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18: Portfolio Management: Capital Market Theory: Basic Concepts 1.A: The Investment Setting Question ID: 11156 If CPI0 = the Consumer Price Index today, and CPI -1 = the Consumer Price Index one year ago, then the future expected rate of inflation is measured by: A. B. C. D. (CPI0 - CPI-1)/CPI0.</FONT< td> (CPI0 - CPI-1)/CPI-1. none of these choices are correct. ((50%*CPI0) + (50%*CPI-1))/CPI--1. C Question ID: 11159 Which of the following is NOT required to determine an investor's required rate of return? A. B. C. D. Expected rate of inflation. Risk premium. Real risk-free rate. Timing of cash flows. D Question ID: 11217 Individuals with a greater dislike for postponing consumption will expect which of the following in comparison to others? A. B. Lower risk-free rate of return. Lower rate of inflation. 1 C. D. Greater risk-free rate of return. Lower rate of unsystematic risk. C Question ID: 11218 The real risk-free rate assumes there is no inflation and: the time preference of individuals for income consumption remains constant over long periods of time. there is an inflation premium. there is no uncertainty about future cash flows. The real growth rate of the economy remains constant over long periods of time. A. B. C. D. C Question ID: 11240 If an investor is concerned that he or she will not be able to sell an investment when needed, what kind of risk will the investor be incurring? A. B. C. D. Liquidity. Business. Exchange rate. Financial. A Question ID: 11237 2 The expected return that an investor demands specifically to compensate for the uncertainty of future payments is known as the: A. B. C. D. risk premium. net present value. none of these choices are correct. discount rate. A Question ID: 11239 Systematic risk is also known as: A. B. C. D. market risk. country risk. fundamental risk. diversifiable risk. A Question ID: 11238 The risk premium portion of the required rate of return includes all but which of the following? A. B. C. D. Inflation risk. Business risk. Liquidity risk. Foreign exchange risk. 3 A Question ID: 11242 A company's beta is the: A. B. C. D. excess return above its expected risk-adjusted return. covariance of returns with the market portfolio. average rate of return over the long-term. standard deviation of its rates of return. B Question ID: 11243 The Security Market Line demonstrates the relationship between the expected return of an asset and what kind of risk? A. B. C. D. Diversifiable. Total. Unique. Systematic. D Question ID: 11244 An unexpected change in the economy that causes investors to expect a higher risk premium will result in: A. B. movement along the Security Market Line. a change in the slope of the Security Market Line. 4 C. D. a parallel shift in the Security Market Line. an increase in the stock's beta. B Question ID: 21160 The slope of the security market line (SML) changes over time. Which of the following would cause a steepening in the slope of the SML? The market becomes more optimistic, causing an increase in the market risk premium. Inflation decreases, causing an increase in the market risk premium. Inflation increases, causing an increase in the market risk premium. The market becomes more pessimistic, causing an increase in the market risk premium. A. B. C. D. D Changes in inflation cause parallel shifts in the SML, not slope shifts. When the market is optimistic and confident, the market risk premium narrows because risk is expected to decrease. When it is pessimistic and uncertain, the market risk premium widens. A change in the market risk premium (expected market return – nominal risk free rate) causes a slope shift in the SML. Question ID: 11245 A change in the expected rate of inflation will result in: A. B. C. D. movement along the Security Market Line. a parallel shift in the Security Market Line. a change in the slope of the Security Market Line. an increase in the stock's beta. 5 B Question ID: 11241 Examples of macroeconomic variables that create systematic risk include: A. B. C. D. all of these choices are correct. variability in the growth of the money supply. changes in governmental tax policy. volatility in interest rates. A 1.B: The Asset Allocation Decision (Including Appendix) Question ID: 11251 The phase when individuals distribute excess assets to others is known as the: A. B. C. D. death phase. distribution phase. disinvesting phase. gifting phase. D Question ID: 11248 Individuals in the early years of their careers that are expanding their base of assets are generally considered to be in the: A. accumulation phase. 6 B. C. D. buying phase. spending phase. purchasing phase. A Question ID: 11253 The first step in the investment process should be the formulation of: A. B. C. D. a list of investment alternatives. a policy statement. a current income statement. a current balance sheet. B Question ID: 11256 What investment goals will a risk-averse individual in the spending phase with limited financial resources likely have? A. B. C. D. Current income and speculative returns. Capital appreciation and wealth accumulation. Capital preservation and current income. Capital appreciation and total returns. C Question ID: 11259 7 Contributions to individual retirement accounts and 401(K) accounts are popular because: A. the returns accumulate tax-deferred until withdrawals begin. securities purchased for these accounts pay a higher rate of return than when they are purchased for other non-retirement accounts. all of these choices are correct. the amount of the contributions can be claimed as a tax credit. B. C. D. A Question ID: 11264 Which of the following is a typical step in the asset allocation process? A. B. C. D. The asset classes to be included are determined. The allowable allocation ranges for each asset class are determined. The normal policy weights for each eligible asset class are assigned. All of these choices are correct. D Question ID: 11263 Asset allocation is based on the belief that: A. market timing of individual securities is the best method of asset investing. diversification is of benefit only to those who can afford an entire portfolio that matches the market. the total return of a portfolio is influenced more by the selection of asset classes than by the selection of actual investments. technical analysis is a more important and credible theory than fundamental analysis. 8 B. C. D. C Question ID: 11267 Which of the following organizations have a necessity for short-term liquidity? A. B. C. D. Property insurance firms. All of these choices are correct. Banks. Casualty insurance firms. B Question ID: 11269 The "tension" that exists in an endowment fund's investment policy is between: the amount of time spent managing investments versus the time spent seeking new contributions. the balance of taxable investments versus non-taxable assets. the use of short-term versus long-term investments. the need for current income versus the need to grow the investment base to protect against future inflation. A. B. C. D. D Question ID: 21161 A mutual fund is a: A. B. portfolio of financial assets in which an investor buys shares. portfolio of real estate investments in which an investor buys shares. 9 C. D. funding source for new venture and mid-stage start-up companies. portfolio of mutual savings banks in which an investor buys shares. A A mutual fund is correctly described as a portfolio of financial assets in which an investor buys shares. Note that a funding source for new venture and mid-stage start up companies is best described as venture capital, and a portfolio of real estate investments is a real estate investment trust (REIT). Question ID: 21162 Which of the following is a constraint faced by mutual funds? Fund managers are: A. not allowed to sell shares at a loss. constrained from selling shares of stock until the gains may be classified as long-term capital gains. prohibited from taking money from certain groups of investors. constrained with respect to investment choices that can be made. B. C. D. D Fund managers are constrained with respect to investment choices that they may make, which are typically laid out in the fund’s prospectus. Fund managers have the discretion to decide who to take money from, when they sell, and whether or not they sell at a gain or a loss. Question ID: 11272 The risk in a defined contribution pension plan is borne by the: A. B. C. D. employer. both the employee and the employer. neither the employee and the employer. employee. 10 D Question ID: 11275 Which of the following statements is TRUE regarding defined-benefit pension plans? They tend to be: more tax conscious with an older employee base than with a younger employee base. neither liquid nor tax conscious with an older employee base and a younger employee base. both liquid and tax conscious with an older employee base and with a younger employee base. more liquid with an older employee base than with a younger employee base. A. B. C. D. D Question ID: 11254 The assessment of risk tolerance should occur: A. B. after one is fully informed as to the potential returns of an investment. as the first step in establishing investment objectives. after one selects potential investments but prior to actually committing funds. after tax considerations have been evaluated. C. D. B Question ID: 11273 11 When assets in a defined-benefit plan are worth less than the present value of the promised benefits, the fund is considered to be: A. B. C. D. unfunded. under funded. over funded. fully funded. B Question ID: 11252 Higher risk investments are often recommended to help meet: A. B. C. D. near-term, high priority goals. long-term, high priority goals. entrepreneurial or money-making goals. emergency spending goals. B Question ID: 11257 Which of the following constraints concerns individual investors least, with respect to their portfolios? A. B. C. D. Political issues. Legal Issues. Liquidity. Taxes. 12 A Question ID: 11268 Taxes are an important investment constraint for: A. B. C. D. individuals. banks. endowments. pension funds. A Question ID: 11265 Studies on investment performance reflect that what percent of overall investment returns are dependent on the long-term asset allocation decisions. A. B. C. D. 50%-65%. 85%-95%. 70%-80%. 30%-50%. B Question ID: 11262 An asset allocation plan specifies: A. B. C. the set of investments that minimizes an investor's tax obligations. how an investor's portfolio should be divided among various asset classes. the number of stocks an investor needs for adequate diversification. 13 D. the average beta for an investor's portfolio. B Question ID: 11249 During the consolidation phase, an individual's: A. B. C. D. debt-to-net worth is extremely high. risk tolerance is extremely low. investment horizon is short. revenues generally exceed expenses. D 1.C: Selecting Investments in a Global Market Question ID: 11277 All of the following statements represent valid reasons why investors should consider global portfolios EXCEPT: A. The international investment opportunity set is large. The correlation between international securities and domestic securities is high. Non-US securities have outperformed domestic securities on a B. C. risk-adjusted basis over extended periods in the past. The covariance between the average domestic security and the average D. international security, multiplied by the product of their respective standard deviations is low. B The correlation between domestic and foreign securities is low. Low correlations provide better diversification benefits. 14 Question ID: 11280 Between 1969 and 1998, the U.S. share of global financial markets fell from: A. B. C. D. 65 to 41 percent. 65 to 29 percent. 75 to 59 percent. 41 to 29 percent. A Question ID: 11283 You are a U.K.-based investor with a global portfolio. A strengthening British pound would most likely: A. B. C. D. Have no impact on the pound-denominated returns to your portfolio. Reduce your pound-denominated return. Increase your pound-denominated return. Significantly affect the return to the domestic securities in your portfolio. B The strengthening of the pound means that other currencies are depreciating relative to the pound and the pound-based returns to these foreign securities will fall. Question ID: 11288 The addition of foreign bonds to a purely domestic mixed-asset portfolio is beneficial because: A. B. C. The Capital Market Line would most likely flatten. The beta of bonds relative to stocks is low. The correlation between foreign bonds and other asset classes is low. 15 D. The Markowitz efficient frontier would shift downward. C Low correlation between asset classes will cause the efficient frontier to shift outward causing the capital market line to steepen. While a low beta may be beneficial to some investors, it is clearly not the best answer of the four. Question ID: 11287 The performance of an internationally diversified portfolio may be affected by: A. B. C. D. all of these choices are correct. country selection. currency selection. stock selection. A Question ID: 11278 Investors should consider global securities portfolios over purely domestic portfolios because: The domestic reward to variability ratio exceeds that of the global reward to variability ratio. The domestic Markowitz efficient frontier exceeds that of the global frontier. The global capital market line lies below that of the domestic capital market line. The global investor opportunity set is greater than a purely domestic opportunity set. A. B. C. D. D The global opportunity set is greater than the domestic opportunity set. Also, the global capital market line will lie above the domestic capital market line because the global reward to variability ratio will exceed the domestic reward to variability ratio. 16 Question ID: 11281 Between 1969 and 1998, the size of the global debt and equity markets expanded from: A. B. C. D. $5.9 trillion to $20.4 trillion. $10.9 trillion to $90.3 trillion. $58.2 trillion to $140.4 trillion. $2.3 trillion to $58.2 trillion. D Question ID: 11284 Over a recent five-year period, non-U.S. bond returns averaged 9%, U.S. bond returns averaged 7% and the U.S. dollar appreciated 2% on average against the major currencies of the world. Assuming that you are a U.S.-based investor, given this information, which of the following was most likely to occur? The 2% appreciation of the dollar over the period served to enhance the dollar-based return to the U.S. bond portfolio to 9%. The 2% depreciation of the average foreign currency over the period served to increase the U.S. dollar-based return to non-U.S. bonds to 11%. The appreciation of the dollar over the period had no significant impact on the return to a global bond portfolio over the period. The returns to a purely domestic U.S. portfolio were roughly equal to the returns to the non-U.S. bond portfolio expressed in U.S. dollars. A. B. C. D. D As a U.S.-based investor, the 2% depreciation of the foreign currencies relative to the dollar most likely served to decrease the dollar-based return to foreign bond investing to 7% = 9% 2%. 1.D: An Introduction to Portfolio Management 17 Question ID: 11291 The basic premise of the risk-return trade-off suggests that risk-averse individuals purchasing investments with higher non-diversifiable risk should expect to earn: A. B. C. D. higher rates of return. lower rates of return. unknown-not enough information provided. rates of return equal to the market. A Question ID: 11290 Support for the assumption that most individuals are risk averse with their investment portfolios is reflected by: A. B. the ability of Treasury bills to generate high positive-alpha rates of return. the desire of many individuals to purchase lottery tickets. the positive relationship between expected returns and expected risk with various assets. the negative relationship between systematic risk and return. C. D. C Question ID: 11289 Risk aversion means that if two assets have identical returns, an individual will choose the asset with the: A. B. lower risk level. higher standard deviation. 18 C. D. higher unsystematic risk. lower payback period. A Question ID: 11293 A measure of how well the returns of two risky assets move together is the: A. B. C. D. standard deviation. semi-variance. covariance. range. C Question ID: 11296 If two stocks have positive covariance, which of the following statements is TRUE? A. The two stocks must be in the same industry. The rates of return tend to move in the same direction relative to their individual means. If one stock doubles in price, the other will also double in price. The two stocks will create a perfectly diversified portfolio. B. C. D. B Question ID: 11295 Which of the following statements regarding correlation is FALSE? 19 A. B. Correlation of +1 means that the returns are perfectly positively correlated. The lower the correlation, the greater the benefits of diversification. If the correlation coefficient is 0, a zero variance portfolio can be constructed. Benefits from diversification arise when the correlation is less that 1. C. D. C Question ID: 11302 Each of the following statements regarding the Markowitz model of portfolio theory is true EXCEPT the model assumes investors: evaluate investment opportunities as a probability distribution of expected returns over some time period. estimate a portfolio's risk on the basis of the variability of expected returns. prefer higher returns to lower returns if the expected risk is the same, and less risk to more risk if the expected return is the same. view the mean of the distribution of potential outcomes as the expected risk of an investment. A. B. C. D. D Question ID: 11303 An investor constructs a portfolio consisting of 40 percent of a risk-free asset and 60 percent of the market portfolio. If the expected return of the risk-free asset is 6 percent and the expected return of the market portfolio is 12 percent, what is the expected rate of return of the investor's portfolio? A. B. 9.6%. 10.4%. 20 C. D. 9.0%. 11.1%. A Expected return of the portfolio = (.4)(.06) + (.6)(.12) = .096 or 9.6% Question ID: 11301 In a set of portfolios, the portfolio with the highest rate of return, but the same variance of the rate of return as the others, would be considered a(n): A. B. C. D. efficient portfolio. positive alpha portfolio. risk-free portfolio. positive beta portfolio. A Question ID: 11310 Stock A has a standard deviation of 10.00. Stock B also has a standard deviation of 10.00. If the correlation coefficient between these stocks is - 1.00, what is the covariance between these two stocks? A. B. C. D. 1.00. 100.00. 0.00. 0.01. B Covariance = (- 1.00)(10.00)(10.00) = - 100.00. Question ID: 11309 21 Which of the following statements is TRUE regarding a larger range of expected returns compared to a smaller range of expected returns? It: A. B. C. D. would result in a smaller standard deviation. translates to a greater certainty of expected future returns. would have greater risk. would be preferred by a risk averse investor. C Question ID: 11308 Stock A has a standard deviation of 0.5 and Stock B has a standard deviation of 0.3. Stock A and Stock B are perfectly positively correlated. According to Markowitz portfolio theory how much should be invested in each stock to minimize the portfolio's standard deviation? A. B. C. D. 100% in Stock A. 50% in Stock A and 50% in Stock B. 30% in Stock A and 70% in Stock B. 100% in Stock B. D Since they are perfectly correlated you get no benefit from diversification. Question ID: 11321 The risk of a portfolio can be reduced only if the rates of return on the securities are: A. B. C. D. not perfectly positively correlated. not equal to zero. equal to zero. perfectly positively correlated. 22 A Any correlation less than 1 (1 being a perfect positive correlation) will lower the overall risk of a portfolio. With a correlation less than 1 when one stock moves up for example the other stock will either move in the same direction a lesser amount or move in the opposite direction if they are negatively correlated. Either way, the difference in the movements of the stocks will lower the overall risk of the portfolio. Question ID: 11322 If the standard deviation of returns for stock 3 is 0.80 and for stock 4 is 0.50 and the covariance between the returns of the two stocks is 0.009 what is the correlation between stocks 3 and 4? A. B. C. D. 177.778 0.0225 44.444 0.004 B Cov3,4 = (r3,4)(SD3)(SD4) 0.009 = (r3,4)(0.80)(0.50) 0.009/(0.80)(0.50) = (r3,4) 0.009/0.40 = 0.0225 Question ID: 11314 If the standard deviation of returns for stock A is 0.40 and for stock B is 0.30 and the covariance between the returns of the two stocks is 0.007 what is the correlation between stocks A and B? A. B. C. 190.476 0.00084 17.143 23 D. 0.0583 D CovA,B = (rA,B)(SDA)(SDB) 0.007 = (rA,B)(0.40)(0.30) 0.007/(0.40)(0.30) = (rA,B) 0.007/.12 = 0.058 Question ID: 11317 If the standard deviation of returns for stock 5 is 0.90 and for stock 6 is 0.40 and the covariance between the returns of the two stocks is -0.005 what is the correlation between stocks 5 and 6? A. B. C. D. -0.002 -72.000 -450.000 -0.0139 D Cov5,6 = (r5,6)(SD5)(SD6) -0.005 = (r5,6)(0.90)(0.40) -0.005/(0.90)(0.40) = (r5,6) -0.005/0.36 = -0.0139 Question ID: 11323 The efficient frontier represents the set of portfolios that: A. consistently produce betas greater than one. 24 B. C. D. consistently produce betas less than one. provides the minimum level of risk for every level of return. consistently produce positive alphas. C Question ID: 11327 Which of the following statements regarding a portfolio and the efficient frontier is TRUE? A portfolio to the left of the efficient frontier is not attainable, while a portfolio to the right of the efficient frontier is not attainable. A portfolio to the left of the efficent frontier is not attainable, while a portfolio to the right of the the efficient frontier is inefficient. A portfolio to the left of the efficient frontier is inefficient, while a portfolio to the right of the efficient frontier is not attainable. A portfolio to the left of the efficient frontier is inefficient, while a portfolio to the right of the efficient frontier is inefficient. A. B. C. D. B Question ID: 11325 Which one of the following portfolios cannot lie on the efficient frontier? Portfolio A B C D E Expected Return 20% 11% 8% 10% 8% D. C. Standard Deviation 35% 13% 10% 11% 9% A. B. 25 C. D. B. A. B Portfolio C cannot lie on the frontier because it has the same return as Portfolio E, but has more risk. Question ID: 11324 The slope of the efficient frontier: A. B. C. D. decreases steadily as one moves upward on the curve. increases steadily as one moves upward on the curve. is constant as one moves upward on the curve. cannot determine from the information provided. A Question ID: 11336 The optimal portfolio is determined by: the point of tangency between a capital allocation line and the investor's utility curve. the point of tangency between the risk-free rate and the individual's utility curve with the highest possible utility. the point of tangency between the efficient frontier and the individual's utility curve with the highest possible utility. the point of tangency between the risk-free rate and the current market return on the efficient frontier. A. B. C. D. C 26 Question ID: 11334 Which of the following portfolios falls below the Markowitz efficient frontier? Portfolio A B C D Expected Return 7% 9% 15% 12% Expected Standard Deviation 14% 26% 30% 22% A. B. C. D. B. C. D. A. A Question ID: 11335 The particular portfolio on the efficient frontier that best suits an individual investor is determined by: A. the beta of the market at that particular time. the current market risk-free rate as compared to the current market return rate. the individual's utility curve. the individual's asset allocation plan. B. C. D. C Question ID: 11366 An investor has two stocks in their portfolio, stock A and stock B. What is the variance of the 27 portfolio given the following information about the two stocks? σA = 55% σB = 85% Cor = 0.9 W A = 70% WB = 30% A. B. C. D. 0.62447 0.38997 0.40960 0.15904 B σ2 of a 2 stock portfolio = W A2σA2+W B2 σB2+2W AWBσA σBrA,B σ2A,B = (0.70)2 (0.55)2 + (0.30)2 (0.85)2 2(0.7)(0.30)(0.55)(0.85)(0.9) = (0.4900)(0.3025)+(0.0900)(0.7225)+(0.17672) = 0.14823 + 0.06503 + 0.17672 = 0.38997 Setup Text: As a fund manager, Bryan Cole, CFA, is responsible for assessing the risk and return parameters of the portfolios he oversees. Cole is currently considering a portfolio consisting of only two stocks. The first stock, Remba Co., has an expected return of 12 percent and a standard deviation of 16 percent. The second stock, Labs Inc., has an expected return of 18 percent and a standard deviation of 25 percent. The correlation of returns between the two securities is .25. Question ID: 11348 If Cole forms a portfolio with 30 percent in Remba and 70 percent in Labs, what is the portfolio's expected return? 28 A. B. C. D. 21.5%. 16.2%. 15.0%. 17.3%. B Question ID: 11348 Suppose that the correlation between Remba and Labs is -1. In order to construct a zero variance portfolio using only Remba and Labs, what portion of the portfolio should be invested in Remba? A. B. C. D. 21%. 28%. 39%. 61%. D When r1,2 = -1 the risk will actually go to zero at one point. The optimal weighting that drives σ to zero is: W 1 = σ2 / (σ1 + σ2) W 2 = σ1 / (σ1 + σ2) W 1 = .25/ (.16 + .25) = .25/.41 = .61 Question ID: 11337 An investor has two stocks, stock Y and stock Z in their portfolio. What is the standard 29 deviation of the portfolio given the following information about the two stocks? σY= 65% σZ= 46% Cor = 0.5 WY= 60% WZ= 40% A. B. C. D. 0.1086 0.3295 0.5077 0.2577 C σ of a 2 stock portfolio = [W Y2σY2+W Z2σZ2+2WYWZσYσZrY,Z]1/2 σY,Z=[( 0.6)2( 0.65)2+( 0.4)2( 0.46)2+ 2(0.6)(0.4)(0.65)(0.46)(0.5)] 1/2 = [( 0.36)(0.4225)+(0.16)(0.2116)+0.07176] 1/2 = (0.1521 + 0.03386 + 0.07176)1/2 = (0.25772)1/2 = 0.5077 Question ID: 11341 An investor has two stocks, stock Y and stock Z in their portfolio. What is the standard deviation of the portfolio given the following information about the two stocks? σY = 75% σZ = 49% Cor = 0.7 WY = 55% WZ = 45% 30 A. B. C. D. 0.4007 0.3461 0.1606 0.5883 D σ of a 2 stock portfolio = [W Y σY +W Z σZ +2WYWZσYσZrY,Z] 2 2 2 2 1/2 σY,Z=[( 0.55)2( 0.75)2+( 0.45)2( 0.49)2+ 2(0.55)(0.45)(0.75)(0.49)(0.7)] 1/2 = [( 0.30)(0.5625)+(0.20)(0.2401)+0.12734] 1/2 = (0.17015625 + 0.04862 + 0.12734)1/2 = (0.34612)1/2 = 0.5883 Question ID: 11352 An investor owns the following portfolio. What is the investor's expected rate of return? Stock A B C Market Value $5,000 $3,000 $4,000 10.00%. 9.67%. 10.50%. 29.00%. Expected Return 12% 8% 9% A. B. C. D. A Return = [5,000/12,000*(.12) + 3,000/12,000*(.08) + 4,000/12,000*(.09)] = 10% 31 Question ID: 11351 The variance of a portfolio of stocks is equal to: A. B. C. D. the weighted average of the variances of the individual securities. none of these choices are correct. the sum of the covariance of the individual securities. the square root of the standard deviation of the portfolio. B Question ID: 11346 You put 60 percent of your money in T-Bills that earn 5 percent and 40 percent of your money into stocks which are expected to earn 10 percent and have an expected standard deviation of 15 percent. What is the expected return of your portfolio and its expected standard deviation? A. B. C. D. 7%; 6% 4%; 3% 5%; 7% 6%; 7% A Since T-Bills are "risk free," their standard deviation must, by definition be zero. Since it doesn’t move, its covariance with other stocks must be zero. Question ID: 11355 An investor owns the following portfolio today. What is the investor's expected total rate of return after three years? Stock R S T Market Value $2,000 $3,200 $2,800 32 Expected Annual Return 17% 8% 13% A. B. C. D. 48.75%. 53.46%. 57.10%. 16.25%. C Annual rate of return = [2000/8000*(.17) + 3200/8000*(.08) + 2800/8000*(.13)] = 16.25%. Return after three years = (1.1625)3 - 1 = 57.10% Question ID: 11343 An investor has two stocks in their portfolio, stock A and stock B. What is the variance of the portfolio given the following information about the two stocks? σA = 126% σB = 87% Cor = -0.2 W A = 33% WB = 67% A. B. C. D. 0.99740 0.01939 0.41571 0.64476 C σ of a 2 stock portfolio = W A σA +W B σB +2W AW BσAσBrA,B σ2A,B = (0.33)2 (1.26)2 + (0.67)2 (0.87)2 + 2(0.33)(0.67)(1.26)(0.87)(-0.2) = (0.1089)(1.5876)+(0.4489)(0.7569)+(-0.09695) = 0.17289 + 0.33977 + -0.09695 = 0.41571 33 2 2 2 2 2 Question ID: 11315 If the standard deviation of returns for stock S is 0.70 and for stock T is 0.50 and the covariance between the returns of the two stocks is 0.009 what is the correlation between stocks S and T? A. B. C. D. 38.889 0.0257 0.003 155.556 B CovS,T = (rS,T )(SDS)(SDT ) 0.009 = (rS,T )(0.70)(0.50) 0.009/(0.70)(0.50) = (rS,T ) 0.009/0.35 = 0.0257 Question ID: 11333 If the standard deviation of returns for stock A is 0.60 and for stock B is 0.40 and the covariance between the returns of the two stocks is 0.009 what is the correlation between stocks A and B? A. B. C. D. 0.002 26.667 166.667 0.0375 D CovA,B = (rA,B)(SDA)(SDB) 34 0.009 = (rA,B)(0.60)(0.40) 0.009/(0.60)(0.40) 0.009/0.24 = 0.0375 Question ID: 11356 An investor owns the following portfolio today. What is the investor's expected portfolio value in one year? Stock W X Y Market Value $5,600 $9,400 $1,600 $21,366. $17,245. $19,778. $18,961. Expected Annual Return 20% 12% 7% A. B. C. D. D Rate of return = [5600/16600*(.20) + 9400/16600*(.12) + 1600/16600*(.07)] = 14.22%. Portfolio value = 16600*1.1422 = $18,961 Question ID: 11326 An investor has identified the following possible portfolios. Which portfolio lies to the right of the efficient frontier? Portfolio A B C D E Expected Return 18% 12% 10% 14% 13% A. D. Standard Deviation 35% 16% 10% 20% 24% A. B. 35 C. D. E. F. C Portfolio E must be inefficient because its risk is higher than the risk of Portfolio D. Question ID: 11306 Which one of the following statements is FALSE? A. Positive covariance means that asset returns move together. A zero covariance implies there is no relationship between the two variables. If two assets have perfect negative correlation, it is impossible to reduce the portfolio's overall variance. The covariance is equal to the correlation coefficient times the standard deviation of one stock times the standard deviation of the other stock. B. C. D. C Question ID: 11357 An investor has two stocks, Stock A and Stock B in her portfolio. What is the standard deviation the portfolio given the following information about the two stocks? σA = 20% σB = 15% rA,B = .32 W A = 70% WB = 30% A. B. C. .1832. .0096. .1472. 36 D. .16. D Standard deviation of two-stock portfolio = [W 12σ12 + W22σ22 + 2W1W 2σ1σ2r1,2.]1/2 = [(.7)2(.2)2 + (.3) (.15) + (2)(.7)(.3)(.2)(.15)(.32)] 2 2 1/2 = .16 Question ID: 11300 Mike Palm, CFA, is an analyst with a large money management firm. Currently, Palm is considering the risk and return parameters associated with Alux, a small technology firm. After in depth analysis of the firm and the economic outlook, Palm estimates the following return probabilities: Probability (Pi) .3 .5 .2 Return (Ri) -5% 15% 25% Palm's objective is to quantify the risk/return relationship for Alux. The measure of risk used in Markowitz portfolio theory is: A. B. C. D. range. semivariance. standard deviation. Beta. C Question ID: 11313 If the standard deviation of returns for stock C is 0.60 and for stock D is 0.40 and the covariance between the returns of the two stocks is 0.009 what is the correlation between stocks C and D? A. 0.0375 37 B. C. D. 26.667 166.667 0.002 A CovC,D = (rC,D)(SDC)(SDD) 0.009 = (rC,D)(0.60)(0.40) 0.009/(0.60)(0.40) = (rC,D) 0.009/0.24 = 0.0375 Question ID: 11345 If you had two assets that were perfectly positively correlated, what would be their combined variance if 40 percent were put in the asset with a variance of .25 and 60 percent were invested in an asset with a variance of .4? A. B. C. D. .336. .144. .232. .101. A Question ID: 11294 In time 1: Stock A's return was 10 percent and stock B's return was 15 percent. In time 2: 38 Stock A's return was 6 percent and Stock B's return was 9 percent. What is the covariance of returns between A and B? A. B. C. D. 6. 12. 3. 2. A [(10-8)(15-12) + (6-8)(9-12)]/2 1.E: An Introduction to Asset Pricing Models Question ID: 11370 Combining the market portfolio with the risk-free asset results in: A. B. C. D. new efficient portfolios. an elimination of systematic risk. a movement along an individual investor's utility curve. a less diversified portfolio. A Question ID: 11371 What is the risk measure associated with the CML? A. B. C. Beta. Market risk. Standard deviation. 39 D. Covariance. C Question ID: 11374 For an investor to move further up the Capital Market LIne, the investor must: A. B. C. D. continue to invest only in common stocks. at some point borrow and invest in the market portfolio. reduce the portfolio's risk below that of the market. diversify the portfolio even more. B Question ID: 11384 A diversified portfolio has lower risk than a concentrated portfolio due to lower: A. B. C. D. none of these choices are correct. market risk. nondiversifiable risk. nonsystematic risk. D Question ID: 11382 As an investor increases the number of stocks in a portfolio the systematic risk will: A. B. increase at a decreasing rate. decrease at an increasing rate. 40 C. D. decrease at a decreasing rate. remain constant. D It's the unsystematic risk that falls. Setup Text: Jim Williams, CFA, is assessing the investment merits of several securities. Specifically, Williams has collected the following data for three possible investments. Stock Alpha Omega Lambda Price Today Forecasted Price* 25 105 10 31 110 10.80 Dividend Beta 2 1 0 1.6 1.2 0.5 *Forecasted Price = expected price one year from today. The expected return on the market is 12 percent and the risk-free rate is 4 percent. Question ID: 11392 According to the Security Market Line (SML), which of the three securities is correctly priced? A. B. C. D. None of the securities is overpriced. Alpha. Lambda. Omega. C Question ID: 11392 Which of the three securities identified by Williams would plot on the Capital Market Line(CML)? 41 A. B. C. D. Omega. Lambda. None would plot on the CML. Alpha. C Question ID: 11389 What would happen to the SML if the inflation rate increased? The Y intercept would remain the same, but the SML would rotate clockwise. The SML would have a parallel shift downward. The SML would have a parallel shift upward. The Y intercept would remain the same, but the SML would rotate counter clockwise. A. B. C. D. C Question ID: 11396 What is the required rate of return for a stock with a beta of 1.2, when the risk-free rate is 6 percent and the market is offering 12 percent? A. B. C. D. 12.0%. 6.0%. 13.2%. 7.2%. C 42 Question ID: 11401 The market is expected to return 12 percent next year and the risk free rate is 6 percent. What is the expected rate of return on a stock with a beta of .9? A. B. C. D. 16.2. 11.4. 10.8. 13.0. B Question ID: 11399 A stock selling for $50 is expected to increase to $55 by year end and pay a $1 dividend. If the stock had a beta of .7, an expected market return of 15 percent, and a risk-free rate of 8 percent, it would be considered: A. B. C. D. properly priced. overpriced. Cannot be determined with the information given. under priced. B Question ID: 11413 An investor determines the following information through fundamental analysis: ERS = 15% RF = 5% ERM = 12% Beta = 1.2 43 The investor should consider the stock to be: A. B. C. D. undervalued. properly valued. overvalued. unable to determine based on the information given. A Expected return of Stock S = 5 + 1.2(12 - 5) = 13.4. Since the estimated return is greater than the expected return, the stock is undervalued. Question ID: 11408 An investor owns a stock with a beta of -1. If the market is expected to decline by 10 percent, then the investor's stock would be expected to: A. B. C. D. decrease by 1%. cannot determine without knowing the risk-free rate. increase by 10%. decrease by 10%. C Question ID: 11409 Which of the following statements are TRUE regarding a stock's beta: a beta greater than one is aggressive, while a beta less than one is defensive. a beta greater than one is overvalued, while a beta less than one is undervalued. a beta greater than one is undervalued, while a beta less than one is overvalued. A. B. C. 44 D. a beta greater than one is risky, while a beta less than one is risk-free. A Question ID: 11420 The ratio of return to systematic risk for an investment portfolio is .70, while the market is .50. This information suggests that the portfolio: A. exhibits inferior performance because it has more risk than the market. is not diversified enough, and more securities should be purchased to bring the portfolio in line with the market. exhibits superior performance because the return per unit of risk is above that of the market. is too diversified, and some securities should be sold to bring the portfolio in line with the market. B. C. D. C Question ID: 21163 Regarding beta as a measure of systematic risk, which of the following is FALSE? The estimate of beta depends on: A. B. C. the market's expectation of the systematic risk of the asset. an index such as the S&P 500, since there is no "all risky assets" index. the proxy used to represent the market. the time interval used to calculate the historical returns (i.e. daily, weekly, monthly, etc.) D. A 45 Beta is calculated as the slope coefficient of a regression line and does not depend on market expectations. Beta depends on the time interval chosen as well as the market proxy (often the S&P 500). Question ID: 11421 Using the APT to determine the expected return on a stock, you determine that the risk-free rate is 6 percent; B1 is 1.5; B2 is 2; risk factor F1 is .03, and risk factor F2 is .02. What return would you expect to receive on the stock? A. B. C. D. 9.50. 12.2. 14.5. 16.0. C Question ID: 11372 A portfolio to the right of the market portfolio on the CML is a(n): A. B. C. D. lending portfolio. borrowing portfolio. impossible portfolio. inefficient portfolio. B Question ID: 11414 An investor determines the following information: ERL = 16% RF = 6% ERM = 12% 46 Beta = 1.4 Should the investor purchase the stock? A. B. C. D. No, because it is undervalued. Yes, because it is overvalued. Yes, because it is undervalued. No, because it is overvalued. C Expected return of Stock L = 6 + 1.4(12 - 6) = 14.4. Since the estimated return is greater than the expected return, the stock is undervalued. Question ID: 11375 A market portfolio should include assets: A. B. C. D. in proportion to their market value. with the exception of non-financial assets (art, stamps, antiques). in proportion to their book value. until thirty stocks are included. A Question ID: 11400 The market is expected to return 15 percent next year and the risk-free rate is 7 percent. What is the expected rate of return on a stock with a beta of 1.3? A. B. C. D. 17.4. 16.3. 10.4. 17.1. 47 A Question ID: 11422 The Arbitrage Pricing Theory (APT) differs from the Capital Asset Pricing Model (CAPM) in the APT: A. B. C. D. identifies the specific factors that determine expected returns. recognizes unsystematic risk factors. requires less restrictive assumptions. all of these choices are correct. C Question ID: 11410 The beta of Stock A is 1.3. If the expected return of the market is 12 percent, and the risk-free rate of return is 6 percent, what is the expected return of Stock A? A. B. C. D. 15.6%. 8.5%. 14.2%. 13.8%. D Expected return of Stock A = 6 + 1.3(12-6) = 13.8` Question ID: 11369 An investor is constructing a portfolio consisting of a risk-free asset and the market portfolio. The investor desires a portfolio variance of .0064 while remaining on the Capital Market Line. If the expected variance of the market portfolio is .0225, what should be the investor weights for the risk-free asset and the market portfolio? 48 A. B. C. D. 72% risk-free, 28% market portfolio. 67% risk-free, 33% market portfolio. 47% risk-free, 53% market portfolio. 50% risk-free, 50% market portfolio. C Market portfolio weight = (.0064/.0225) 0.5 = 0.53 or 53% Question ID: 11385 Which of the following statements is TRUE? A. B. C. D. Firm-specific risk can be reduced through diversification. The two classes of risk are market risk and systematic risk. Risk can be totally avoided through diversification. Market risk can be reduced through diversification. A Question ID: 11397 What is the required rate of return for a stock with a beta of .7, when the risk free rate is 7 percent and the market is offering 14 percent? A. B. C. D. 14.0%. 11.9%. 14.9%. 16.8%. B 49 Question ID: 11383 Total risk equals: A. B. C. D. systematic plus unsystematic risk. market plus non-diversifiable risk. unique plus diversifiable risk. systematic plus non-diversifiable risk. A 2: International Portfolio Investment Question ID: 11426 The largest equity market in the world is in: A. B. C. D. The United Kingdom. The United States. China. Japan. B Question ID: 21164 Investors can increase the benefits of diversification by diversifying across country borders. Which of the following regarding international diversification is FALSE? Local monetary and fiscal policy and different institutional and legal A. systems are most likely responsible for the benefits of international diversification. 50 There are more opportunities to diversify internationally, versus B. domestically (about 60% of the world's stock market capitalization is in non-U.S. companies). There are fewer opportunities to diversify internationally, versus C. domestically (approximately 85% of the world's stock market capitalization is in U.S. stocks) but the benefits still exist. An internationally diversified portfolio is only 11.7% as risky as the typical D. individual stock while a fully diversified U.S. portfolio is 27% as risky as an individual stock. C Approximately 60% of the world's stock market capitalization is in non-U.S. stocks and the percentage is growing. Question ID: 11427 Which of the following is NOT a benefit of international diversification? A. B. C. D. Tax reduction. Riding the yield curve. Increasing expected return. Risk reduction. B Question ID: 21165 Emerging markets present excellent investment opportunities because: emerging market stocks tend to have more reliable returns than developed country equity returns. investors prefer high correlation coefficients between international and U.S. stocks and the developing world market provides this. A. B. 51 C. emerging market stocks have very high betas as measured against the world index. much of the country risk is eliminated due to low correlations between returns of these countries. D. D The greatest diversification benefits come from adding assets to a portfolio that have low correlations with existing portfolio assets. Emerging markets have high volatility when considered in isolation, but due to their low correlations with other national stock indexes, can lower the overall risk of portfolio. Question ID: 11432 The world market provides high return opportunities because: A. B. C. D. there are many rapidly growing economies in developing countries. the returns in developing countries are higher than in developed countries. many foreign countries have guaranteed profit making strategies. foreign markets are easy to manipulate. A Question ID: 11434 One reason an investor in the United States should consider investing in international capital markets is: A. foreign countries have lower taxes than the United States. foreign capital markets are more efficient than the capital market in the United States. foreign capital markets are more profitable than the capital market in the United States. foreign capital markets have weak correlations with the United States 52 B. C. D. capital market. D Question ID: 11438 A U.S. investor can maximize risk reduction by combining U.S. securities with those of a country that: A. B. C. D. trades with the U.S. is negatively or weakly correlated with the U.S. correlated with the U.S. is an oil importer. B Question ID: 11446 Which of the following is NOT a constraint to a domestic investor to international investment? A. B. C. D. Inefficiencies in foreign markets. Lack of instruments to hedge against currency risk. High transaction costs for international investments. Cultural uncertainties. D Question ID: 21166 When an investor adds bonds to an internationally diversified stock portfolio, the efficient frontier shifts: 53 A. B. C. D. upward and to the right of the stocks-only efficient frontier. upward and to the left of the stocks-only efficient frontier. downward and to the right of the stocks-only efficient frontier. downward and to the left of the stocks-only efficient frontier. B When you add bonds to an internationally diversified, stock only-portfolio, returns increase and risk falls. This means that the efficient frontier shifts upward and to the left of the stock-only efficient frontier. Question ID: 21167 The best portfolio to own, according to the efficient frontier is a(n): A. B. C. D. internationally diversified stock and bond portfolio. internationally diversified stock portfolio. fully diversified U.S. stock and bond portfolio. fully diversified U.S. stock portfolio. A The highest return and lowest risk possibilities come from an internationally diversified stock and bond portfolio. Question ID: 11454 While working abroad, United States citizen Michael Ordway purchases a foreign bond with an annual coupon of 7.5 percent for 96.0 He holds the bond for one year and then sells it for 97.5 before he leaves. During the year, the foreign currency appreciated 3% relative to the dollar. Which of the following is closest to Ordway's Total Dollar Return? A. 9.375%. 54 B. C. D. 6.094%. 12.656%. 4.609%. C R$ = { [ 1 + ($coupon + VEND - VBEG) / VBEG ] * (1 + g) } - 1, Where R$ = Total dollar return, VEND = Bond value at end of period, V BEG = Bond value at end of period, and g = % change in the dollar value of the foreign currency. R$ = { [ 1 + (7.5 + 97.5 - 96.0) / 96.0 ] * (1 + 0.030) } - 1 = { [1.09375 ] * (1.030) } - 1 = 0.12656, or 12.656% Question ID: 11455 While working abroad, United States citizen Araysa Kendall purchases a foreign bond with an annual coupon of 8.0 percent for 93.5. She holds the bond for one year and then sells it for 96.0 before she leaves. During the year, the foreign currency depreciated 4.5% relative to the dollar. Which of the following is closest to Kendall's Total Dollar Return? A. B. C. D. 11.230%. 16.235%. 6.225%. -1.947%. C R$ = { [ 1 + ($coupon + VEND - VBEG) / VBEG ] * (1 + g) } - 1, Where R$ = Total dollar return, VEND = Bond value at end of period, V BEG = Bond value at end of period, and g = % change in the dollar value of the foreign currency. 55 R$ = { [ 1 + (8.0 + 96.0 - 93.5) / 93.5 ] * (1 - 0.045) } - 1 = { [1.112299 ] * (0.955) } - 1 = 0.06225, or 6.225% Question ID: 11452 While working abroad, United States citizen David Sarrel purchases a foreign bond with an annual coupon of 6.5 percent for 92.5 He holds the bond for one year and then sells it for 96.0 before he leaves. During the year, the dollar appreciated 2% relative to the foreign currency. Which of the following is closest to Sarrel's Total Dollar Return? A. B. C. D. 8.595%. 1.708%. 13.027%. 10.811%. A R$ = { [ 1 + ($coupon + VEND - VBEG) / VBEG ] * (1 + g) } - 1, Where R$ = Total dollar return, VEND = Bond value at end of period, V BEG = Bond value at end of period, and g = % change in the dollar value of the foreign currency. R$ = { [ 1 + (6.5 + 96.0 - 92.5) / 92.5 ] * (1 - 0.02) } - 1 = { [1.108108 ] * (0.980) } - 1 = 0.08595, or 8.595% Question ID: 11453 While working abroad, United States citizen Kim Trane purchases a foreign bond with an annual coupon of 9.0 percent for 93.0. She holds the bond for one year and then sells it for 95.5 before she leaves. During the year, the dollar depreciated 3.5% relative to the foreign currency. 56 Which of the following is closest to Trane's Total Dollar Return? A. B. C. D. 6.282%. 12.366%. 8.433%. 16.298%. D R$ = { [ 1 + ($coupon + VEND - VBEG) / VBEG ] * (1 + g) } - 1, Where R$ = Total dollar return, VEND = Bond value at end of period, VBEG = Bond value at end of period, and g = % change in the dollar value of the foreign currency. R$ = { [ 1 + (9.0 + 95.5 - 93.0) / 93.0 ] * (1 + 0.035) } - 1 = { [1.123656 ] * (1.035) } - 1 = 0.16298, or 16.298% Question ID: 11456 While working abroad, United States citizen Magda Silver purchases a foreign bond with an annual coupon of 7.0 percent for 96.0 She holds the bond for one year and then sells it for 98.0 before she leaves. During the year, the dollar appreciated 5% relative to the foreign currency. Which of the following is closest to Silver's Total Dollar Return? A. B. C. D. 3.906%. -3.021%. 14.844%. 9.375%. A 57 R$ = { [ 1 + ($coupon + VEND - VBEG) / VBEG ] * (1 + g) } - 1, Where R$ = Total dollar return, VEND = Bond value at end of period, VBEG = Bond value at end of period, and g = % change in the dollar value of the foreign currency. R$ = { [ 1 + (7.0 + 98.0 - 96.0) / 96.0 ] * (1 - 0.05) } - 1 = { [1.09375 ] * (0.950) } - 1 = 0.03906, or 3.906% Question ID: 11428 The United States market has a strong correlation with the world market because of: A. United States has advanced derivatives market. the stable political conditions in the United States compared to other countries. the significant size of the United States market relative to the world market. the high dependence among all world markets. B. C. D. C Question ID: 11459 While working abroad, United States citizen Par Henick purchases a foreign bond with an annual coupon of 5.5 percent for 98.0. He holds the bond for one year and then sells it for 99.0 before he leaves. During the year, the foreign currency depreciated 6.0% relative to the dollar. Which of the following is closest to Henick's Total Dollar Return? A. B. C. D. 13.031%. 6.633%. -5.041%. 0.235%. 58 D R$ = { [ 1 + ($coupon + VEND - VBEG) / VBEG] * (1 + g) } - 1, Where R$ = Total dollar return, VEND = Bond value at end of period, V BEG = Bond value at end of period, and g = % change in the dollar value of the foreign currency. R$ = { [ 1 + (5.5 + 99.0 - 98.0) / 98.0 ] * (1 - 0.060) } - 1 = { [1.066327 ] * (0.940) } - 1 = 2.34738 -03 = 0.00235, or 0.2350% Question ID: 11457 While working abroad, United States citizen Chai Mieda purchases a foreign bond with an annual coupon of 8.5 percent for 98.0. She holds the bond for one year and then sells it for 96.0 before she leaves. During the year, the dollar depreciated 3.0% relative to the foreign currency. Which of the following is closest to Mieda's Total Dollar Return? A. B. C. D. 3.434%. 9.832%. 6.633%. 0.898%. B R$ = { [ 1 + ($coupon + VEND - VBEG) / VBEG] * (1 + g) } - 1, Where R$ = Total dollar return, VEND = Bond value at end of period, V BEG = Bond value at end of period, and g = % change in the dollar value of the foreign currency. R$ = { [ 1 + (8.5 + 96.0 - 98.0) / 98.0 ] * (1 + 0.03) } - 1 = { [1.066327 ] * (1.03) } - 1 59 = 0.09832, or 9.832% Question ID: 11447 International investment can be limited due to regulations imposed by: A. B. C. D. foreign governments. a country's central bank. domestic governments. both domestic governments and foreign governments. D Question ID: 11439 A domestic investor desiring to achieve high returns and low risk exposure should look for: stable currencies compared with the domestic currency, high overall growth potential and high correlation with the domestic currency. a rate of return and correlation comparable to the domestic market. a compound rate of return and correlation close to that of the domestic market. a compound rate of return higher than that in the domestic market and low or negative correlation with the domestic market. A. B. C. D. D Question ID: 11433 Diversification reduces what type of risk? A. B. Systematic. Interest rate risk. 60 C. D. All of these choices are correct. Unsystematic. D Question ID: 11436 Intensifying competition in the international personal computer industry would most likely: A. B. C. D. increase correlations between international markets. decrease correlations between international markets. not affect correlations between international markets. increase the covariance between international markets. A Question ID: 11458 While working abroad, United States citizen Andrew Gregg purchases a foreign bond with an annual coupon of 6.0 percent for 93.5 He holds the bond for one year and then sells it for 92.5 before he leaves. During the year, the foreign currency appreciated 4% relative to the dollar. Which of the following is closest to Gregg's Total Dollar Return? A. B. C. D. 9.561%. 5.348%. 2.888%. 1.134%. A R$ = { [ 1 + ($coupon + VEND - VBEG) / VBEG ] * (1 + g) } - 1, 61 Where R$ = Total dollar return, VEND = Bond value at end of period, VBEG = Bond value at end of period, and g = % change in the dollar value of the foreign currency. R$ = { [ 1 + (6.0 + 92.5 - 93.5) / 93.5 ] * (1 + 0.040) } - 1 = { [1.053476 ] * (1.040) } - 1 = 0.09561, or 9.561% 62

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