Finance Theory Practice Exam
Course Introduction
Finance Theory explores the fundamental principles underlying financial decision-making in firms and markets. This course covers essential concepts such as risk and return, portfolio theory, market efficiency, asset pricing models, and the valuation of financial instruments. Students will examine how individuals and organizations allocate resources over time under uncertainty, analyze the role of financial markets in the economy, and study the theoretical frameworks that influence financial policy and investment strategies. Through case studies and mathematical models, the course provides a rigorous foundation for understanding modern finance and prepares students for advanced coursework or careers in the financial sector.
Recommended Textbook
Analysis of Investments and Mangement of Portfolios International 10th Edition by Reilly
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Chapter 1: An Overview of the Investment Process
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Q1) Refer to Exhibit 1.5.What are the real rates of return for each of these securities?
A) 4.29% and 6.32%
B) 1.23% and 4.29%
C) 3.20% and 6.32%
D) 1.23% and 3.20%
E) 3.75% and 5.75%
Answer: D
Q2) Refer to Exhibit 1.7.Calculate the annual real rate of return for U.S.large-cap stocks.
A) 7.06%
B) 6.18%
C) 4.75%
D) 3.75%
E) None of the above Answer: B
Q3) Nominal rates are averages of all possible real rates.
A)True
B)False
Answer: False
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Chapter 2: The Asset Allocation Decision
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Q1) Important reasons for constructing a policy statement include:
A) Helps investors decide on realistic investment goals
B) Create a standard by which to judge the performance of the portfolio manager
C) Develop an instrument to judge risk
D) Choices a and b
E) All of the above
Answer: D
Q2) The typical investor's goals rarely change during his/her lifetime.
A)True
B)False
Answer: False
Q3) Asset allocation is
A) The process of dividing funds into asset classes.
B) Concerned with returns variability.
C) Concerned with the risk associated with different assets.
D) Concerned with the relationship among investments' returns.
E) All of the above.
Answer: E
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Chapter 3: The Global Market Investment Decision
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Q1) In order to diversify risk an investor must have investments that have correlations with other investments in the portfolio that are
A) low positive
B) zero
C) negative
D) any of the above
E) none of the above
Answer: D
Q2) Income bonds are considered as safe as debentures because they pay higher rates of interest.
A)True
B)False
Answer: False
Q3) Which of the following is <b>not</b> a type of investment company?
A) Money market funds
B) Common stock funds
C) Balanced funds
D) Bond funds
E) None of the above
Answer: E
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Chapter 4: Securities Markets: Organization and Operation
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Q1) Refer to Exhibit 4.3.How many shares of Jackson can Kathy buy?
A) 1875
B) 1500
C) 1750
D) 1200
E) None of the above
Q2) The over-the-counter market includes all stocks not listed on one of the major exchanges but constitutes a lesser of a dollar value than the New York and American Exchanges combined.
A)True
B)False
Q3) The value of the stocks traded in the over-the-counter market is greater than the combined values of the stocks traded on the New York Stock Exchange and the American Stock Exchange combined.
A)True
B)False
Q4) Initial public offerings (IPOs)involve selling of bonds to the public for the first time.
A)True
B)False
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Chapter 5: Security-Market Indexes
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Q1) In a price weighted average stock market indicator series,the following type of stock has the greatest influence
A) The stock with the highest price
B) The stock with the lowest price
C) The stock with the highest market capitalization
D) The stock with the lowest market capitalization
E) The stock with the highest P/E ratio
Q2) An equally weighted indicator series is also known as an unweighted indicator series.
A)True
B)False
Q3) The New York Stock Exchange Index is based on a sample of all of the New York Stock Exchange stocks.
A)True
B)False
Q4) An aggregate market index can be used as a benchmark to judge the performance of professional money managers.
A)True B)False
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Chapter 6: Efficient Capital Markets
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Q1) Refer to Exhibit 6.4.What is the abnormal rate of return for Stock B when you consider its systematic risk measure (beta)?
A) 0.1%
B) -1.4%
C) 0.5%
D) 1.5%
E) 2.0%
Q2) The results of studies that have looked at the relationship between PEG ratios and subsequent stock returns
A) Find an inverse relationship, with annual rebalancing.
B) Find no relationship, with monthly or quarterly rebalancing.
C) Find an inverse relationship, with monthly or quarterly rebalancing.
D) Find a direct relationship, with monthly or quarterly rebalancing.
E) Find a direct relationship with annual rebalancing
Q3) The results of return prediction studies have found
A) Limited success predicting short-horizon returns.
B) Limited success predicting long-horizon returns.
C) Good success predicting long-horizon returns.
D) a and b.
E) a and c.
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Chapter 7: An Introduction to Portfolio Management
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Q1) Refer to Exhibit 7.8.What is the expected return of a portfolio of two risky assets if the expected return E(R?),standard deviation (s?),covariance (COV?,?),and asset weight (W?)are as shown above?
A) 6.4%
Q2) A measure that only considers deviations above the mean is semi-variance. A)True B)False
Q3) Refer to Exhibit 7.10.What is the expected return of a portfolio of two risky assets if the expected return E(R?),standard deviation (s?),covariance (COV?,?),and asset weight (W?)are as shown above?
A) 11%
B) 12%
C) 13%
D) 14%
E) 15%
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Chapter 8: An Introduction to Asset Pricing Models
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Q1) Refer to Exhibit 8.2.What are the estimated rates of return for the three stocks (in the order X,Y,Z)?
A) 21.25%, 8.33%, 11.43%
B) 6.20%, 2.20%, 8.20%
C) 16.50%, 5.50%, 22.00%
D) 9.25%, 10.5%, 7.5%
E) 15.00%, 3.50%, 7.30%
Q2) Which of the following is <b>not</b> an assumption of the Capital Market Theory?
A) All investors are Markowitz efficient investors.
B) All investors have homogeneous expectations.
C) There are no taxes or transaction costs in buying or selling assets.
D) All investments are indivisible so it is impossible to buy or sell fractional shares.
E) All investors have the same one period time horizon.
Q3) The only way to estimate a beta for a security is to calculate the covariance of the security with the market.
A)True
B)False
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Chapter 9: Multifactor Models of Risk and Return
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Q1) Dhrymes,Friend,and Gultekin,in their study of the APT,found that
A) As the number of securities used to form portfolios increased the number of factors that characterized the return generating process decreased.
B) As the number of securities used to form portfolios increased the number of factors that characterized the return generating process increased.
C) As the number of securities used to form portfolios decreased the number of factors that characterized the return generating process increased.
D) As the number of securities used to form portfolios increased the number of factors that characterized the return generating process remained unchanged.
E) None of the above.
Q2) Consider the following two factor APT model
E(R)= ?? + ??b? + ??b?
A) ?1 is the expected return on the asset with zero systematic risk.
B) ?1 is the expected return on asset 1.
C) ?1 is the pricing relationship between the risk premium and the asset.
D) ?1 is the risk premium.
E) ?1 is the factor loading.
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Chapter 10: Analysis of Financial Statements
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Q1) Refer to Exhibit 10.2.What was Star's quick ratio for 2004?
A) 0.11
B) 0.44
C) 0.38
D) 0.74
E) 0.98
Q2) Which of the following is <b>not</b> a use of financial ratios?
A) Stock valuation
B) Assigning credit quality ratings on bonds
C) Predicting insolvency
D) Identification of internal corporate variables that affect a stock's systematic risk
E) None of the above (that is, all are uses of financial ratios)
Q3) Refer to Exhibit 10.5.Calculate the financial leverage.
A) 1.05
B) 5.32
C) 2.15
D) 1.54
E) 2.31
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Chapter 11: Security Valuation Principles
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Q1) Growth companies are those firms that consistently earn higher rates of return by assuming greater amounts of risk.
A)True
B)False
Q2) Which of the following is <b>not </b>considered a basic economic force?
A) Fiscal policy
B) Monetary policy
C) Inflation
D) P/E ratio
E) None of the above (that is, all are basic economic forces)
Q3) The importance of an industry's performance on an individual stock's performance varies across industries.
A)True
B)False
Q4) The growth rate of dividends and profit margin are the main determinants of the P/E ratio.
A)True
B)False
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Chapter 12: Macroanalysis and Microvaluation of the Stock Market
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Q1) Which of the following is <b>not</b> a reason given for why forecaster are so often incorrect?
A) There is a temptation for economic forecasters to stay fairly close to the "norm," that is, "group think."
B) Many analysts are simply too short-sighted.
C) Economists and economic forecaster often suffer from information overload.
D) Some economic forecasters are too broad-minded, trying to include a number of ideas in their forecasts.
E) None of the above (that is, all are reasons cited for why forecasters are often incorrect)
Q2) Which of the following economic series are included in the NBER leading indicator group?
A) Average weekly hour of production workers.
B) Average weekly initial claims for unemployment insurance.
C) Index of bond prices.
D) a and b.
E) b and c.
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Chapter 13: Industry Analysis
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Q1) An example of a barrier to entry is high prices relative to costs.
A)True
B)False
Q2) The rates of returns for firms within an industry vary which indicates that company analysis is necessary after industry analysis.
A)True
B)False
Q3) Which of the following is <b>not</b> a competitive force suggested by Porter?
A) Rivalry among existing competitors
B) Threat of new entrants
C) Threat of substitute products
D) Government and regulatory influences
E) None of the above (that is, all are competitive forces)
Q4) Refer to Exhibit 13.1.Calculate the per share EBIT for the year 2004.
A) $95.33
B) $70.42
C) $85.56
D) $95.89
E) $75.32
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Chapter 14: Company Analysis and Stock Valuation
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Q1) Refer to Exhibit 14.8.Calculate the intrinsic value of the stock now (Year 2010).
A) $155.55
B) $173.27
C) $196.44
D) $207.79
E) $108.30
Q2) Refer to Exhibit 14.3.Determine the P/E ratio for Harcourt Industries assuming Harcourt can maintain its superior growth rate for the next 3 years.
A) 4.25
B) 12.50
C) 15.67
D) 30.10
E) 42.80
Q3) A firm's competitive strategy can be either defensive or offensive.
A)True
B)False
Q4) An undervalued stock is a growth stock.
A)True
B)False
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Chapter 15: Equity Portfolio Management Stragtegies
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Q1) Growth stocks would have the following characteristics:
A) Low price/book, high price/earnings.
B) Low price/book, low price/earnings.
C) High EPS growth, high profitability.
D) Low EPS growth, high profitability.
E) None of the above.
Q2) A portfolio manager who uses tactical asset allocation is attempting to create alpha.
A)True
B)False
Q3) Exchange-Traded Funds (ETF)are depository receipts that give investors a pro rata claim on the capital gains and cash flows of securities held by financial institutions. A)True B)False
Q4) The goal of a passive portfolio is to track the index as closely as possible. A)True
B)False
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Chapter 16: Technical Analysis
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Q1) According to technical analysts using mutual fund cash positions to guide investment decisions
A) A low cash ratio position is a bullish indicator.
B) A high cash position is a bullish indicator.
C) A high cash position is a bearish indicator.
D) A low cash position is neither bearish nor bullish.
E) None of the above.
Q2) The Dow theory contends that stock price movements are similar to the movement of tides,waves,and ripples.
A)True
B)False
Q3) A support level is the price range at which the technician would expect an increase in the supply of stock and a price reversal.
A)True
B)False
Q4) Most technicians feel that since price patterns repeat themselves,a single trading rule is sufficient.
A)True
B)False
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Chapter 17: Bond Fundamentals
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Q1) You purchase a 10 3/8s February $10,000 par Treasury Note at 103:11 and hold it for exactly one year at which time you sell it.What is your rate of return if your selling price is 101:13?
A) 8.14%
B) 8.16%
C) 8.22%
D) 8.32%
E) 8.47%
Q2) A 6.5 percent coupon bond issued by the State of California sells for $1,000.What coupon rate on a corporate bond selling at $1,000 par value would produce the same after tax return to the investor as the municipal bond if the investor is in the 26 percent marginal tax bracket?
A) 1.69%
B) 11.25%
C) 8.78%
D) 14.63%
E) 25%
Q3) The secondary bond market is significantly more active than the stock market. A)True B)False
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Chapter 18: The Analysis and Valuation of Bonds
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Q1) According to the segmented market hypothesis,yields for a particular maturity segment depend on supply and demand within the maturity segment.
A)True
B)False
Q2) The nominal yield of a bond is the
A) Annual coupon as a percent of the current price.
B) Annual rate earned including the capital gain or loss.
C) Rate earned giving consideration to coupon reinvestment.
D) Coupon rate.
E) Promised yield to maturity.
Q3) According to the expectations hypothesis a rising yield curve indicates that investors expect
A) future short term rates to fall
B) future short term rates to rise
C) future long term rates to rise
D) future long term rates to fall
E) none of the above
Q4) The lower a bond's yield to maturity,the greater its duration.
A)True
B)False
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Chapter 19: Bond Portfolio Management Strategies
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Q1) Refer to Exhibit 19.4.The value of the swap is ____ basis points in one year.
A) 26.91
B) 26.25
C) 31.25
D) 41.25
E) 51.25
Q2) Which of the following is a passive bond portfolio strategy?
A) Indexing
B) Buy-and-Hold
C) Classical immunization
D) Choices a and b
E) None of the above
Q3) Interest rate anticipation is the most conservative management strategy.
A)True
B)False
Q4) When applying active management techniques to a global portfolio the additional concern is expectations regarding exchange rates between countries.
A)True
B)False
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Chapter 20: An Introduction to Derivative Markets and Securities
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Q1) A stock currently sells for $15 per share.A put option on the stock with an exercise price $15 currently sells for $1.50.The put option is
A) At-the-money.
B) In-the-money.
C) Out-of-the-money.
D) At breakeven.
E) None of the above.
Q2) A forward contract is similar to an option contract because they both
A) Can provide insurance against the price of the underlying stock
B) Are paid for up front in the form of premiums
C) Are paid for at the end of the contract in the form of premiums
D) Require a future settlement payment
E) None of the above
Q3) The price at which a futures contract is set at the end of the day is the
A) Stock price.
B) Strike price.
C) Maintenance price.
D) Settlement price.
E) Parity price.
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Chapter 21: Forward and Futures Contracts
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Q1) Stock index futures are useful in providing a hedge against movements in an underlying financial asset.
A)True
B)False
Q2) Refer to Exhibit 21.11.Calculate the number of contract required to hedge the risk exposure and indicate whether the manager should be short or long.
A) 100 contracts long.
B) 44 contracts long.
C) 44 contracts short.
D) 100 contract short.
E) None of the above.
Q3) Refer to Exhibit 21.7.If you expected the TED spread to narrow over the next month then an appropriate strategy would be to
A) Go long T-Bill futures and long Eurodollar futures.
B) Go short T-Bill futures and short Eurodollar futures.
C) Go long T-Bill futures and short Eurodollar futures.
D) Go short T-Bill futures and long Eurodollar futures.
E) None of the above.
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Chapter 22: Option Contracts
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Q1) Refer to Exhibit 22.2.If you establish a long strap using the options with an 85 exercise price,what is your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
A) $1,687.50 loss
B) $3,362.50 loss
C) $3,675.50 gain
D) $13.00 gain
E) $13.00 loss
Q2) A foreign currency option contract traded on U.S.exchanges allows for the sale or purchase of a set amount of
A) U.S. currency at a floating exchange rate
B) U.S. currency at a fixed exchange rate
C) Foreign currency at a floating exchange rate
D) Foreign currency at a fixed exchange rate
E) None of the above
Q3) Options on futures expire at the same time the futures contract expires.
A)True
B)False
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Chapter 23: Swap Contracts,convertible Securities,and
Other Embedded Derivatives
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Q1) An investor considering investment in warrants as part of an overall program,should consider which of the following?
A) Diversification
B) Cutting losses short, and letting profits run
C) A low intrinsic value
D) Viewing warrant selection as a portion of the total investment process
E) All of the above
Q2) Refer to Exhibit 23.10.Suppose that 3-month LIBOR is 4.00% on the rate determination day,and the contract specified settlement in advance,describe the transaction that occurs between the dealer and Newport.
A) The dealer is obligated to pay Newport $123,762.
B) The dealer is obligated to pay Newport $125,000.
C) Newport is obligated to pay the dealer $125,000.
D) Newport is obligated to pay the dealer $123,762.
E) None of the above
Q3) A plain vanilla swap agreement is used in similar situations as a forward rate agreement.
A)True
B)False
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Chapter 24: Professional Money Management, alternative
Assets, and Industry Ethics
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Q1) An open-end investment company differs from a closed-end investment company by the way they operate after the initial public offering.
A)True
B)False
Q2) Ethical conflicts may arise as a result of
A) Incentive compensation schemes.
B) Soft dollar arrangements.
C) Marketing investment management services.
D) All of the above.
E) None of the above.
Q3) Management and advisory firms can advise clients on how to structure their own portfolios.
A)True
B)False
Q4) In the case of closed-end investment companies,shares of the company
A) Trade on the secondary market.
B) Can be bought from or sold to the investment company at the NAV.
C) Are determined by supply and demand.
D) a and c.
E) b and c.
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Chapter 25: Evaluation of Portfolio Performance
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Q1) An appropriate composite risk measure that indicates the relative price volatility for a bond compared to interest rate changes is the bond's yield to maturity.
A)True
B)False
Q2) The portfolio performance measure that can be most affected by a benchmark error is the Sharpe measure.
A)True
B)False
Q3) Refer to Exhibit 25.4.Compute the Jensen Measure for the BBB fund.
A) 2.10
B) 2.74
C) 5.43
D) 2.00
E) 1.65
Q4) A negative Treynor measure (negative T)for a portfolio always indicates that the portfolio would plot below the SML.
A)True
B)False
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Chapter 26: Investment Return and Risk Analysis Questions
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Q1) Refer to Exhibit 1A.1.The standard deviation of your expected return from this investment is
A) 0.001
B) 0.004
C) 0.124
D) 1.240
E) None of the above
Q2) Refer to Exhibit 1A.1.The expected return from this investment is
A) -0.0752
B) -0.0040
C) 0.00
D) 0.0075
E) 0.4545
Q3) Refer to Exhibit 1A.2.The expected return for project X is
A) 0.0 percent
B) 0.5 percent
C) 2.5 percent
D) 5.0 percent
E) 7.5 percent
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Chapter 27: Investment and Retirement Plans
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Q1) Cash flows for nonlife insurance companies,such as property and casualty,are similar to cash flows of life insurance companies.
A)True
B)False
Q2) ____ are investment specialists that are responsible for managing the investments of others.There are often legal standards against which they must abide in the performance of their duties.
A) Underwriters
B) Investments bankers
C) Fiduciaries
D) Account executives
E) Trust officers
Q3) Defined contribution pension plans promise to pay retirees a specific income stream after retirement.
A)True
B)False
Q4) Banks face regulatory constraints at both the state and federal level.
A)True
B)False
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Chapter 28: Calculating Covariance and Correlation
Coefficient of Assets
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Q1) Refer to Exhibit 3A.1.Calculate the coefficient of correlation.
A) -0.456
B) -0.354
C) 0.000
D) 0.456
E) 3.538
Q2) Refer to Exhibit 3A.1.Calculate the covariance.
A) -32.20
B) -23.32
C) 1.00
D) 23.32
E) 32.20
Q3) What is the correlation coefficient for two assets with a covariance of .0032,if asset 1 has a standard deviation of 12 percent and asset 2 has a standard deviation of 9 percent?
A) 0.2963
B) 0.3456
C) 0.8721
D) 1.5980
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Chapter 29: Portfolio Variance and Stock Weight
Calculations
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Q1) Refer to Exhibit 7A.1.Show the minimum portfolio variance for a two stock portfolio when r<sub>1.2</sub> = 1.
A) E(?<sub>2</sub>) ¸ [E(?<sub>1</sub>) - E(?<sub>2</sub>)]
B) E(?<sub>2</sub>) ¸ [E(?<sub>1</sub>) + E(?<sub>2</sub>)]
C) E(?<sub>1</sub>) ¸ [E(?<sub>1</sub>) - E(?<sub>2</sub>)]
D) E(?<sub>1</sub>) ¸ [E(?<sub>1</sub>) + E(?<sub>2</sub>)]
E) None of the above
Q2) Refer to Exhibit 7A.1.What weight of security 1 gives the minimum portfolio variance when r<sub>1.2 </sub>= .60,E(?<sub>1</sub>)= .10 and E(?<sub>2</sub>)= .16?
A) .0244
B) .3679
C) .5697
D) .6309
E) .9756
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Chapter 30: Portfolio Optimization with Negative
Correlation: Finding Minimum Variance and Weight
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Sample Questions
Q1) Refer to Exhibit 7B.1.Show the minimum portfolio variance for a portfolio of two risky assets when r . = -1.
A) E( 1) ¸ [E( 1) + E( 2)]
B) E( 1) ¸ [E( 1) - E( 2)]
C) E( 2) ¸ [E( 1) + E( 2)]
D) E( 2) ¸ [E( 1) - E( 2)]
E) None of the above
Q2) Refer to Exhibit 7B.1.What is the value of W when r . = -1 and E(s )= .10 and E(s )= .12?
A) 45.46%
B) 50.00%
C) 59.45%
D) 54.55%
E) 74.55%
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