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SET 1 ANSWERS to PRACTICE QUESTIONS Background Chapters 1-5 CHAPTER 1: 1. b (definition) 2. a (they minimize risk consistent with return) 3. c (a and d are incorrect—must be upward sloping for the future) 4. a 5. c (common stocks are more risky than preferreds or bonds) 6. d (could be—does not have to be) 7. b (always involves return and risk; must be expected for future) 8. a CHAPTER 2: 9. c (it is possible to invest only indirectly, using mutual funds) 10. b (savings bond are monmarketable; other Treasury bonds are marketable) 11. b (this is a nonmarketable security) 12. d 13. b 14. c (Treasuries have the lowest risk of all) 15. b (there are no guarantees from bond ratings) 16. a (first four are investment grade) 17. b (AAA would have lowest yield, AA next lowest) 18. d (with c, average return should be more; with a, long-term fund should do better over long run) 19. d (.055/[1 - .35] = .0846 or 8.46% 20. b (.037/[1 - .35] = .0569 which is >.056 21. c (c—should be homogeneous) 22. d (hybrid security, therefore middle position) 23. a (no guarantees, last priority) 24. d 25. c (there are no specific promises with common stock that can be counted on) 26. c 27. a (puts and calls are created by investors) 28. d (same reason as #27) 29. a (calls are short term options to buy) 30. b (believes price will be flat or rise) 31. b (most contracts are offset, not exercised) 32 d (short-term, wasting asset) CHAPTER 3: 33. b 34. a 35. a (they earn money by charging a management fee) 36. d (barring an emergency) 37. b 38. b 39. a (from $1 trillion to about $7 trillion) 40. c (money market shares are, as standard practice, set at $1/share) 41. c 42. d 43. c 44. d (no sales fee, are open-end, can hold taxable or nontaxable) 45. d (computed once a day, change often) 46. a ($55.46 + .92 + .73 - .72 – 2.12 = $54.27) 47. b 48. a 49. b 50. d (must buy from and sell to the company) 51. b 52. c ($10,000 X 1.103 X .868 X 1.143 = $10,943.13) 53. c ($10,000 X 1.143 X .981 = $11,212.83) 54. b ($10,943.13 [from #52] X .981 [for 2002] = $10,735.21) 55. b (11.5% = 1.115; [1.115]5 = 1.7234; 1.7234 – 1.0 = .723 or 72.3%) 56. a (for a one-year period, the annual return = the cumulative total return) 57. d (b and c are equivalent; both represent compounding) CHAPTER 4: 58. b 59. b (up from 1995 through 1999, down 2000 through 2002) 60. d (Nasdaq has most number of companies) 61. a (secondary market, which the NYSE refers to as an agency auction market) 62. c 63. b 64. c (NYSE, Amex and Nasdaq have listed stocks) 65. d 66. d 67. a (not linked to all brokers; clearly a threat) 68. d 69. b (S&P Index is higher) 70. b (a few corporates trade on exchanges) 71. c (left undefined, more change expected) 72. c 73. d (growth stocks often split, lowering their price) 74. b 75. d 76. b (remember, only the DJIA is price weighted) 77. c 78. a (all indexes except DJIA are capitalization weighted) 79. d ($7.50/.10 = 75 points on Dow; 75/225 = 1/3) CHAPTER 5: 80. b (investors not assured of exact price) 81. c 82. d 83. d 84. b 85. d 86. a 87. a (only required full disclosure; no assurance of quality) 88. d 89. c 90. a (200 shares x $100 = $20,000; $20,000 x .6 = $12,000) 91. a (100 shares x $20 profit = $2,000; amount investor puts up = $60% of $20,000, or $12,000; $2,000/$12,000 = 16.67%) 92. c ($1675 x 55% borrowed = $921.25) 93. b ($3,000/.60 = $5,000; borrow $2,000; buy 100 shares) 94. a ($2,000/.40 = $5,000; borrow $3,000; buy 125 shares) 95. b (no time limit; need margin account; must pay dividends) 96. c (price moves against you) 97. a 98. d 99. d (your out-of-pocket investment is $2000 [buy on margin] + $40 brokerage cost; you receive $100 dividends and $200 price appreciation; you pay $200 interest + $42 brokerage cost to sell; therefore, you net $300 - $242 = $58; return on actual cash investment = $58/$2040 = 2.84%) 100. d (you have a paper gain only because you have not sold yet) SET 2 ANSWERS to PRACTICE QUESTIONS Returns and Bonds Chapters 6-9 CHAPTER 6: 1. d 2. d ([$60 for semiannual coupon + $45 price gain]/1005 = 10.45%) 3. a ($90 interest is offset by $90 loss on sale; therefore zero return) 4. c (10% TR = .10; 1 + .10 = 1.10 return relative) 5. a ([$46 + $1]/$34 = 1.38) 6. a ([$38 + $1]/40 = .975; this is a TR of -2.5%) 7. a (-.10 + 1.0 = .90) 8. c (divide CWI by CYI; geometric mean of $30.41 is 4.2%; $30.41 = (1.042)83 therefore, dividing CWI by (1.042)83 produces the same answer) 9. a 10. c (this is approximate, but clearly the closest of the answers given) 11. b (always true by definition) 12. a (note that c is reversed—should be (1 + G)2 = (1 + A.M.) 2 etc.) 13. d ($1 x 1.1676 x .98 = $1.1442) 14. a (it is identical to cumulative total return, so d is incorrect) 15. b (remember, no addition or subtraction with CWI) 16. c (multiply these two together to get CWI) 17. c 18. b (RR = [(46+ 2)/50 = .96]; currency adj. = .96; .96 (.96) = .9216 as a RR; .9216 – 1.0 = -7.84% as a TR) 19. a 20. a (TR for French investor = ([300 + 10]/250) – 1.0 = 24%) CHAPTER 7: 21. a (10% x .2 + 20% x .5 + (-25%) x .3 = 4.5%) 22. b (the two factors are the expected returns for securities and the weights) 23. c (correlation coefficient is not in equation for expected return) 24. c 25. c (1/2 of 10% + 1/2 of 18%) 26. b (choose the stock with the smallest standard deviation because corr. is +1.0) 27. d (total # of terms = n2; 30 x 30 = 900) 28. b (covariance = corr. coeff x std. dev x std. dev; .30 x 12 x 20 = 72) 29. c (covariance = n (n – 1); unique covariances = [n (n -1)] /2) 30. c 31. a (proper weights must also be chosen to eliminate all risk in this situation) 32. d CHAPTER 8: 33. d (covariances or correlations must also be provided) 34. c 35. d 36. b 37. c (the Markowitz efficient frontier is an arc and not a straight line) 38. a 39. d 40. b (B is dominated by D; the other 2 portfolios are the extreme ends of the eff. frontier) 41. c 42. c (3n + 2) 43. a 44. a 45. d 46. b (many observers argue it is the most important decision) 47. d 48. a (market risk premium is expected market return – RF = 16 – 7) 49. d 50. c CHAPTER 9: 51. d 52. c 53. d 54. b 55. d 56. b 57. d (15% x .6 + 5% x .4 = 11%) 58. a (riskless asset has no risk here; therefore, 60% of 18% = 10.8%) 59. a 60. a 61. a 62. d 63. d 64. c 65. c 66. c (stock’s risk premium = market risk premium x stock’s beta) 67. d (the market risk premium = 9%) 68. c 69. d 70. b (investors are compensated for taking systematic risk) 71. b (7 + 1.4[16 – 7] = 19.6% 72. a (calculate required return for each stock and compare to expected return) 73. b 74. b (it has less restrictive assumptions) 75. c (requires less assumptions) SET 3 ANSWERS to PRACTICE QUESTIONS Common Stocks (Valuation and Management), Efficient Markets, Market/Economy, Industry, Company Analysis Chapters 10-15 CHAPTER 10: 1. a 2. a 3. b 4. b 5. b (d is incorrect—it is the value for someone using the equation) 6. b (dividends, not earnings) 7. b ([$1.20(1.07)] / [.14 - .07]) Note: $1.20 = current dividend 8. e (k = Dl/P0 + g; therefore, g = k – Dl/P0; g = .15 - .05 = .10 9. b ($20 / [.15 – .10] = 400) 10. d (beta = .85 because BLC is 15% less risky; k = 6 + .85 [8] = 12.8; P0 = D1 / [k – g] = $1.50 / [12.8 - .07] = $25.86) 11. a (D0 = $2.55; D1 = $2.75; P0 = $2.75 / [.15 - .08] = $39.29) 12. b (k = 6 + 1.0 [8] = 14%; P0 = $1.20(1.07) / [.14 - .07] = $18.34) 13. d (D1 = Earnings X payout ratio = $4.00 X .3 = $1.20; k = 5 + 1.1[14 - 5] = 14.9; P0 = $1.20 / [14.9 - .08] = $17.39) 14. d (g = estimated growth rate, therefore use 6%; D1 = $2(1.06) = $2.12; P0 = $2.12 / [.16 - .06] = $21.20) 15. b (k = expected return = D1/P0 + g; 2/40 + .07 = 12%) 16. a (g = 8% [found by rule of 72]; D1 = $1.00 X 1.08 = $1.08; P0 = $1.08 / [.15 - .08] = $15.43) 17. b (expected return = D1/P0 + g = 14.9; required return of 15.1 is greater than expected return; therefore, you cannot justify buying the stock) 18. c (value is determined by a procedure regardless of holding period) 19. c ([$2 / (.15 - .07)] = [$2 / (.16 - .08)]; D1 stays the same) 20. c (D1 = $1.50 X 1.05 = $1.575; dividend yield = $1.575 / $15.75 = 10%; capital gains yield = the growth rate; Note: the sum of the two must be 15%) 21. e (D0 = $2.00; D1 = $2 X .95 = $1.90; D2 = $1.90 X .95 = $1.81; D3 = $1.81 X .95 = $1.72; D4 = $1.72 x .95 = $1.63; D5 = $1.63 x .95 = $1.55; P4 = D5 / [k – g] = $1.55 / (k – [-.05]) = $1.55 / [.14 + .05] = $8.16) 22. e (P0 = $2.00 (1/1.14) + $1.50 (1/(1.14)2) + $2.00 (1/(1.14)3) + $3.50 (1/(1.14)4) + ($3.50(1.08) / [.14 - .08)]) X (1/(1.14)4) = $43.62) 23. c (multiple growth rate company; D0 = $2.00; D1 = $2.28; D2 = $2.60; D3 = $2.96; PV of D1 = $1.93; PV of D2 = $1.87; PV of D3 = $1.80; sum of these 3 present values = $5.60; constant growth rate is 6%; P3 = D4 / [k-g;]; D4 = $2.96 x 1.06 = $3.14; P3 = $3.14 / [.18 - .06] = $26.15; PV of $26.15 = $15.92; $15.92 + $5.60 = $21.52) (NOTE: round off error can account for a few cents difference) 24. b (k = 7 + 2[11 – 7] = 15%); D1 = $3(1.20) = $3.60; D2 = $3.60(1.20) = $4.32; D3 = $4.32(1.10) = $4.75; PV of D1 and D2 = $6.40; P2 = D3 / [k – g] = $4.75 / [.15 - .10] = $95; PV of P2 = $71.83; P0 = $71.83 + $6.40 = $78.23; Dividend yield = $3.60 / $78.23 = 4.6%) 25. b 26. d 27. c (P/E = [D/E] / (k – g) = .75 / [.16 - .06] = 7.5) 28. a (if 70% is retained, 30% is paid out, therefore Earnings must be $1.50 / .3 = $5.00; k = 8 + 2 [12 – 8] = .16; P0 = $1.50 (1.10) / [.16 - .10] = $27.50 P/E = $27.50 / $5.50 = $5 Note: E0 = $5.00 and E1 = $5.00(1.10) = $5.50 29. c CHAPTER 11 30. c (pessimism leads to an increase) 31. a (risk-free rate + stock’s risk premium) 32. d 33. b 34. d 35. b 36. a 37. c 38. c (the top-down approach) 39. b (rising, not falling) CHAPTER 12 40. d 41. c 42. b 43. c 44. c 45. b 46. a 47. a 48. c (all have not been refuted) 49. c 50. c 51. d CHAPTER 13 52. c (stock prices tend to lead the economy) 53. d 54. d 55. (E1 = $30; D1 = $30 X .4 = $12; k = 9 + 8 = 17%; P0 = $12 / [.17 - .10] = $171.43) 56. b 57. c (can be calculated using estimated data) 58. c 59. a 60. d (market tends to lead economy) 61. d CHAPTER 14 62. b 63. b 64. c 65. a 66. a 67. a 68. a 69. c 70. c 71. b 72. b 73. b CHAPTER 15 74. b 75. a 76. b 77. d 78. a (.15 x 2) 79. d (.3 x 1.5) 80. c 81. c 82. b (ROE = .1845 x 2.278; EPS = BVps x ROE) 83. d ($10 x .10 = $1) 84. d (g = ROE x retention rate) 85. c 86. c (should be Total Assets / Stockholders Equity) 87. a 88. c 89. c (D1 = $2 X .10 = $2.20; P0 = $2.20 / [.20 - .10] = $22) 90. b 91. b 92. a (negative numbers count the same as positive, therefore choose largest) 93. c 94. d (minimum expected return; NOTE: a is correct because it does not specify stock required rate of return or market required rate of return) 95. c 96. c 97. c 98. b 99. a 100. d ($2 / $4 = .5 payout; .5 / [.16 - .06] = 5) SET 4 ANSWERS to PRACTICE QUESTIONS Technical Analysis Chapter 16 1. d 2. d 3. d 4. a 5. d 6. c 7. a 8. a 9. b 10. c 11. d 12. d 13. a 14. b 15. b SET 5 ANSWERS to PRACTICE QUESTIONS Bonds Chapters 17-18 CHAPTER 17: 1. c 2. c (remember, it is expected inflation) 3. a 4. b (price and yield move inversely; 1 3/32 = 1.0938%; .010938 x 1000 = $10.938) 5. c (current yield = coupon/bond price; for bonds selling at a discount [<$1,000], current yield has to be > coupon rate) 6. d (a debenture is an unsecured bond) 7. a (since there are no coupons, there is nothing to reinvest) 8. c 9. b 10. d 11. d (YTM is a promised return) 12. c (intrinsic value is a present value process) 13. c 14. b (not reinvesting the coupons lowers the realized yield) 15. a 16. b 17. a 18. c 19. d (long-term bond prices fluctuate more than do short-term bond prices) 20. c 21. d (YTM has a reinvestment rate assumption, therefore c is incorrect) 22. d (using a calculator, n = 40; PMT = 35; PV = -810; FV = 1000) 23. d (using a calculator, n = 28; PMT = 30; FV = 1000; I/Y = 8%) 24. d (1/24 = .0417; 1000/400 = 2.50; 2.50.0417 – 1.0 = 3.89; 3.89 x 2 = 7.79) 25. a (.09/2 + 1.0 = 1.045; 1.04530 = 3.7453; 1 / 3.7453 = .267; $1000 x .267 = $267) 26. c (coupons; capital gain; interest-on-interest) 27. c 28. d 29. a (coupon is inverse; decreasing rate; weighted average) 30. b (it is the same as the bond’s maturity) 31. d 32. b (-8 x .0075 = -.06 or -6%) 33. c CHAPTER 18: 34. b 35. c (term structure is static because it is one point in time) 36. a 37. c (this is dealt with in the term structure) 38. c (forward rates are anticipated but unobservable) 39. a 40. c (during boom periods, risk decreases, spreads narrow) 41. b 42. d 43. c (remember, immunization deals with interest rate risk) 44. d 45. a 46. b (the horizon is specified) SET 6 ANSWERS to PRACTICE QUESTIONS Derivative Securities Chapters 19 and 20 CHAPTER 17: 1. d (right only) 2. c (could remain steady) 3. d 4. c 5. e 6. c 7. e 8. a 9. c 10. b 11. c 12. a 13. b CHAPTER 18: 14. c 15. d 16. c 17. c 18. d 19. b 20. d 21. d 22. a 23. b 24. d 25. a 26. c (10 point loss [because investor sold and price went up] X $250 multiplier) 27. d SET 7 ANSWERS to PRACTICE QUESTIONS Portfolio Management, Performance Evaluation Chapters 21 and 22 CHAPTER 21: 1. c 2. a 3. c 4. d 5. d 6. b 7. c 8. b 9. b 10. c 11. b 12. d CHAPTER 22: 13. b 14. a 15. b 16. b 17. d 18. b 19. b 20. a 21. c (for d, alpha is the difference between excess return and what should have been earned given the risk of the portfolio) 22. c 23. a (13.2% is required using the CAPM, but only 13% was earned, therefore inferior) 24. a 25. a 26. b (the square of the correlation coefficient is the coefficient of determination) 27. b 28. b 29. d (for a, should be after the fact) 30. d (need to know the risk of each portfolio) 31. c (the largest R2) 32. c (the largest beta) 33. a (the largest standard deviation) 34. b (this is the only fund with a statistically significant alpha) 35. d (the one with the lowest R2)

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