you expect the market to fall within the next 30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250). A. selling 1 B. selling 14 C. buying 1 D. buying 14 E. selling 6
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30. Assume that you manage a $1.3 million portfolio that pays no dividends and has a beta of 1.45 and an alpha of 1.5% per month. Also, assume that the risk-free rate is 0.025% (per month) and the S&P 500 is at 1,220. If you expect the market to fall within the next 30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250). A. selling 1 B. selling 6 C. buying 1 D. buying 6 E. selling 4
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
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31. Assume that you manage a $2 million portfolio that pays no dividends and has a beta of 1.25 and an alpha of 2% per month. Also, assume that the risk-free rate is 0.05% (per month) and the S&P 500 is at 1,300. If you expect the market to fall within the next 30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250). A. selling 1 B. selling 8 C. buying 1 D. buying 8 E. selling 6
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32. Assume that you manage a $2 million portfolio that pays no dividends and has a beta of 1.3 and an alpha of 2% per month. Also, assume that the risk-free rate is 0.05% (per month) and the S&P 500 is at 1,500. If you expect the market to fall within the next 30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250). A. selling 1 B. selling 7 C. buying 1 D. buying 7 E. selling 11
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 26-02 Hedge Fund Strategies. Topic: 26-02 Hedge Fund Strategies
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33. Market neutral bets can result in ______ volatility because hedge funds use ______. A. very low; hedging techniques to eliminate risk B. low; risk management techniques to reduce risk C. considerable; risk management techniques to reduce risk D. considerable; considerable leverage
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 26-05 Performance Management for Hedge Funds. Topic: 26-05 Portable Alpha
34. ______ bias arises because hedge funds only report returns to database publishers if they want to. A. Survivorship B. Backfill C. Omission D. Incubation E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-05 Performance Management for Hedge Funds. Topic: 26-05 Portable Alpha
35. ______ bias arises when the returns of unsuccessful funds are left out of the sample. A. Survivorship B. Backfill C. Omission D. Incubation E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-05 Performance Management for Hedge Funds. Topic: 26-05 Portable Alpha
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36. Performance evaluation of hedge funds is complicated by A. liquidity premiums. B. survivorship bias. C. unreliable market valuations of infrequently-traded assets. D. merger arbitrage. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-05 Performance Management for Hedge Funds. Topic: 26-05 Portable Alpha
37. The previous value of a portfolio that must be reattained before a hedge fund can charge incentive fees is known as a A. benchmark. B. water stain. C. water mark. D. high water mark. E. low water mark.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-06 Fee Structure in Hedge Funds. Topic: 26-06 An Example of a Pure Play
38. The typical hedge fund fee structure is A. a management fee of 1% to 2%. B. an annual incentive fee equal to 20% of investment profits beyond a stipulated benchmark performance. C. a 12-b1 fee of 1%. D. a management fee of 1% to 2% and an annual incentive fee equal to 20% of investment profits beyond a stipulated benchmark performance. E. a management fee of 1% to 2% and a 12-b1 fee of 1%.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-06 Fee Structure in Hedge Funds. Topic: 26-06 An Example of a Pure Play
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39. Hedge fund incentive fees are essentially A. put options on the portfolio with a strike price equal to the current portfolio value. B. put options on the portfolio with a strike price equal to the expected future portfolio value. C. call options on the portfolio with a strike price equal to the expected future portfolio value. D. call options on the portfolio with a strike price equal to the current portfolio value times one plus the benchmark return. E. straddles.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 26-06 Fee Structure in Hedge Funds. Topic: 26-06 An Example of a Pure Play
40. Regarding hedge fund incentive fees, hedge fund managers ______ if the portfolio return is very large and ______ if the portfolio return is negative. A. get nothing; get nothing B. refund the fee; get the fee C. get the fee; lose nothing except the incentive fee D. get the fee; lose the management fee E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-06 Fee Structure in Hedge Funds. Topic: 26-06 An Example of a Pure Play
41. Hedge funds often employ ______ that require investors to provide ________ notice of their desire to redeem funds. A. redemption notices; several weeks to several months B. redemption notices; several hours to several days C. redemption notices; several days to several weeks D. lock-up; several years E. lock-up; several hours
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-01 Hedge Funds versus Mutual Funds. Topic: 26-01 Hedge Funds versus Mutual Funds
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42. Pairs trading is associated with A. triangular arbitrage. B. statistical arbitrage. C. data mining. D. triangular arbitrage and data mining. E. statistical arbitrage and data mining.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-05 Performance Management for Hedge Funds. Topic: 26-05 Portable Alpha
43. ________ refers to sorting through huge amounts of historical data to uncover systematic patterns in returns that can be exploited by traders. A. Data mining B. Pairs trading C. Alpha transfer D. Beta shifting
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-05 Performance Management for Hedge Funds. Topic: 26-05 Portable Alpha
44. Hedge fund performance may reflect significant compensation for ________ risk. A. liquidity B. systematic C. unsystematic D. default E. unsystematic and default
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-05 Performance Management for Hedge Funds. Topic: 26-05 Portable Alpha
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45. A ________ is an investment fraud in which a manager collects funds from clients, claims to invest those funds on their behalf, and reports extremely favorable investment returns, but in fact uses the funds for his or her own use. A. Ponzi scheme B. bonsai scheme C. statistical arbitrage scheme D. pairs trading scheme E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-06 Fee Structure in Hedge Funds. Topic: 26-06 An Example of a Pure Play
46. Sadka (2010) shows that exposure to unexpected declines in ________ is an important determinant of average hedge fund returns, and that the spreads in average returns across funds with the highest and lowest ________ may be as much as 6% annually. A. market risk; systematic risk B. market liquidity; liquidity risk C. unsystematic risk; unique risk D. default risk; default risk
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 26-05 Performance Management for Hedge Funds. Topic: 26-05 Portable Alpha
Chapter 27 The Theory of Active Portfolio Management
Multiple Choice Questions
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1. In the Treynor-Black model, A. portfolio weights are sensitive to large alpha values, which can lead to infeasible long or short positions for many portfolio managers. B. portfolio weights are not sensitive to large alpha values, which can lead to infeasible long or short positions for many portfolio managers. C. portfolio weights are sensitive to large alpha values, which can lead to the optimal portfolio for most portfolio managers. D. portfolio weights are not sensitive to large alpha values, which can lead to the optimal portfolio for most portfolio managers.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
2. Absent research, you should assume the alpha of a stock is A. zero. B. positive. C. negative. D. not zero. E. zero or positive.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
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3. If you begin with a ______ and obtain additional data from an experiment, you can form a ______. A. posterior distribution; prior distribution B. prior distribution; posterior distribution C. tight posterior; Bayesian analysis D. tight prior; Bayesian analysis E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
4. Benchmark risk is defined as A. the return difference between the portfolio and the benchmark. B. the standard deviation of the return of the benchmark portfolio. C. the standard deviation of the return difference between the portfolio and the benchmark. D. the standard deviation of the return of the actively-managed portfolio.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
5. Benchmark risk A. is inevitable and is never a significant issue in practice. B. is inevitable and is always a significant issue in practice. C. cannot be constrained to keep a Treynor-Black portfolio within reasonable weights. D. can be constrained to keep a Treynor-Black portfolio within reasonable weights.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
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6. ____________ can be used to measure forecast quality and guide in the proper adjustment of forecasts. A. Regression analysis B. Exponential smoothing C. ARIMA D. Moving average models E. GAUSS
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
7. Even low-quality forecasts have proven to be valuable because R-squares of only ____________ in regressions of analysts' forecasts can be used to substantially improve portfolio performance. A. 0.656 B. 0.452 C. 0.258 D. 0.153 E. 0.001
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
8. The ____________ model allows the private views of the portfolio manager to be incorporated with market data in the optimization procedure. A. Black-Litterman B. Treynor-Black C. Treynor-Mazuy D. Black-Scholes
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
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9. The Black-Litterman model and Treynor-Black model are A. nice in theory but practically useless in modern portfolio management. B. complementary tools that should be used in portfolio management. C. contradictory models that cannot be used together. Therefore, portfolio managers must choose which one suits their needs. D. not useful due to their complexity. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
10. The Black-Litterman model is geared toward ____________ while the Treynor-Black model is geared toward ____________. A. security analysis; security analysis B. asset allocation; asset allocation C. security analysis; asset allocation D. asset allocation; security analysis E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-03 The Black-Litterman Model. Topic: 27-03 Restriction of Benchmark Risk
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11. Alpha forecasts must be ____________ to account for less-than-perfect forecasting quality. When alpha forecasts are ____________ to account for forecast imprecision, the resulting portfolio position becomes ____________. A. shrunk; shrunk; far less moderate B. shrunk; shrunk; far more moderate C. grossed up; grossed up; far less moderate D. grossed up; grossed up; far more moderate E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
12. Tracking error is defined as A. the difference between the returns on the overall risky portfolio versus the benchmark return. B. the variance of the return of the benchmark portfolio. C. the variance of the return difference between the portfolio and the benchmark. D. the variance of the return of the actively-managed portfolio.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
13. The tracking error of an optimized portfolio can be expressed in terms of the ____________ of the portfolio, and thus reveals ____________. A. return; portfolio performance B. total risk; portfolio performance C. beta; portfolio performance D. beta; benchmark risk E. relative return; benchmark risk
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
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14. The Treynor-Black model is a model that shows how an investment manager can use security analysis and statistics to construct A. a market portfolio. B. a passive portfolio. C. an active portfolio. D. an index portfolio. E. a balanced portfolio.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
15. If a portfolio manager consistently obtains a high Sharpe measure, the manager's forecasting ability A. is above average. B. is average. C. is below average. D. does not exist. E. cannot be determined based on the Sharpe measure.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
16. Active portfolio management consists of A. market timing. B. security analysis. C. indexing. D. market timing and security analysis. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
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17. Passive portfolio management consists of A. market timing. B. security analysis. C. indexing. D. market timing and security analysis. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
18. The critical variable in the determination of the success of the active portfolio is A. alpha/systematic risk. B. alpha/nonsystematic risk. C. gamma/systematic risk. D. gamma/nonsystematic risk.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
19. The Treynor-Black model requires estimates of A. alpha/beta. B. alpha/beta/residual variance. C. beta/residual variance. D. alpha/residual variance.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
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20. Active portfolio managers try to construct a risky portfolio with A. a higher Sharpe measure than a passive strategy. B. a lower Sharpe measure than a passive strategy. C. the same Sharpe measure as a passive strategy. D. very few securities.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
21. The beta of an active portfolio is 1.20. The standard deviation of the returns on the market index is 20%. The nonsystematic variance of the active portfolio is 1%. The standard deviation of the returns on the active portfolio is A. 3.84%. B. 5.84%. C. 19.60%. D. 24.17%. E. 26.0%.
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22. The beta of an active portfolio is 1.36. The standard deviation of the returns on the market index is 22%. The nonsystematic variance of the active portfolio is 1.2%. The standard deviation of the returns on the active portfolio is A. 3.19%. B. 31.86%. C. 42.00%. D. 27.57%. E. 2.86%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
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23. Consider the Treynor-Black model. The alpha of an active portfolio is 2%. The expected return on the market index is 16%. The variance of return on the market portfolio is 4%. The nonsystematic variance of the active portfolio is 1%. The risk-free rate of return is 8%. The beta of the active portfolio is 1. The optimal proportion to invest in the active portfolio is A. 0%. B. 25%. C. 50%. D. 100%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 27-03 The Black-Litterman Model. Topic: 27-03 Restriction of Benchmark Risk
24. Consider the Treynor-Black model. The alpha of an active portfolio is 1%. The expected return on the market index is 16%. The variance of the return on the market portfolio is 4%. The nonsystematic variance of the active portfolio is 1%. The risk-free rate of return is 8%. The beta of the active portfolio is 1.05. The optimal proportion to invest in the active portfolio is A. 48.7%. B. 50.0%. C. 51.3%. D. 100.0%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 27-03 The Black-Litterman Model. Topic: 27-03 Restriction of Benchmark Risk
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25. There appears to be a role for a theory of active portfolio management because A. some portfolio managers have produced sequences of abnormal returns that are difficult to label as lucky outcomes. B. the "noise" in the realized returns is enough to prevent the rejection of the hypothesis that some money managers have outperformed a passive strategy by a statistically small, yet economic, margin. C. some anomalies in realized returns have been persistent enough to suggest that portfolio managers who identified these anomalies in a timely fashion could have outperformed a passive strategy over prolonged periods. D. some portfolio managers have produced sequences of abnormal returns that are difficult to label as lucky outcomes, and the "noise" in the realized returns is enough to prevent the rejection of the hypothesis that some money managers have outperformed a passive strategy by a statistically small, yet economic, margin. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
26. The Treynor-Black model A. considers both macroeconomic and microeconomic risks. B. considers security selection only. C. is nearly impossible to implement. D. considers both macroeconomic and microeconomic risks and is nearly impossible to implement. E. considers security selection only and is nearly impossible to implement.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
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27. Which of the following are not true regarding the Treynor-Black model? A. It considers both macroeconomic and microeconomic risks. B. It considers security selection only. C. It is nearly impossible to implement. D. It considers both macroeconomic and microeconomic risks, and it is nearly impossible to implement. E. It considers security selection only, and it is nearly impossible to implement.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-04 The Treynor-Black Model and Forecast Precision
28. To improve future analyst forecasts using the statistical properties of past forecasts, a regression model can be fitted to past forecasts. The intercept of the regression is a __________ coefficient, and the regression beta represents a __________ coefficient. A. bias; precision B. bias; bias C. precision; precision D. precision; bias
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-04 Treynor-Black versus Black-Litterman: Complements, Not Substitutes. Topic: 27-04 The Treynor-Black Model and Forecast Precision
29. A purely passive strategy is defined as A. one that uses only index funds. B. one that allocates assets in fixed proportions that do not vary with market conditions. C. one that is mean-variance efficient. D. one that uses only index funds and allocates assets in fixed proportions that do not vary with market conditions. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
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30. Consider these two investment strategies:
Expected return Standard deviation Highest return Lowest return
Strategy 1(%) 6 0 6 6
Strategy 2(%) 9 4 15 6
Strategy __________ is the dominant strategy because __________. A. 1; it is riskless B. 1; it has the highest reward/risk ratio C. 2; its return is greater than or equal to the return of Strategy 1 D. 2; it has the highest reward/risk ratio E. Both strategies are equally preferred.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 27-03 The Black-Litterman Model. Topic: 27-03 Restriction of Benchmark Risk
31. Consider these two investment strategies:
Expected return Standard deviation Highest return Lowest return
Strategy 1(%) 5 0 6 5
Strategy 2(%) 10 3 12 6
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Strategy __________ is the dominant strategy because __________. A. 1; it is riskless B. 1; it has the highest reward/risk ratio C. 2; its return is greater than or equal to the return of Strategy 1 D. 2; it has the highest reward/risk ratio E. Both strategies are equally preferred.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 27-03 The Black-Litterman Model. Topic: 27-03 Restriction of Benchmark Risk
32. The Treynor-Black model assumes that A. the objective of security analysis is to form an active portfolio of a limited number of mispriced securities. B. the cost of less than full diversification comes from the nonsystematic risk of the mispriced stock. C. the optimal weight of a mispriced security in the active portfolio is a function of the degree of mispricing, the market sensitivity of the security, and its degree of nonsystematic risk. D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
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33. The Treynor-Black model does not assume that A. the objective of security analysis is to form an active portfolio of a limited number of mispriced securities. B. the cost of less than full diversification comes from the nonsystematic risk of the mispriced stock. C. the optimal weight of a mispriced security in the active portfolio is a function of the degree of mispricing, the market sensitivity of the security, and its degree of nonsystematic risk. D. indexing is always optimal.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
34. Consider the Treynor-Black model. The alpha of an active portfolio is 3%. The expected return on the market index is 18%. The standard deviation of the return on the market portfolio is 25%. The nonsystematic standard deviation of the active portfolio is 15%. The risk-free rate of return is 6%. The beta of the active portfolio is 1.2. The optimal proportion to invest in the active portfolio is A. 50.0%. B. 69.4%. C. 72.3%. D. 80.6%. E. 100.0%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
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35. According to the Treynor-Black model, the weight of a security in the active portfolio depends on the ratio of __________ to __________. A. the degree of mispricing; the nonsystematic risk of the security B. the degree of mispricing; the systematic risk of the security C. the market sensitivity of the security; the nonsystematic risk of the security D. the nonsystematic risk of the security; the systematic risk of the security E. the total return on the security; the nonsystematic risk of the security
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
36. One property of a risky portfolio that combines an active portfolio of mispriced securities with a market portfolio is that, when optimized, its squared Sharpe measure increases by the square of the active portfolio's A. Sharpe ratio. B. information ratio. C. alpha. D. Treynor measure. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
37. A purely passive strategy A. uses only index funds. B. uses weights that change in response to market conditions. C. uses only risk-free assets. D. is best if there is "noise" in realized returns. E. is useless if abnormal returns are available.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
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38. A manager who uses the mean-variance theory to construct an optimal portfolio will satisfy A. investors with low risk-aversion coefficients. B. investors with high risk-aversion coefficients. C. investors with moderate risk-aversion coefficients. D. all investors regardless of their level of risk aversion. E. only clients with whom she has established long-term relationships because she knows their personal preferences.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
39. Ideally, clients would like to invest with the portfolio manager who has A. a moderate personal risk-aversion coefficient. B. a low personal risk-aversion coefficient. C. the highest Sharpe measure. D. the highest record of realized returns. E. the lowest record of standard deviations.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
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40. An active portfolio manager faces a trade-off between I) using the Sharpe measure. II) using mean-variance analysis. III) exploiting perceived security mispricings. IV) holding too much of the risk-free asset. V) letting a few stocks dominate the portfolio. A. I and II B. II and V C. III and V D. III and IV E. II and III
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Hard Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
41. To determine the optimal risky portfolio in the Treynor-Black model, macroeconomic forecasts are used for the _________, and composite forecasts are used for the __________. A. passive index portfolio; active portfolio B. active portfolio, passive index portfolio C. expected return; standard deviation D. expected return ; beta coefficient E. alpha coefficient; beta coefficient
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
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42. The beta of an active portfolio is 1.45. The standard deviation of the returns on the market index is 22%. The nonsystematic variance of the active portfolio is 3%. The standard deviation of the returns on the active portfolio is A. 36.30%. B. 5.84%. C. 19.60%. D. 24.17%. E. 26.0%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
43. Consider the Treynor-Black model. The alpha of an active portfolio is 1%. The expected return on the market index is 11%. The variance of return on the market portfolio is 6%. The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 4%. The beta of the active portfolio is 1.1. The optimal proportion to invest in the active portfolio is A. 45%. B. 25%. C. 50%. D. 100%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
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44. Consider the Treynor-Black model. The alpha of an active portfolio is 3%. The expected return on the market index is 10%. The variance of the return on the market portfolio is 4%. The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 3%. The beta of the active portfolio is 1.15. The optimal proportion to invest in the active portfolio is A. 48.7%. B. 98.4%. C. 51.3%. D. 100.0%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
45. Consider the Treynor-Black model. The alpha of an active portfolio is 2%. The expected return on the market index is 12%. The variance of the return on the market portfolio is 4%. The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 3%. The beta of the active portfolio is 1.15. The optimal proportion to invest in the active portfolio is A. 48.7%. B. 98.3%. C. 47.6%. D. 100.0%.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Learning Objective: 27-02 The Treynor-Black Model and Forecast Precision. Topic: 27-02 Forecasts of Alpha Values and Extreme Portfolio Weights
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46. Perfect timing ability is equivalent to having __________ on the market portfolio. A. a call option B. a futures contract C. a put option D. a commodities contract
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 27-05 The Value of Active Management. Topic: 27-05 Adjusting Forecasts for the Precision of Alpha
47. Kane, Marcus, and Trippi (1999) show that the annualized fee that investors should be willing to pay for active management, over and above the fee charged by a passive index fund, depends on I) the investor's coefficient of risk aversion. II) the value of the at-the-money call option on the market portfolio. III) the value of the out-of-the-money call option on the market portfolio. IV) the precision of the security analyst. V) the distribution of the squared information ratio in the universe of securities. A. I, II, and IV B. I, III, and V C. II, IV, and V D. I, IV, and V E. II, III, and V
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
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48. Kane, Marcus, and Trippi (1999) show that the annualized fee that investors should be willing to pay for active management, over and above the fee charged by a passive index fund, does not depend on I) the investor's coefficient of risk aversion. II) the value of the at-the-money call option on the market portfolio. III) the value of the out-of-the-money call option on the market portfolio. IV) the precision of the security analyst. V) the distribution of the squared information ratio in the universe of securities. A. I, II, and IV B. II, III, and V C. II and III D. I, IV, and V E. II, IV, and V
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 27-01 Optimal Portfolios and Alpha Values. Topic: 27-01 Optimal Portfolios and Alpha Values
Chapter 28 Investment Policy and the Framework of the CFA Institute
Multiple Choice Questions 1. The CFA Institute divides the process of portfolio management into three main elements, which are ______, ______, and ______. A. planning; execution; results B. security selection; asset allocation; action C. planning; asset allocation; feedback D. planning; execution; feedback E. risk tolerance; feedback; action
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
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2. The planning phase of the CFA Institute's investment management process A. uses data about the client and capital market. B. uses details of optimal asset allocation and security selection. C. uses changes in expectations and objectives. D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
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3. The execution phase of the CFA Institute's investment management process A. uses data about the client and capital market. B. uses details of optimal asset allocation and security selection. C. uses changes in expectations and objectives. D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
4. The feedback phase of the CFA Institute's investment management process A. uses data about the client and capital market. B. uses details of optimal asset allocation and security selection. C. uses changes in expectations and objectives. D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
5. __________ refer to strategies aimed at attaining the established rate of return requirements while meeting expressed risk tolerance and applicable constraints. A. Investment constraints B. Investment objectives C. Investment policies D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-03 Policy Statements. Topic: 28-03 Individual Investors
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6. One incorrect belief that is often cited as a reason for fully-funded pension funds to invest in equities is A. stocks have higher risk. B. bonds have lower returns. C. stocks provide a hedge against inflation. D. stocks have higher returns. E. All of the options are incorrect beliefs that are often cited.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-06 Pension Funds. Topic: 28-06 Pension Funds
7. __________ in the process of asset allocation. A. Deriving the efficient portfolio frontier is a step B. Specifying asset classes to be included in the portfolio is a step C. Specifying the capital market expectations is a step D. All of the options are steps. E. None of the options are steps.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-04 Asset Allocation. Topic: 28-04 Personal Trusts
8. Questionnaires and attitude surveys suggest that risk tolerance A. increases with age. B. decreases with age. C. stays constant over the life cycle for most investors. D. cannot be assessed. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
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9. __________ can be used to create a perfect inflation hedge. A. Gold B. Real estate C. TIPS D. The S&P 500 Index E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
10. A fully-funded pension plan can invest surplus assets in equities provided it reduces the proportion in equities when the value of the fund drops near the accumulated benefit obligation. This strategy is referred to as A. immunization. B. hedging. C. diversification. D. contingent immunization. E. overfunding.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-06 Pension Funds. Topic: 28-06 Pension Funds
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11. Workers who change jobs may wind up with lower pension benefits at retirement than otherwise identical workers who stay with the same employer, even if the employers have defined benefit plans with the same final-pay benefit formula. This is referred to as A. an accumulated benefit obligation. B. an unfunded liability. C. immunization. D. indexation. E. the portability problem.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
12. The __________ the proportion of total return that is in the form of price appreciation, the __________ will be the value of the tax-deferral option for taxable investors. A. greater; greater B. greater; lower C. lower; greater D. The answer cannot be determined from the information provided. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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13. An important benefit of Keogh plans is that A. they are not taxable until funds are withdrawn as benefits. B. they are protected against inflation. C. they are automatically insured by the Federal government. D. they are not taxable until funds are withdrawn as benefits, and they are protected against inflation. E. they are not taxable until funds are withdrawn as benefits, and they are automatically insured by the Federal government.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
14. Variable life insurance A. combines life insurance with a tax-deferred annuity. B. provides a minimum death benefit that increases subject to investment performance. C. can be converted to a stream of income. D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-06 Pension Funds. Topic: 28-06 Pension Funds
15. Endowment funds are held by A. charitable organizations. B. educational institutions. C. for-profit firms. D. charitable organizations and educational institutions. E. educational institutions and for-profit firms.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
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16. __________ center on the trade-off between the return the investor wants and how much risk the investor is willing to assume. A. Investment constraints B. Investment objectives C. Investment policies D. All of the options are correct. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
17. The stage an individual is in his/her life cycle will affect his/her A. return requirements. B. risk tolerance. C. asset allocation. D. return requirements and risk tolerance. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
18. A remainderman is A. a stockbroker who remained working on Wall Street after the 1987 crash. B. an employee of a trustee. C. one who receives interest and dividend income from a trust during their lifetime. D. one who receives the principal of a trust when it is dissolved.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
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19. __________ are boundaries that investors place on their choice of investment assets. A. Investment constraints B. Investment objectives C. Investment policies D. All of the options are correct E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-02 Constraints. Topic: 28-02 Objectives
20. The investment horizon is A. the investor's expected age at death. B. the starting date for establishing investment constraints. C. based on the investor's risk tolerance. D. the date at which the portfolio is expected to be fully or partially liquidated.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-02 Constraints. Topic: 28-02 Objectives
21. Liquidity is A. the ease with which an asset can be sold. B. the ability to sell an asset for a fair price. C. the degree of inflation protection an asset provides. D. the ease with which an asset can be sold and the ability to sell an asset for a fair price. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-02 Constraints. Topic: 28-02 Objectives
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22. The objectives of personal trusts normally are __________ in scope than those of individual investors, and personal trust managers typically are __________ than individual investors. A. broader; more risk averse B. broader; less risk averse C. more limited; more risk averse D. more limited; less risk averse
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
23. When a company sets up a defined contribution pension plan, the __________ bears all the risk, and the __________ receives all the return from the plan's assets. A. employee; employee B. employee; employer C. employer; employee D. employer; employer E. Cannot determine; depends on the economic environment.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-06 Pension Funds. Topic: 28-06 Pension Funds
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24. Suppose that the pre-tax holding period returns on two stocks are the same. Stock A has a high dividend-payout policy and stock B has a low dividend-payout policy. If you are an individual in a high marginal tax bracket and do not intend to sell the stocks during the holding period, A. stock A will have a higher after-tax holding period return than stock B. B. the after-tax holding period returns on stocks A and B will be the same. C. stock B will have a higher after-tax holding period return than stock A. D. it is impossible to determine which stock will have a higher after-tax holding period return given the information available.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
25. The prudent investor rule requires A. executives of companies to avoid investing in options of companies by which they are employed. B. executives of companies to disclose their transactions in stocks of companies by which they are employed. C. professional investors who manage money for others to avoid all risky investments. D. professional investors who manage money for others to constrain their investments to those that would have been approved by the prudent investor.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
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26. The longest time horizons are likely to be set by A. banks. B. property and casualty insurance companies. C. pension funds. D. banks and pension funds. E. property and casualty insurance companies and pension funds.
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27. The longest time horizons are likely to be set by A. banks. B. property and casualty insurance companies. C. endowment funds. D. banks and endowment funds. E. property and casualty insurance companies and endowment funds.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-06 Pension Funds. Topic: 28-06 Pension Funds
28. The shortest time horizons are likely to be set by A. banks. B. property and casualty insurance companies. C. pension funds. D. banks and property and casualty insurance companies. E. property and casualty insurance companies and pension funds.
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29. Institutional investors will rarely invest in which of these asset classes? A. Bonds B. Stocks C. Cash D. Real estate E. Precious metals
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
30. For an individual investor, the value of home ownership is likely to be viewed A. as a hedge against increases in rental rates. B. as a guarantee of availability of a particular residence. C. as a hedge against inflation. D. as a hedge against increases in rental rates and as a guarantee of availability of a particular residence. E. All of the options are correct.
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31. Assume that at retirement you have accumulated $500,000 in a variable annuity contract. The assumed investment return is 6%, and your life expectancy is 15 years. What is the hypothetical constant-benefit payment? A. $30,000.00 B. $33,333.33 C. $51,481.38 D. $52,452.73 E. The answer cannot be determined from the information provided.
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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32. Assume that at retirement you have accumulated $500,000 in a variable annuity contract. The assumed investment return is 6%, and your life expectancy is 15 years. If the first year's actual investment return is 8%, what is the starting benefit payment? A. $30,000.00 B. $33,333.33 C. $51,481.38 D. $52,452.73 E. The answer cannot be determined from the information provided.
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33. The first step a pension fund should take before beginning to invest is to A. establish investment objectives. B. develop a list of investment managers with superior records to interview. C. establish asset allocation guidelines. D. decide between active and passive management.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-06 Pension Funds. Topic: 28-06 Pension Funds
34. General pension funds typically invest __________ of their funds in equity securities. A. none B. 5-10% C. 15-35% D. 40-60% E. more than 60%
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35. The optimal portfolio on the efficient frontier for a given investor depends on A. the investor's degree-of-risk tolerance. B. the coefficient, A, which is a measure of risk aversion. C. the investor's required rate of return. D. the investor's degree-of-risk tolerance and the investor's required rate of return. E. the investor's degree-of-risk tolerance and the coefficient, A, which is a measure of risk aversion.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
36. The optimal portfolio on the efficient frontier for a given investor does not depend on A. the investor's degree-of-risk tolerance. B. the coefficient, A, which is a measure of risk aversion. C. the investor's required rate of return. D. the investor's degree-of-risk tolerance and the investor's required rate of return. E. the investor's degree-of-risk tolerance and the coefficient, A, which is a measure of risk aversion.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
37. Target-date retirement funds are not A. funds of funds diversified across stocks and bonds. B. designed to change their asset allocation as time passes. C. a simple, but useful, strategy. D. designed to function much like hedge funds.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-07 Investments for the Long Run. Topic: 28-07 Endowment Funds
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38. A ___________ is established when an individual confers legal title to property to another person or institution to manage the property for one or more beneficiaries. A. tax shelter B. defined contribution plan C. personal trust D. fixed annuity E. Keogh plan
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
39. Professional financial planners should A. assess their client's risk-and-return requirements on a one-time basis. B. explain the investment plan to the client. C. inform the client about the outcome of the plan. D. assess their client's risk-and-return requirements on a one-time basis, explain the investment plan to the client, and inform the client about the outcome of the plan. E. explain the investment plan to the client and inform the client about the outcome of the plan.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Learning Objective: 28-01 The Investment Management Process. Topic: 28-01 The Investment Management Process
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40. Deferral of capital gains tax I) means that the investor doesn't need to pay taxes until the investment is sold. II) allows the investment to grow at a faster rate. III) means that you might escape the capital gains tax if you live long enough. IV) provides a tax shelter for investors. A. II and III B. I, II, IV C. I, III, and V D. II, III, and IV
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41. Deferral of capital gains tax does not I) mean that the investor doesn't need to pay taxes until the investment is sold. II) allow the investment to grow at a faster rate. III) mean that you might escape the capital gains tax if you live long enough. IV) provide a tax shelter for investors. A. III B. II C. I, II, and V D. II, III, and IV
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1-964
42. Which of the following investments does not allow the investor to choose how to allocate assets? A. Variable Life insurance policies B. Keogh plans C. Personal funds D. Tax-qualified defined contribution plans E. Universal Life policies
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43. Which of the following investments allows the investor to choose how to allocate assets? A. Variable Life insurance policies B. Keogh plans C. Personal funds D. Tax-qualified defined contribution plans E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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44. Pension funds I) accept contributions from employers, which are tax deductible. II) pay distributions that are taxed as ordinary income. III) pay benefits only from the income component of the fund. IV) accept contributions from employees, which are not tax deductible. A. I and IV B. II and III C. I and II D. I, II, and IV E. I, II, III, and IV
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-06 Pension Funds. Topic: 28-06 Pension Funds
45. Pension funds do not I) accept contributions from employers, which are tax deductible. II) pay distributions that are taxed as ordinary income. III) pay benefits only from the income component of the fund. IV) accept contributions from employees, which are not tax deductible. A. III and IV B. II and III C. I and II D. I, II, and IV E. I, II, III, and IV
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-06 Pension Funds. Topic: 28-06 Pension Funds
1-966
46. Stephanie Watson is 23 years old and has accumulated $4,000 in her self-directed defined contribution pension plan. Each year she contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk-free real rate of return. The other offers an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk-free investment and 95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments. Her salary will grow at the same rate as inflation. How much does Stephanie currently have in the safe account; how much in the risky account? A. $3,800; $200 B. $2,000; $2,000 C. $200; $3,800 D. $2,500; $1,500 E. $1,500; $2,500
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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47. Stephanie Watson is 23 years old and has accumulated $4,000 in her self-directed defined contribution pension plan. Each year she contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk-free real rate of return. The other offers an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk-free investment and 95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments. Her salary will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Stephanie and by her employer on her behalf, how much will she put into the safe account each year; how much into the risky account? A. $3,800; $200 B. $2,000; $2,000 C. $200; $3,800 D. $2,500; $1,500 E. $1,500; $2,500
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1-968
48. Stephanie Watson is 23 years old and has accumulated $4,000 in her self-directed defined contribution pension plan. Each year she contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk-free real rate of return. The other offers an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk-free investment and 95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments. Her salary will grow at the same rate as inflation. How much can Stephanie be sure of having in the safe account at retirement? A. $37,221 B. $16,423 C. $11,856 D. $21,156. E. $49,219
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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49. Stephanie Watson is 23 years old and has accumulated $4,000 in her self-directed defined contribution pension plan. Each year she contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk-free real rate of return. The other offers an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk-free investment and 95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments. Her salary will grow at the same rate as inflation. How much can Stephanie expect to have in her risky account at retirement? A. $2,731,838 B. $2,915,415 C. $1,425,316 D. $224,651 E. $3,545,886
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50. Genny Webb is 27 years old and has accumulated $7,500 in her self-directed defined contribution pension plan. Each year she contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she will live to age 90. The plan allows for two types of investments. One offers a 3% risk-free real rate of return. The other offers an expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk-free investment and 80% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments. Her salary will grow at the same rate as inflation. How much does Genny currently have in the safe account; how much in the risky account? A. $1,500; $6,000 B. $3,000; $4,500 C. $2,000; $5,500 D. $4,800; $2,700 E. $3,500; $3,500
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
1-971
51. Genny Webb is 27 years old and has accumulated $7,500 in her self-directed defined contribution pension plan. Each year she contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she will live to age 90. The plan allows for two types of investments. One offers a 3% risk-free real rate of return. The other offers an expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk-free investment and 80% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments. Her salary will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Genny and by her employer on her behalf, how much will Genny put into the safe account each year; how much into the risky account? A. $1,500; $2,500 B. $1,200; $1,800 C. $800; $3,200 D. $1,250; $2,750 E. $1,400; $1,600
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
1-972
52. Genny Webb is 27 years old and has accumulated $7,500 in her self-directed defined contribution pension plan. Each year she contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she will live to age 90. The plan allows for two types of investments. One offers a 3% risk-free real rate of return. The other offers an expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk-free investment and 80% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments. Her salary will grow at the same rate as inflation. How much can Genny be sure of having in the safe account at retirement? A. $45,473 B. $62,557 C. $78,943 D. $54,968 E. $74,643
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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53. Genny Webb is 27 years old and has accumulated $7,500 in her self-directed defined contribution pension plan. Each year she contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she will live to age 90. The plan allows for two types of investments. One offers a 3% risk-free real rate of return. The other offers an expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk-free investment and 80% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments. Her salary will grow at the same rate as inflation. How much can Genny expect to have in her risky account at retirement? A. $1,800,326 B. $1,905,095 C. $1,743,781 D. $1,224,651 E. $345,886
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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54. Alex Goh is 39 years old and has accumulated $128,000 in his self-directed defined contribution pension plan. Each year he contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will live to age 86. The plan allows for two types of investments. One offers a 4% risk-free real rate of return. The other offers an expected return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk-free investment and 75% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation. How much does Alex currently have in the safe account; how much in the risky account? A. $31,200; $46,800 B. $39,000; $39,000 C. $32,000; $96,000 D. $45,300; $32,700 E. $64,000; $14,000
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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55. Alex Goh is 39 years old and has accumulated $128,000 in his self-directed defined contribution pension plan. Each year he contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will live to age 86. The plan allows for two types of investments. One offers a 4% risk-free real rate of return. The other offers an expected return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk-free investment and 75% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Alex and by his employer on his behalf, how much will Alex put into the safe account each year; how much into the risky account? A. $2,500; $2,500 B. $3,200; $1,800 C. $3,000; $2,000 D. $1,250; $3,750 E. $2,400; $2,600
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
1-976
56. Alex Goh is 39 years old and has accumulated $128,000 in his self-directed defined contribution pension plan. Each year he contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will live to age 86. The plan allows for two types of investments. One offers a 4% risk-free real rate of return. The other offers an expected return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk-free investment and 75% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation. How much can Alex be sure of having in the safe account at retirement? A. $132,473 B. $162,557 C. $178,943 D. $189,211 E. $124,643
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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57. Alex Goh is 39 years old and has accumulated $128,000 in his self-directed defined contribution pension plan. Each year he contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will live to age 86. The plan allows for two types of investments. One offers a 4% risk-free real rate of return. The other offers an expected return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk-free investment and 75% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation. How much can Alex expect to have in his risky account at retirement? A. $1,400,326 B. $1,309,529 C. $1,543,781 D. $1,224,651 E. $1,345,886
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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58. Alan Barnett is 43 years old and has accumulated $78,000 in his self-directed defined contribution pension plan. Each year he contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will live to age 83. The plan allows for two types of investments. One offers a 4% risk-free real rate of return. The other offers an expected return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk-free investment and 60% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation. How much does Alan currently have in the safe account; how much in the risky account? A. $31,200; $46,800 B. $39,000; $39,000 C. $15,900; $62,100 D. $45,300; $32,700 E. $64,000; $14,000
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1-979
59. Alan Barnett is 43 years old and has accumulated $78,000 in his self-directed defined contribution pension plan. Each year he contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will live to age 83. The plan allows for two types of investments. One offers a 4% risk-free real rate of return. The other offers an expected return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk-free investment and 60% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Alan and by his employer on his behalf, how much will he put into the safe account each year; how much into the risky account? A. $1,500; $1,500 B. $1,200; $1,800 C. $2,000; $1,000 D. $2,500; $500 E. $1,400; $1,600
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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60. Alan Barnett is 43 years old and has accumulated $78,000 in his self-directed defined contribution pension plan. Each year he contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will live to age 83. The plan allows for two types of investments. One offers a 4% risk-free real rate of return. The other offers an expected return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk-free investment and 60% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation. How much can Alan be sure of having in the safe account at retirement? A. $59,473 B. $62,557 C. $78,943 D. $89,211 E. $104,632
Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Medium Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
1-981
61. Alan Barnett is 43 years old and has accumulated $78,000 in his self-directed defined contribution pension plan. Each year he contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will live to age 83. The plan allows for two types of investments. One offers a 4% risk-free real rate of return. The other offers an expected return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk-free investment and 60% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation. How much can Alan expect to have in his risky account at retirement? A. $158,982 B. $309,529 C. $543,781 D. $224,651 E. $345,886
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62. An income beneficiary is A. a stockbroker who remained working on Wall Street after the 1987 crash. B. an employee of a trustee. C. one who receives interest and dividend income from a trust during their lifetime. D. one who receives the principal of a trust when it is dissolved. E. None of the options are correct.
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Learning Objective: 28-05 Managing Portfolios of Individual Investors. Topic: 28-05 Mutual Funds
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63. Assume that at retirement you have accumulated $750,000 in a variable annuity contract. The assumed investment return is 9%, and your life expectancy is 25 years. What is the hypothetical constant-benefit payment? A. $30,000.00 B. $33,333.33 C. $51,481.38 D. $76,354.69 E. The answer cannot be determined from the information provided.
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64. Assume that at retirement you have accumulated $750,000 in a variable annuity contract. The assumed investment return is 9%, and your life expectancy is 25 years. If the first year's actual investment return is 9%, what is the starting benefit payment? A. $30,000.00 B. $33,333.33 C. $76,354.69 D. $52,452.73 E. The answer cannot be determined from the information provided.
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65. Assume that at retirement you have accumulated $825,000 in a variable annuity contract. The assumed investment return is 5.5%, and your life expectancy is 18 years. What is the hypothetical constant-benefit payment? A. $73,358.93 B. $33,333.33 C. $51,481.38 D. $52,452.73 E. The answer cannot be determined from the information provided.
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66. Assume that at retirement you have accumulated $825,000 in a variable annuity contract. The assumed investment return is 5.5%, and your life expectancy is 18 years. If the first year's actual investment return is 7%, what is the starting benefit payment? A. $30,000.00 B. $74,401.95 C. $51,481.38 D. $52,452.73 E. The answer cannot be determined from the information provided.
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67. Which of the following are commonly thought to be good general investment guidelines? I) Don't try to outguess the market, buying and holding generally pays off. II) Diversify investments to spread risk. III) Investments should be highly concentrated in your company's stock. IV) 401K money is best placed in money market accounts because risk is very low. V) Investments should be allocated to stocks, bonds, and money-market funds. A. I, III, and IV B. I, II, and V C. II, IV, and V D. III, IV, and V E. I, II, IV, and V
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 28-03 Policy Statements. Topic: 28-03 Individual Investors
68. Which of the following are commonly thought to be bad general investment guidelines? I) Don't try to outguess the market, buying and holding generally pays off. III) Investments should be highly concentrated in your company's stock. IV) 401K money is best placed in money market accounts because risk is very low. V) Investments should be allocated to stocks, bonds, and money-market funds. A. I, III, and IV B. I, II, and IV C. II, IV, and V D. III and IV E. I, II, IV, and V
Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Learning Objective: 28-03 Policy Statements. Topic: 28-03 Individual Investors
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69. The principle of duration matching is A. used only in bond portfolio management. B. a useful concept for investments with target dates. C. matching one's assets to one's objectives. D. a useful concept for investments with target dates and means matching one's assets to one's objectives. E. None of the options are correct.
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70. The principle of duration matching is not A. used only in bond portfolio management. B. a useful concept for investments with target dates. C. matching one's assets to one's objectives. D. a useful concept for investments with target dates or matching one's assets to one's objectives. E. None of the options are correct.
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71. Target-date retirement funds A. are funds of funds diversified across stocks and bonds. B. are inappropriate for most investors. C. have very high fees. D. function much like hedge funds.
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72. Target-date retirement funds are not A. inappropriate for most investors. B. very high in fees. C. designed to function much like hedge funds. D. inappropriate for most investors or very high in fees. E. All of the options are correct.
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73. Target-date retirement funds A. change their asset allocation as time passes. B. are a simple, but useful, strategy. C. function much like hedge funds. D. change their asset allocation as time passes and are a simple, but useful, strategy. E. All of the options are correct.
Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Learning Objective: 28-03 Policy Statements. Topic: 28-03 Individual Investors
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74. The desirable components of an Investment Policy Statement for individual investors can be divided into A. three main elements consisting of scope and purpose, governance, and risk management. B. three main elements consisting of scope and purpose, governance, and investment, returnand-risk objectives. C. four main elements consisting of scope and purpose, governance, risk management, and feedback. D. four main elements consisting of scope and purpose, governance, risk management, and investment, return-and-risk objectives. E. five main elements consisting of scope and purpose, governance, risk management, investment, return-and-risk objectives, and evaluation.
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75. The scope and purpose section of an Investment Policy Statement for individual investors typically consists of defining the A. return, distribution, and risk requirements. B. process for review of the IPS. C. appropriate metrics for risk measurement. D. relevant constraints. E. context, investor, and structure.
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76. The governance section of an Investment Policy Statement for individual investors typically contains A. assigning the responsibility for determining investment policy. B. the review process for the IPS. C. assigning the responsibility for risk management. D. the review process for the IPS and assigning the responsibility for risk management. E. All of the options are correct.
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77. The risk-management section of an Investment Policy Statement for individual investors typically contains A. relevant constraints. B. other relevant considerations. C. performance measurement accountabilities, metrics for risk measurement, and the rebalancing process. D. relevant constraints and other relevant considerations. E. All of the options are correct.
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