Test Bank for Investment Analysis and Portfolio Management, 11th Edition

Test Bank for Investment Analysis and Portfolio Management, 11th Edition.

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Chapter 01 - Appendix Multiple Choice Exhibit 1A.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Your expectations from a one-year investment in Wang Computers is as follows: Probability .15 .15 .35 .25 .10

Rate of Return −.10 −.20 .00 .15 .15

1. 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.

ANSWER: d 2. 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 these are correct.

ANSWER: c 3. Refer to Exhibit 1A.1. The coefficient of variation of this investment is a. −0.06. b. −0.65. c. 6.60. d. 16.53. e. 165.10.

ANSWER: d Exhibit 1A.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You have an opportunity to invest in project X with the following expected rates of return: Probability .25

Rate of Return −.10

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.25 .50

.00 .10

4. 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.

ANSWER: c 5. a. b. c. d. e.

ANSWER: b 6. An investment has a standard deviation of 12 percent and an expected return of 7 percent. What is the coefficient of variation for this investment? a. 1.714 b. 1.372 c. 0.714 d. 0.583 e. 0.500 ANSWER: a

Chapter 01 - The Investment Setting True / False 1. Investors are willing to forgo current consumption in order to increase future consumption for a nominal rate of interest. a. True b. False ANSWER: False 2. The rate of exchange between certain future dollars and certain current dollars is known as the pure rate of interest. a. True b. False ANSWER: True richard@qwconsultancy.com

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3. An investment is the current commitment of dollars over time to derive future payments to compensate the investor for the time funds are committed, the expected rate of inflation, and the uncertainty of future payments. a. True b. False ANSWER: True 4. The holding period return (HPR) is equal to the holding period yield (HPY) stated as a percentage. a. True b. False ANSWER: False 5. The geometric mean of a series of returns is always larger than the arithmetic mean, and the difference increases with the volatility of the series. a. True b. False ANSWER: False 6. The expected return is the average of all possible returns. a. True b. False ANSWER: False 7. An individual who selects the investment that offers greater certainty when everything else is the same is known as a risk averse investor. a. True b. False ANSWER: True 8. Two measures of the risk premium are the standard deviation and the variance. a. True b. False ANSWER: False 9. The variance of expected returns is equal to the square root of the expected returns. a. True b. False ANSWER: False 10. The coefficient of variation is the expected return divided by the standard deviation of the expected return. a. True b. False ANSWER: False

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11. The two most common calculations investors use to measure return performance are arithmetic means and geometric means. a. True b. False ANSWER: True 12. The arithmetic mean is a superior measure of the long-term performance because it indicates the compound annual rate of return based on the ending value of the investment versus its beginning value. a. True b. False ANSWER: False 13. Nominal rates are averages of all possible real rates. a. True b. False ANSWER: False 14. The risk premium is a function of the volatility of operating earnings, sales volatility, and inflation. a. True b. False ANSWER: False 15. The line that reflects the combination of risk and return available on alternative investments is referred to as the security market line (SML). a. True b. False ANSWER: True Multiple Choice 16. The basic trade-off in the investment process is a. between the anticipated rate of return for a given investment instrument and its degree of risk. b. between understanding the nature of a particular investment and having the opportunity to purchase it. c. between high returns available on single instruments and the diversification of instruments into a portfolio. d. between the desired level of investment and possessing the resources necessary to carry it out. e. None of these are correct.

ANSWER: a 17. The rate of exchange between future consumption and current consumption is the a. nominal risk-free rate. richard@qwconsultancy.com

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b. coefficient of investment exchange. c. pure rate of interest. d. consumption/investment paradigm. e. expected rate of return.

ANSWER: c 18. In the phrase "nominal risk-free rate," nominal means a. computed. b. historical. c. market. d. average. e. risk adverse.

ANSWER: c 19. If a significant change is noted in the yield of a T-bill, the change is most likely attributable to a a. downturn in the economy. b. static economy. c. change in the expected rate of inflation. d. change in the real rate of interest. e. change in risk aversion.

ANSWER: c 20. The real risk-free rate is affected by two factors: a. the relative ease or tightness in capital markets and the expected rate of inflation. b. the expected rate of inflation and the set of investment opportunities available in the economy. c. the relative ease or tightness in capital markets and the set of investment opportunities available in the economy. d. time preference for income consumption and the relative ease or tightness in capital markets. e. time preference for income consumption and the set of investment opportunities available in the economy.

ANSWER: e 21. The ____ the variance of returns, everything else remaining constant, the ____ the dispersion of expectations and the ____ the risk. a. larger, greater, lower b. larger, smaller, higher c. larger, greater, higher d. smaller, greater, lower e. smaller, greater, greater ANSWER: c 22. The coefficient of variation is a measure of a. central tendency. richard@qwconsultancy.com

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b. absolute variability. c. absolute dispersion. d. relative variability. e. relative return.

ANSWER: d 23. The nominal risk-free rate of interest is a function of the a. real risk-free rate and the investment's variance. b. prime rate and the rate of inflation. c. T-bill rate plus the inflation rate. d. tax free rate plus the rate of inflation. e. real risk-free rate and the rate of inflation.

ANSWER: e Exhibit 1.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume you bought 100 shares of NewTech common stock on January 15, 2003 at $50.00 per share and sold it on January 15, 2004 for $40.00 per share.

24. Refer to Exhibit 1.1. What was your holding period return? a. −10% b. −0.8 c. 25% d. 0.8 e. −20% ANSWER: d 25. Refer to Exhibit 1.1. What was your holding period yield? a. −10% b. −0.8 c. 25% d. 0.8 e. −20% ANSWER: e Exhibit 1.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Suppose you bought a GM corporate bond on January 25, 2001 for $750 and solid it on January 25, 2004 for $650.00.

26. Refer to Exhibit 1.2. What was your annual holding period return? richard@qwconsultancy.com

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a. 0.8667 b. −0.1333 c. 0.0333 d. 0.9534 e. −0.0466 ANSWER: d 27. Refer to Exhibit 1.2. What was your annual holding period yield? a. −0.0466 b. −0.1333 c. 0.0333 d. 0.3534 e. 0.8667 ANSWER: a Exhibit 1.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The common stock of XMen Inc. had the following historic prices.

Time 3/01/1999 3/01/2000 3/01/2001 3/01/2002 3/01/2003 3/01/2004

Price of X-Tech 50.00 47.00 76.00 80.00 85.00 90.00

28. Refer to Exhibit 1.3. What was your holding period return for the time period of 3/1/1999 to 3/1/2004? a. 0.1247 b. 1.8 c. 0.1462 d. 0.40 e. 0.25 ANSWER: b 29. Refer to Exhibit 1.3. What was your annual holding period yield (Annual HPY)? a. 0.1462 b. 0.1247 c. 1.8 d. 0.40 e. 0.25 ANSWER: b 30. richard@qwconsultancy.com

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a. b. c. d. e.

ANSWER: a 31. a. b. c. d. e.

ANSWER: d Exhibit 1.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You have concluded that next year the following relationships are possible: Economic Status Weak Economy Static Economy Strong Economy

Probability .15 .60 .25

Rate of Return −5% 5% 15%

32. Refer to Exhibit 1.4. What is your expected rate of return [E(Ri)] for next year? a. 4.25% b. 6.00% c. 6.25% d. 7.75% e. 8.00% ANSWER: b 33. a. b. c. d. e.

ANSWER: d 34. Refer to Exhibit 1.4. Compute the coefficient of variation for your portfolio. a. 0.043 b. 0.12 c. 1.40 richard@qwconsultancy.com

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d. 0.69 e. 1.04 ANSWER: e Exhibit 1.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that during the past year the consumer price index increased by 1.5 percent and the securities listed below returned the following nominal rates of return.

U.S. Government T-bills U.S. Long-term bonds

2.75% 4.75%

35. 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 36. Refer to Exhibit 1.5. If next year the real rates all rise by 10 percent while inflation climbs from 1.5 percent to 2.5 percent, what will be the nominal rate of return on each security? a. 1.24% and 1.52% b. 1.35% and 3.52% c. 3.89% and 6.11% d. 3.52% and 3.89% e. 1.17% and 6.11% ANSWER: c Exhibit 1.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that you hold a two-stock portfolio. You are provided with the following information on your holdings: Stock 1 2

Shares 15 25

Price(t) 10 15

Price(t + 1) 12 16

37. Refer to Exhibit 1.6. Calculate the HPY for stock 1. a. 10% b. 20% c. 15% d. 12% e. 7% ANSWER: b richard@qwconsultancy.com

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38. Refer to Exhibit 1.6. Calculate the HPY for stock 2. a. 5% b. 6% c. 7% d. 8% e. 10% ANSWER: c 39. Refer to Exhibit 1.6. Calculate the market weights for stock 1 and 2 based on period t values. a. 39%for stock 1 and 61% for stock 2 b. 50% for stock 1 and 50% for stock 2 c. 71% for stock 1 and 29% for stock 2 d. 29% for stock 1 and 71% for stock 2 e. 30% for stock 1 and 82% for stock 2 ANSWER: d 40. Refer to Exhibit 1.6. Calculate the HPY for the portfolio. a. 10.6% b. 6.95% c. 13.5% d. 10% e. 15.7% ANSWER: a Exhibit 1.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You purchased 100 shares of GE common stock on January 1, for $29 a share. A year later you received $1.25 in dividends per share and you sold it for $28 a share.

41. Refer to Exhibit 1.7. Calculate your holding period return (HPR) for this investment in GE stock. a. 0.9655 b. 1.0086 c. 1.0357 d. 1.0804 e. 1.0973 ANSWER: b 42. Refer to Exhibit 1.7. Calculate your holding period yield (HPY) for this investment in GE stock. a. −0.0345 b. −0.0090 c. 0.0086 d. 0.0643 richard@qwconsultancy.com

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e. 0.0804 ANSWER: c Exhibit 1.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The annual rates of return of Stock Z for the last four years are 0.10, 0.15, −0.05, and 0.20, respectively.

43. Refer to Exhibit 1.8. Compute the arithmetic mean annual rate of return for Stock Z. a. 0.03 b. 0.04 c. 0.06 d. 0.10 e. 0.40 ANSWER: d 44. Refer to Exhibit 1.8. Compute the standard deviation of the annual rate of return for Stock Z. a. 0.0070 b. 0.0088 c. 0.0837 d. 0.0935 e. 0.1145 ANSWER: d 45. Refer to Exhibit 1.8. Compute the coefficient of variation for Stock Z. a. 0.837 b. 0.935 c. 1.070 d. 1.145 e. 1.281 ANSWER: b 46. Refer to Exhibit 1.8. Compute the geometric mean rate of return for Stock Z. a. 0.051 b. 0.074 c. 0.096 d. 0.150 e. 1.090 ANSWER: c 47. Which of the following is not a component of the required rate of return? a. expected rate of inflation b. time value of money richard@qwconsultancy.com

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c. risk d. holding period return e. nominal returns ANSWER: d 48. Which of the following is NOT a component of the risk premium? a. business risk b. financial risk c. liquidity risk d. exchange rate risk e. unsystematic market risk ANSWER: e 49. The ability to sell an asset quickly at a fair price is associated with a. business risk. b. liquidity risk. c. exchange rate risk. d. financial risk. e. market risk.

ANSWER: b 50. The variability of operating earnings is associated with a. business risk. b. liquidity risk. c. exchange rate risk. d. financial risk. e. market risk.

ANSWER: a 51. The uncertainty of investment returns associated with how a firm finances its investments is known as a. business risk. b. liquidity risk. c. exchange rate risk. d. financial risk. e. market risk.

ANSWER: d 52. The total risk for a security can be measured by its a. beta with the market portfolio. b. systematic risk. c. standard deviation of returns. d. unsystematic risk. e. alpha with the market portfolio. richard@qwconsultancy.com

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ANSWER: c 53. If over the past 20 years the annual returns on the S&P 500 market index averaged 12 percent with a standard deviation of 18 percent, what was the coefficient of variation? a. 0.6 b. 0.6% c. 1.5 d. 1.5% e. 0.66% ANSWER: c 54. Given investments A and B with the following risk return characteristics, which one would you prefer and why?

Investment A B

Expected Return 12.2% 8.8%

Standard Deviation of Expected Returns 7% 5%

a. Investment A because it has the highest expected return. b. Investment A because it has the lowest relative risk. c. Investment B because it has the lowest absolute risk. d. Investment B because it has the lowest coefficient of variation. e. Investment A because it has the highest coefficient of variation.

ANSWER: d Exhibit 1.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You are provided with the following information: Nominal return on risk-free asset = 4.5% Expected return for asset i = 12.75% Expected return on the market portfolio = 9.25%

55. Refer to Exhibit 1.9. Calculate the risk premium for asset i. a. 4.5% b. 8.25% c. 4.75% d. 3.5% e. 0% ANSWER: b 56. Refer to Exhibit 1.9. Calculate the risk premium for the market portfolio. a. 4.5% b. 8.25% richard@qwconsultancy.com

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c. 4.75% d. 3.5% e. 0% ANSWER: c 57. Economists project the long-run real growth rate for the next five years to be 2.5 percent and the average annual rate of inflation over this five-year period to be 3 percent. What is the expected nominal rate of return over the next five years? a. 0.500 percent b. 1.056 percent c. 2.750 percent d. 5.500 percent e. 5.575 percent ANSWER: e Exhibit 1.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the following information Nominal annual return on U.S. government T-bills for year 2018 = 3.5% Nominal annual return on U.S. government long-term bonds for year 2018 = 4.75% Nominal annual return on U.S. large-cap stocks for year 2018= 8.75% Consumer price index January 1, 2018 = 165 Consumer price index December 31, 2018 = 169

58. Refer to Exhibit 1.10. Compute the rate of inflation for the year 2018. a. 2.42% b. 4.0% c. 1.69% d. 1.24% e. 0% ANSWER: a 59. Refer to Exhibit 1.10. Calculate the annual real rate of return for U.S. T-bills. a. 2.26% b. 1.81% c. −0.5% d. 1.05% e. 0% ANSWER: d 60. Refer to Exhibit 1.10. Calculate the annual real rate of return for U.S. long-term bonds. a. 3.06% b. 2.27% richard@qwconsultancy.com

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c. 2.51% d. 3.5% e. 0% ANSWER: b 61. Refer to Exhibit 1.10. 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. 0% ANSWER: b 62. What will happen to the security market line (SML) if the following events occur, other things constant: (1) inflation expectations increase, and (2) investors become more risk averse? a. shift up and keep the same slope b. shift up and have less slope c. shift up and have a steeper slope d. shift down and keep the same slope e. shift down and have less slope ANSWER: c 63. A decrease in the market risk premium, all other things constant, will cause the security market line to a. shift up. b. shift down. c. have a steeper slope. d. have a flatter slope. e. remain unchanged.

ANSWER: d 64. A decrease in the expected real growth in the economy, all other things constant, will cause the security market line to a. shift up. b. shift down. c. have a steeper slope. d. have a flatter slope. e. remain unchanged.

ANSWER: b 65. Unsystematic risk refers to risk that is a. undiversifiable. b. diversifiable. c. due to fundamental risk factors. d. due to market risk. richard@qwconsultancy.com

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e. unexplainable.

ANSWER: b 66. The security market line (SML) graphs the expected relationship between a. business risk and financial risk. b. systematic risk and unsystematic risk. c. risk and return. d. systematic risk and unsystematic return. e. real and nominal returns.

ANSWER: c 67. Two factors that influence the nominal risk-free rate are a. the relative ease or tightness in capital markets and the expected rate of inflation. b. the expected rate of inflation and the set of investment opportunities available in the economy. c. the relative ease or tightness in capital markets and the set of investment opportunities available in the economy. d. time preference for income consumption and the relative ease or tightness in capital markets. e. time preference for income consumption and the set of investment opportunities available in the economy.

ANSWER: a 68. Measures of risk for an investment include a. variance of returns and business risk. b. coefficient of variation of returns and financial risk. c. business risk and financial risk. d. variance of returns and coefficient of variation of returns. e. variance of returns and economic risk.

ANSWER: d 69. Sources of risk for an investment include a. variance of returns and business risk. b. coefficient of variation of returns and financial risk. c. business risk and financial risk. d. variance of returns and coefficient of variation of returns. e. variance of returns and economic risk.

ANSWER: c 70. Modern portfolio theory assumes that most investors are a. risk averse. b. risk neutral. c. risk seekers. d. risk tolerant. e. risk embracing. richard@qwconsultancy.com

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ANSWER: a 71. All of the following are major sources of uncertainty EXCEPT a. business risk. b. financial risk. c. default risk. d. country risk. e. liquidity risk.

ANSWER: c 72. Which of the following is least likely to move a firm's position to the right on the Security Market Line (SML)? a. an increase in the firm's beta b. adding more financial debt to the firm's balance sheet relative to equity c. changing the business strategy to include new product lines with more volatile expected cash flows d. Investors perceive the stock as being riskier. e. an increase in the risk-free required rate of return ANSWER: e

Chapter 02 - Asset Allocation and Security Selection True / False 1. Experts suggest life insurance coverage should be seven to ten times an individual's annual salary. a. True b. False ANSWER: True 2. Term life insurance provides both a death benefit and a savings plan. a. True b. False ANSWER: False 3. Most experts recommend a cash reserve of at least one year's worth of living expenses. a. True b. False ANSWER: False 4. The spending phase occurs when investors are relatively young. a. True b. False ANSWER: False

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5. The gifting phase is similar to, and may be concurrent with, the spending phase. a. True b. False ANSWER: True 6. Long-term, high-priority goals include some form of financial independence. a. True b. False ANSWER: True 7. It is not a good idea to get too specific when constructing your policy statement. a. True b. False ANSWER: False 8. It is essential that both the client and the portfolio manager agree on an appropriate benchmark portfolio. a. True b. False ANSWER: True 9. The third step of the portfolio management process is to construct the portfolio. a. True b. False ANSWER: True 10. Asset allocation is the process of dividing funds into different classes of assets. a. True b. False ANSWER: True 11. The typical investor's goals rarely change during his/her lifetime. a. True b. False ANSWER: False 12. Return is the only important consideration when establishing investment objectives. a. True b. False ANSWER: False 13. In constructing the portfolio, the manager should maximize the investor's risk level. a. True b. False ANSWER: False richard@qwconsultancy.com

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14. Risk tolerance is exclusively a function of an individual's psychological makeup. a. True b. False ANSWER: False 15. An appropriate investment objective for a typical 25-year-old investor is a low-risk strategy, such as capital preservation or current income. a. True b. False ANSWER: False 16. Investment planning is complicated by tax concerns. a. True b. False ANSWER: True 17. The ability to retire at a certain age is a typical example of a long-term, lower-priority goal. a. True b. False ANSWER: False 18. An example of a unique need in an investment policy statement is related to the legal responsibilities of a fiduciary or trustee. a. True b. False ANSWER: False 19. Investing 30 to 40 percent of your retirement funds in the company you work for is reasonable when they match funds. a. True b. False ANSWER: False 20. Individual security selection is far more important than the asset allocation decision. a. True b. False ANSWER: False 21. Average tax rate is defined as total tax payment divided by total income. a. True b. False ANSWER: True 22. The majority of a pension fund's return is explained by asset allocation. richard@qwconsultancy.com

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a. True b. False ANSWER: True 23. The portfolio mixes of institutional investors around the world are approximately the same. a. True b. False ANSWER: False 24. Equity allocations of pension funds in Japan and Germany are similar to those in the United States. a. True b. False ANSWER: False 25. Arts and antiques are inferior inflation hedges compared to long-term bonds and common stocks. a. True b. False ANSWER: False 26. Individual real estate assets had much lower standard deviations and either low positive or negative correlations with other asset classes in a portfolio context. a. True b. False ANSWER: True Multiple Choice 27. The current outlay of money to guard against a potentially large future loss is commonly known as a. asset management. b. portfolio management. c. minimizing risk. d. loss control. e. insurance.

ANSWER: e 28. The ____ phase is the stage when investors in their early-to-middle earning years attempt to accumulate assets to satisfy near-term needs, e.g., children's education or down payment on a home. a. accumulation b. spending c. gifting d. consolidation e. divestiture ANSWER: a

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29. Which of the following is NOT a life cycle phase? a. discovery phase b. accumulation phase c. consolidation phase d. spending phase e. gifting phase ANSWER: a 30. John is 55 years old and has $55,000 outstanding on a mortgage and no other debt. John typically saves $5,000 in an IRA account and another $10,000 in a company pension. John is most likely in the a. discovery phase. b. accumulation phase. c. consolidation phase. d. spending phase. e. gifting phase.

ANSWER: c 31. In an investment policy statement, the objectives of an investor are expressed in terms of a. risk and return. b. risk. c. return. d. time horizon. e. liquidity needs.

ANSWER: a 32. Which of the following is NOT a step in the portfolio management process? a. develop a policy statement b. study current financial and economic conditions c. construct the portfolio d. monitor investor's needs and market conditions e. sell all assets and reinvestment proceeds at least once a year ANSWER: e 33. The first step in the investment process is the development of a(n) a. objective statement. b. policy statement. c. financial statement. d. statement of cash needs. e. statement of cash flows.

ANSWER: b 34. Once the portfolio is constructed, it must be continuously a. rebalanced. b. recycled c. reinvested richard@qwconsultancy.com

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d. monitored. e. manipulated.

ANSWER: d 35. The policy statement may include a ____ against which a portfolio's or portfolio manager's performance can be measured. a. milestone b. benchmark c. landmark d. reference point e. market pair ANSWER: b 36. One of the reasons for constructing a policy statement is it a. creates a standard by which to judge the performance of the investor. b. helps the investor decide on realistic investment goals. c. is open-ended in order to provide guidance for specific investments and time frames. d. guarantees success. e. helps the portfolio manager to become familiar with financial markets and investing risks.

ANSWER: b 37. Which of the following is NOT considered to be an investment objective? a. capital preservation b. capital appreciation c. current income d. total return e. nominal preservation ANSWER: e 38. ____ must be stated in terms of expected returns and risk. An investor's tolerance for risk must be established before returns objectives can be stated. a. Investment requirements b. Investment constraints c. Investment rewards d. Investment objectives e. Investment policy ANSWER: d 39. ____ is an appropriate objective for investors who want their portfolio to grow in real terms, i.e., exceed the rate of inflation. a. Capital preservation b. Capital appreciation c. Portfolio growth d. Value additivity e. Nominal preservation richard@qwconsultancy.com

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ANSWER: b 40. ____ refer(s) to the ability to convert assets to cash quickly and at a fair market price and often increase(s) as one approaches the later stages of the investment life cycle. a. Liquidity needs b. Time horizons c. Liquidation values d. Liquidation essentials e. Capital liquidations ANSWER: a 41. Which of the following statements is FALSE? a. Unrealized capital gains are taxable. b. Realized capital gains are taxable. c. Tax-exempt investments are attractive to individuals with high tax liabilities. d. Returns comparisons should be made on an equivalent tax basis. e. Tax exempt investors prefer tax exempt investments.

ANSWER: a 42. ____ gains are taxable and occur when an asset is sold for more than its basis (the value of the asset when it was purchased by the original owner or inherited by the heirs of the original owner). a. Realized capital b. Income c. Portfolio d. Nominal e. Real ANSWER: a 43. Which of the following statements is TRUE? a. Except for tax-exempt investors and tax-deferred accounts, annual tax payments increase investment returns. b. The only way to maintain purchasing power over time is to invest in bonds. c. After adjusting for taxes, long-term bonds consistently outperform stocks. d. An asset allocation decision for a taxable portfolio that does not include a substantial commitment to common stocks may make it difficult for the portfolio to maintain real value over time. e. None of these are correct.

ANSWER: d 44. Which of the following strategies seeks to increase the portfolio value by reinvesting current income in addition to capital gains? a. capital appreciation b. capital preservation c. return preservation d. current income richard@qwconsultancy.com

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e. total return ANSWER: d Exhibit 2.1 USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S) If Taxable Income Is Over But Not Over

Then

The Tax is This Amount

Plus This %

Of The Excess Over

Single

$0 $7,150 $29,050 $70,350 $146,750 $319,100

$7,150 $29,050 $70,350 $146,750 $319,100 -

0 715 $4,000 $14,325 $35,717 $92,592.50

10% 15% 25% 28% 33% 35%

0 $7,150 $29,050 $70,350 $146,750 $319,100

Married Filing Jointly

$0 $14,300 $58,100 $117,250 $178,650 $319,100

$14,300 $58,100 $117,250 $178,650 $319,100 -

0 1430 $8,000 $22,787.50 $39,979.50 $86,328

10% 15% 25% 28% 33% 35%

0 $14,300 $58,100 $117,250 $178,650 $319,100

45. Refer to Exhibit 2.1. What is the marginal tax rate for a single individual with taxable income of $85,000? a. 15% b. 25% c. 28% d. 33% e. 35% ANSWER: c 46. Refer to Exhibit 2.1. What is the average tax for a single individual with taxable income of $85,000? a. 13.57% b. 15.68% c. 21.68% d. 25.74% e. 29.55% ANSWER: c 47. Refer to Exhibit 2.1. What is the tax liability for a married couple filing jointly with taxable income of $125,000? a. $23,800 b. $18,427 c. $24,958 richard@qwconsultancy.com

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d. $16,867 e. $19,650 ANSWER: c 48. What would the equivalent taxable yield be on an investment that offers a 6 percent tax exempt yield? Assume a marginal tax rate of 28 percent. a. 0.125 percent b. 7.20 percent c. 6.48 percent d. 8.33 percent e. 32.14 percent ANSWER: d 49. What would the after-tax yield be on an investment that offers a 6 percent fully taxable yield?

Assume a marginal tax rate of 31 percent. a. 2.79 percent b. 6.48 percent c. 4.14 percent d. 7.20 percent e. 12.50 percent ANSWER: c 50. The future value of $50,000 invested today, at the end of 10 years assuming an interest rate of 7.5 percent per year, with semiannual compounding, is a. $104,407.60. b. $103,051.58. c. $123,510.52. d. $210,673.43. e. $105,117.46.

ANSWER: a 51. Assume that you invest $750 at the end of each quarter for the next 20 years in a mutual fund. The annual rate of interest that you expect to earn in this account is 5.25 percent. The amount in the account at the end of 20 years is a. $60,000.00. b. $105,039.84. c. $37,009.35. d. $123,510.52. e. $115,637.37.

ANSWER: b 52. Assume that you invest $1250 at the end of each of the next 15 years in a mutual fund. You currently have $10,000 in the mutual fund. The annual rate of interest that you expect to earn in this account is 4.35 percent. The amount in the account at the end of 15 years is a. $58,940.30. b. $28,750.00. richard@qwconsultancy.com

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c. $37,009.35. d. $44,630.81. e. $25,690.50.

ANSWER: d 53. Someone in the 15 percent tax bracket can earn 8 percent annually on his investments in a taxexempt IRA account. What will be the value of a $10,000 investment after five years (assuming annual compounding)? a. $6,805 b. $14,693 c. $15,528 d. $20,114 e. $50,000 ANSWER: b 54. Suppose the 8 percent investment of the previous problem is taxable rather than tax-deferred.

What will be the after-tax value of his $10,000 investment after five years (assuming annual compounding)? a. $10,680 b. $11,765 c. $13,895 d. $14,693 e. $15,528 ANSWER: c 55. An individual in the 36 percent tax bracket invests $5,000 in a tax-exempt IRA. If the investment earns 10% annually, what will be the value of the IRA after five years? a. $6,600 b. $6,818 c. $7,500 d. $8,053 e. $10,879 ANSWER: d 56. An individual in the 15 percent tax bracket has $10,000 invested in a tax-exempt IRA account. If the individual earns 8 percent annually before taxes and inflation is 2.5 percent per year, what is the real value of the investment in 20 years? a. $23,211 b. $28,467 c. $29,178 d. $37,276 e. $46,610 ANSWER: b

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57. An individual in the 36 percent tax bracket has $20,000 invested in a tax-exempt account. If the individual earns 10 percent annually before taxes and inflation is 3.0 percent per year, what is the real value of the investment in 10 years? a. $31,000 b. $33,200 c. $38,614 d. $39,343 e. $47,823 ANSWER: c 58. You currently have $150,000 in an IRA designated for retirement. If you save an additional $100 at the end of every month and expect to earn an annual return of 12 percent, how much do you expect to have in the IRA in 10 years? a. $467,632 b. $518,062 c. $732,546 d. $949,328 e. $1,215,234 ANSWER: b 59. Which of the following is NOT a typical portfolio constraint? a. liquidity needs b. risk tolerance c. time horizon d. tax concerns e. legal factors ANSWER: b 60. For an investor with a time horizon of 6 to 10 years and lower risk tolerance, an appropriate asset allocation strategy would be a. 100 percent stocks. b. 100 percent cash. c. 30 percent cash, 50 percent bonds, and 20 percent stocks. d. 10 percent cash, 30 percent bonds, and 60 percent stocks. e. 100 percent bonds.

ANSWER: c 61. For an investor with a time horizon of eight years and higher risk tolerance, an appropriate asset allocation strategy would be a. 100 percent stocks. b. 100 percent cash. c. 30 percent cash, 50 percent bonds, and 20 percent stocks. d. 10 percent cash, 30 percent bonds, and 60 percent stocks. e. 100 percent bonds.

ANSWER: d richard@qwconsultancy.com

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62. For an investor with a time horizon of 12 years and higher risk tolerance, an appropriate asset allocation strategy would be a. 100 percent stocks. b. 30 percent cash, 50 percent bonds, and 20 percent stocks. c. 10 percent cash, 30 percent bonds, and 60 percent stocks. d. 50 percent bonds and 50 percent stocks. e. 100 percent bonds.

ANSWER: a 63. For an investor with a time horizon of 15 years and moderate risk tolerance, an appropriate asset allocation strategy would be a. 100 percent stocks. b. 40 percent cash and 60 percent stocks. c. 30 percent cash, 50 percent bonds, and 20 percent stocks. d. 50 percent bonds, and 50 percent stocks. e. 20 percent bonds and 80 percent stocks.

ANSWER: e 64. For an investor with a time horizon of four years and higher risk tolerance, an appropriate asset allocation strategy would be a. 100 percent cash. b. 30 percent cash, 50 percent bonds, and 20 percent stocks. c. 20 percent cash, 40 percent bonds, and 40 percent stocks. d. 10 percent cash, 40 percent bonds, and 50 percent stocks. e. 100 percent bonds.

ANSWER: c 65. For an investor with a time horizon of five years and moderate risk tolerance, an appropriate asset allocation strategy would be a. 100 percent cash. b. 30 percent cash, 50 percent bonds, and 20 percent stocks. c. 20 percent cash, 40 percent bonds, and 40 percent stocks. d. 10 percent cash, 30 percent bonds, and 60 percent stocks. e. 100 percent bonds.

ANSWER: b 66. Research from the 1970s to the 1990s found that over 90 percent of a fund's returns over time is explained by a. market timing. b. stock selection. c. manager selection. d. asset allocation. e. cash allocation.

ANSWER: d

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67. 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 these are correct.

ANSWER: e 68. The asset allocation decision must involve a consideration of a. cultural differences. b. the objectives stated in the investor's policy statement. c. the types of assets that are appropriate for the investor. d. the risk associated with different investments. e. All of these are correct.

ANSWER: e 69. Research has shown that the asset allocation decision explains ____% of the variation in fund returns across all funds and ____% of the variation in returns for a particular fund over time. a. 90; 100 b. 100; 40 c. 90; 40 d. 40; 100 e. 40; 90 ANSWER: e 70. Adding Japanese, Australian, and Italian stocks to a U.S. stock portfolio _____ the portfolio risk because the global portfolio reflects only worldwide _____. a. reduces; systematic factors b. increases; systematic factors c. does not change; correlation d. reduces; risk e. increases; risk ANSWER: a 71. Adding foreign stocks and bonds to a U.S. portfolio will almost certainly _____the risk of the portfolio and can possibly _____ its average return. a. reduce; increase b. increase; reduce c. increase; increase d. decrease; decrease e. not change; decrease ANSWER: a 72. A study examining the performance of numerous assets from the United States and around the world confirms that richard@qwconsultancy.com

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a. riskier assets with higher standard deviations experienced lower returns. b. riskier assets with higher standard deviations experienced higher returns. c. standard deviation did a better job of explaining the returns than beta. d. U.S. equities are highly correlated with world government bonds and with the commodities index. e. most assets (including common stocks) have positive correlations with inflation.

ANSWER: b 73. A study examining the performance of numerous assets from the United States and around the world confirms that a. riskier assets with higher standard deviations experienced lower returns. b. riskier assets with lower standard deviations experienced higher returns. c. beta did a better job of explaining the returns than standard deviation. d. U.S. equities are highly correlated with world government bonds and with the commodities index. e. most assets (including common stocks) have positive correlations with inflation.

ANSWER: c 74. A study examining the performance of numerous assets from the United States and around the world confirms that a. riskier assets with higher standard deviations experienced lower returns. b. riskier assets with lower standard deviations experienced higher returns. c. standard deviation did a better job of explaining the returns than beta. d. U.S. equities have zero correlation with world government bonds and with the commodities index. e. most assets (including common stocks) have positive correlations with inflation.

ANSWER: d 75. A study examining the performance of numerous assets from the United States and around the world confirms that a. riskier assets with higher standard deviations experienced lower returns. b. riskier assets with lower standard deviations experienced higher returns. c. standard deviation did a better job of explaining the returns than beta. d. U.S. equities are highly correlated with world government bonds and with the commodities index. e. most assets (including common stocks) have negative correlations with inflation.

ANSWER: e 76. Most art and antiques are _____, and the transaction costs are ____ compared to those of financial assets. a. illiquid; low b. illiquid; high c. liquid; low d. liquid; high e. correlated to bonds; high ANSWER: b richard@qwconsultancy.com

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Chapter 2 - Appendix Multiple Choice Exhibit 2A.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The following are the annual returns for both Alpine Corporation and Tauber Industries:

Year 1995 1996 1997 1998 1999

Alpine's Rate of Return 5 9 11 −10 12

Tauber's Rate of Return 9 16 −16 12 9

1. Refer to Exhibit 2A.1. Calculate the covariance. a. −32.20 b. −23.32 c. 1.00 d. 23.32 e. 32.20 ANSWER: a 2. Refer to Exhibit 2A.1. Calculate the coefficient of correlation. a. −0.456 b. −0.354 c. 0.000 d. 0.456 e. 3.538 ANSWER: b 3. 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 ANSWER: a

Chapter 03 - Organization and Functioning of Securities Markets True / False richard@qwconsultancy.com

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1. A market is a means through which buyers and sellers are brought together to aid in the transfer of goods and/or services. a. True b. False ANSWER: True 2. It is required by law that a stock market must have a physical location. a. True b. False ANSWER: False 3. If transaction prices are volatile, but long-term prices are stable, this is referred to as price continuity. a. True b. False ANSWER: False 4. A continuous market that has price continuity requires depth of buyers and sellers. a. True b. False ANSWER: True 5. A market in which prices adjust rapidly to new information is considered to be internally efficient. a. True b. False ANSWER: False 6. Informational efficiency refers to when the cost of acquiring information is very cheap. a. True b. False ANSWER: False 7. The primary market is where issues are traded between current and potential owners. a. True b. False ANSWER: False 8. Negotiation, competitive bids, and best efforts are three forms of underwriting arrangements. a. True b. False ANSWER: True 9. A corporation wishing to raise funds will normally want the investment banker to use a "best efforts" arrangement rather than a negotiated basis. richard@qwconsultancy.com

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a. True b. False ANSWER: False 10. Rule 415, shelf registration, allows large firms to register ten years’ worth of financing needs all at one time. a. True b. False ANSWER: False 11. Only the stocks of large companies are traded in the primary market. a. True b. False ANSWER: False 12. A good secondary market is important to the efficiency of the primary market. a. True b. False ANSWER: True 13. Rule 415 allows corporations to place securities privately with large, sophisticated institutional investors without extensive registration documents. a. True b. False ANSWER: False 14. Rule 144A reduced registration documentation requirements for placing securities privately with large institutional investors. a. True b. False ANSWER: True 15. Secondary equity issues are new shares offered by firms that already have stock outstanding. a. True b. False ANSWER: False 16. In a pure auction market, buyers and sellers submit bid-and-ask prices for a given stock to a central location. a. True b. False ANSWER: True 17. In a dealer market trading system, shares of stock are sold to the investor with the highest bid price and bought from the seller with the lowest offering price. richard@qwconsultancy.com

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a. True b. False ANSWER: False 18. Call markets can also be used at the opening for stocks on any exchange if there is an overnight buildup of buy and/or sell orders. a. True b. False ANSWER: True 19. In a continuous market, trades occur at any time the market is open and stocks are priced either by auction or by dealers. a. True b. False ANSWER: False 20. A pure auction market is also referred to as a quote-driven market. a. True b. False ANSWER: False 21. The NYSE has dominated the other U.S. exchanges in trading volume. a. True b. False ANSWER: True 22. In recent years, there has been a trend toward the consolidation of existing exchanges in developed markets, such as London, Frankfurt, and Paris. a. True b. False ANSWER: True 23. The over-the-counter market includes all stocks not listed on one of the major exchanges but constitutes a lesser dollar value than the New York and American Exchanges combined. a. True b. False ANSWER: True 24. The over-the-counter market lists more stocks than the New York Stock Exchange and the American Stock Exchange combined. a. True b. False ANSWER: True

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25. 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 ANSWER: False 26. The Nasdaq National Market System is an order-driven market. a. True b. False ANSWER: False 27. The NYSE is a dealer market. a. True b. False ANSWER: False 28. Algorithmic trading is basically creating computer programs to make trading decisions. a. True b. False ANSWER: True 29. Margin transaction involves borrowing part of the cost of an investment. a. True b. False ANSWER: True 30. Short selling is practiced when an investor borrows part of the cost of the investment, e.g., they are "short" on cash. a. True b. False ANSWER: False 31. The individual placing a limit order specifies the buy or sell price. a. True b. False ANSWER: True 32. The financial market landscape has become a few large holding companies that own global exchanges for stocks, bonds, and derivatives. a. True b. False ANSWER: True Multiple Choice

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33. Which of the following statements about a market is true? a. It is not necessary for the market to have a physical location. b. The market does not necessarily own the goods or services involved. c. A market can deal in any variety of goods and services. d. Both buyers and sellers benefit from the existence of a market. e. All of these are correct.

ANSWER: e 34. Which of the following is NOT a characteristic of a good market for goods and services? a. timely and accurate information b. liquidity c. low transaction costs d. external efficiency e. All of these are correct.

ANSWER: e 35. When a market is externally efficient, it means that a. timely and accurate information is available. b. the market is liquid. c. transaction costs are low. d. prices adjust rapidly to new information. e. the number of buyers and sellers are the same.

ANSWER: d 36. When a market is internally efficient, it means that the market has a. price continuity. b. minimal transactions costs. c. good depth. d. more buyers than sellers. e. more sellers than buyers.

ANSWER: b 37. In a negotiated bid, the underwriter carries out the following service(s): a. origination, risk-bearing, and distribution. b. origination and risk-bearing. c. risk-bearing and distribution. d. origination and distribution. e. risk-bearing and distribution.

ANSWER: a 38. Municipal bonds are sold using the following method or methods: a. competitive bid b. negotiated sale c. private placement richard@qwconsultancy.com

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d. using an underwriting function. e. All of these are correct.

ANSWER: e 39. Which of the following is an underwriting function? a. origination b. risk-bearing c. distribution d. putting together an underwriting syndicate. e. All of these are correct.

ANSWER: e 40. The basic distinction between a primary and a secondary market is that a. proceeds from sales in the primary market go to the current owner of a security; proceeds in secondary market go to the original owner. b. primary markets involve direct dealings within regional exchanges. c. only new securities are sold in the primary market; only outstanding securities are bought and sold in the secondary market. d. primary markets deal exclusively in bonds; secondary markets deal primarily in common stock. e. primary markets deal exclusively in common stocks; secondary markets deal primarily in bonds.

ANSWER: c 41. Which of the following is NOT a characteristic of shelf registrations? Shelf registrations a. were introduced by Rule 415. b. allow large firms to register security issues and sell them piecemeal during the following six years. c. provide flexibility and reduce registration fees and expenses. d. are typically used for the sale of straight debentures rather than common stock or convertible issues. e. All of these are correct.

ANSWER: b 42. Which of the following is NOT a secondary equity market? a. treasury market b. national exchanges c. regional exchanges d. over-the-counter market e. call market.

ANSWER: a 43. Which of the following is NOT a function of the specialist? a. assists the Federal Reserve in controlling the money supply b. acts as a broker who handles the limit orders or special orders placed with member brokers richard@qwconsultancy.com

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c. buys and sells securities in order to stabilize the market. d. acts as a dealer in assigned stocks to maintain a fair and orderly market. e. attempts to derive a new equilibrium price using a call-market approach.

ANSWER: a 44. The member of the New York Stock Exchange who acts as a dealer on assigned stocks is known as a a. registered trader. b. commission broker. c. registered broker. d. floor broker. e. specialist.

ANSWER: e 45. In a call market, trading for individual stocks a. occurs anytime the market is open. b. takes place at specific times. c. takes place at the open and close of the trading day. d. is priced either by auction or by dealers. e. None of these are correct.

ANSWER: b 46. A pure auction market is one in which a. dealers provide liquidity by buying and selling shares of stock for themselves. b. dealers compete against each other to provide the highest bid and lowest asking prices. c. buyers submit bid prices to sellers. d. sellers submit ask prices to buyers. e. buyers and sellers submit bid and ask prices to a central location to be matched.

ANSWER: e 47. Trading in the secondary markets for U.S. Government and municipal bonds a. takes place through a network of primary dealers. b. takes place over the counter by dealers who buy and sell on their own account. c. takes place on the NYSE bond annex. d. takes place on financial futures exchanges. e. takes place on equity markets.

ANSWER: a 48. Secondary markets are important because a. the prevailing market price of securities is determined in the secondary market. b. it has an impact on price stability. c. it has an impact on price continuity. d. the proceeds from a sale go to the issuing unit. e. they prevent price discovery. richard@qwconsultancy.com

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ANSWER: a 49. All of the following are advantages of secondary markets EXCEPT that they a. provide liquidity to individuals holding the securities. b. support the primary market by reducing the required rate of return due to the lower liquidity risk for securities. c. provide price discovery for corporations selling seasoned securities. d. impact market efficiency and price volatility. e. All of these are correct.

ANSWER: e 50. Which of the following is NOT a major category of membership in stock exchanges? a. specialist b. commission broker c. floor broker d. financial analyst e. registered trader ANSWER: d 51. All of the following are characteristics of a dealer market EXCEPT that: a. it is a quote-driven market. b. the NASDAQ market is a dealer market. c. individual dealers buy and sell shares for themselves. d. it has a centralized trading location. e. All of these are correct.

ANSWER: d 52. The U.S. secondary market with the largest number of issues traded is the a. AMEX. b. NASDAQ. c. NYSE. d. LSE. e. TSX. ANSWER: b 53. A block trade is one which involves a minimum of a. 1,000 shares. b. 5,000 shares. c. 10,000 shares. d. 100,000 shares. e. 1,000,000 shares.

ANSWER: c

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54. A 1994 study concluded dealers were colluding to maintain wide bid/ask spreads by concentrating market quotes in quarters instead of eighths. This study eventually led to new order handling rules that required quotes to be available to the public through a. the NASDAQ market. b. electronic communications networks (ECN). c. high frequency trading (HFT). d. algorithmic trading (AT). e. intermarket trading system (ITS).

ANSWER: b Exhibit 3.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Jackie has a margin account with a balance of $150,000. The initial margin deposit is 60 percent and Turtle Industries is currently selling at $50 per share.

55. Refer to Exhibit 3.1. How many shares of Turtle can Jackie purchase? a. 5,000 b. 3,000 c. 1,800 d. 1,200 e. 750 ANSWER: a 56. a. b. c. d. e.

ANSWER: b 57. Refer to Exhibit 3.1. If the maintenance margin is 25 percent, to what price can Turtle Industries fall before Jackie receives a margin call? a. $14.56 b. $23.17 c. $32.42 d. $26.67 e. $25.52 ANSWER: d Exhibit 3.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

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Heidi Talbott has a margin account with a balance of $50,000. The initial margin deposit is 50 percent, and RC Industries is currently selling at $50 per share.

58. Refer to Exhibit 3.2. How many shares of RC can Heidi buy? a. 2,500 b. 2,000 c. 1,000 d. 500 e. 250 ANSWER: b 59. Refer to Exhibit 3.2. What is Heidi's profit if RC's price rises to $80? a. $55,000 b. $50,000 c. $60,000 d. $68,270 e. $28,570 ANSWER: c 60. Refer to Exhibit 3.2. If the maintenance margin is 25 percent, to what price can RC Industries stock price fall before Heidi receives a margin call? a. $21.75 b. $23.33 c. $32.00 d. $33.33 e. $22.22 ANSWER: d Exhibit 3.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Kathy Smith has a margin account with a balance of $60,000. Initial margin requirements are 80 percent, and Jackson Industries is currently selling at $40 per share.

61. Refer to Exhibit 3.3. How many shares of Jackson can Kathy buy? a. 1875 b. 1500 c. 1750 d. 1200 e. 950 ANSWER: a 62. Refer to Exhibit 3.3. What is Kathy's profit if Jackson's price rises to $50? richard@qwconsultancy.com

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a. $18,750 b. $15,750 c. $55,000 d. $37,750 e. $28,570 ANSWER: a 63. Refer to Exhibit 3.3. If the maintenance margin is 25 percent, to what price can Jackson Industries fall before Kathy receives a margin call? a. $21.75 b. $23.00 c. $10.67 d. $15.93 e. $12.67 ANSWER: c Exhibit 3.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You decide to sell 100 shares of Davis Industries short when it is selling at its yearly high of $35.

Your broker tells you that your margin requirement is 55 percent and that the commission on the sale is $15. While you are short, Davis pays a $0.75 per share dividend. At the end of one year you buy your Davis shares (cover your short sale) at $30 and are charged a commission of $15 and a 6 percent interest rate.

64. Refer to Exhibit 3.4. What is your dollar return on the investment? a. $130.50 b. $300.50 c. $100.00 d. $1,773.75 e. $3,500.00 ANSWER: b 65. Refer to Exhibit 3.4. What is your rate of return on the investment? a. 10.48 percent b. 12.87 percent c. 13.98 percent d. 15.49 percent e. 18.87 percent ANSWER: d Exhibit 3.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

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You decide to sell 100 shares of Topgun Enterprises Inc. short when it is selling at its yearly high of $42.25. Your broker tells you that your margin requirement is 60 percent and that the commission on the sale is $20. While you are short, Topgun pays a $0.85 per share dividend. At the end of one year you buy your Topgun shares (cover your short sale) at $44 and are charged a commission of $20 and a 5 percent interest rate.

66. Refer to Exhibit 3.5. What is your dollar return on the investment? a. $384.50 b. $432.88 c. −$432.88 d. −$384.50 e. −$950.55 ANSWER: d 67. Refer to Exhibit 3.5. What is your rate of return on the investment? a. 10.48 percent b. 12.87 percent c. −13.98 percent d. −24.49 percent e. −15.05 percent ANSWER: e 68. Suppose you buy a round lot of DG Solutions stock on 60 percent margin when it is selling at $55 a share. The broker charges a 10 percent annual interest rate and commissions are 3 percent of the total stock value on both the purchase and the sale. If at year end you receive a $1.10 per share dividend and sell the stock for 55 5/8, what is your rate of return on the investment? a. −10.38 percent b. −12.84 percent c. −10.95 percent d. 21.84 percent e. 28.38 percent ANSWER: c 69. Suppose you buy a round lot of HS Inc. stock on 55 percent margin when it is selling at $40 a share. The broker charges a 10 percent annual interest rate and commissions are 4 percent of the total stock value on both the purchase and the sale. If at year end you receive a $0.90 per share dividend and sell the stock for 35 5/8, what is your rate of return on the investment? a. −35.17 percent b. −21.84 percent c. 14.74 percent d. 21.84 percent e. 35.17 percent ANSWER: a

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70. Suppose you buy a round lot of Altman Industries stock on 50 percent margin when it is selling at $35 a share. The broker charges a 10 percent annual interest rate and commissions are 5 percent of the total stock value on both the purchase and the sale. If at year end you receive a $1.00 per share dividend and sell the stock for $42.63, what is your rate of return on the investment? a. 15.58 percent b. 11.84 percent c. 14.74 percent d. 21.84 percent e. 28.38 percent ANSWER: a Exhibit 3.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You decide to sell short 200 shares of XCorp stock at a price of $75. Your margin deposit is 65 percent. Commission on the sale is 1.25 percent. While you are short, the stock pays a $1.75 per share dividend. Interest on margin debt is 5.25 percent per year.

71. Refer to Exhibit 3.6. At the end of one year you close out your short position by purchasing share of XCorp at $45 per share. The commission is 1.25 percent. What is your rate of return on the investment? a. −55.92 percent b. 10.31 percent c. 51.06 percent d. 23.1 percent e. −33.05 percent ANSWER: c 72. Refer to Exhibit 3.6. Suppose at the end of one year XCorp is selling at $90 per share and you cover your short position at this price. What is your rate of return on the investment? (Assume a 1.25 percent commission on the purchase.) a. −40.64 percent b. −25.53 percent c. 5.21 percent d. 72.7 percent e. −71.2 percent ANSWER: a Exhibit 3.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Shares of RossCorp stock are selling for $45 per share. Brokerage commissions are 2 percent for purchases and 2 percent for sales. The interest rate on margin debt is 6.25 percent per year. The maintenance margin is 30 percent.

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73. Refer to Exhibit 3.7. At the end of one year, shares of RossCorp stock are selling for $55 per share and the company paid dividends of $0.85 per share. Assuming that you paid the full cost of the purchase, what is your rate of return if you sell RossCorp stock? a. 18.08 percent b. 23.51 percent c. 22.32 percent d. 14.96 percent e. 19.28 percent ANSWER: e 74. Refer to Exhibit 3.7. At the end of one year, shares of RossCorp stock are selling for $35 per share and the company paid dividends of $0.85 per share. Assuming that you paid the full cost of the purchase, what is your rate of return if you sell RossCorp stock? a. −33.05 percent b. −23.42 percent c. 23.42 percent d. 33.05 percent e. −25.35 percent ANSWER: b 75. Refer to Exhibit 3.7. At the end of one year, shares of RossCorp stock are selling for $55 per share and the company paid dividends of $0.85 per share. Assuming that you borrowed 25 percent of cost of the purchase, what is your rate of return? a. −23.51 percent b. 29.35 percent c. 23.51 percent d. 5.21 percent e. 10.06 percent ANSWER: c 76. Refer to Exhibit 3.7. At the end of one year, shares of RossCorp stock are selling for $35 per share and the company paid dividends of $0.85 per share. Assuming that you borrowed 25 percent of cost of the purchase, what is your rate of return? a. 33.05 percent b. −33.05 percent c. −23.51 percent d. −25.35 percent e. −40.64 percent ANSWER: b 77. Refer to Exhibit 3.7. Assume that you purchase 150 shares of RossCorp stock at $45 each by making a margin deposit of 55 percent. At what price would you receive a margin call? a. $29.39 b. $26.48 c. $50.39 d. $28.93 richard@qwconsultancy.com

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e. $50.10 ANSWER: d 78. You own 50 shares of Auto Corporation that you purchased for $30 a share. The stock is currently selling for $50 a share, and you placed a stop loss order at $45. If the stock price drops to $35 a share what is your return on this investment? a. −30.0 percent b. 16.7 percent c. 50.0 percent d. 66.7 percent e. 150.0 percent ANSWER: c 79. You purchased 100 shares of Highlight Company for $20 a share one year ago with a margin of 50 percent. The stock is currently selling for $28 a share, and no dividends were ever paid. The broker charges an annual interest rate of 8 percent and a $100 commission on both the purchase and sale of these shares. What is your annual rate of return on this investment? a. 21 percent b. 47 percent c. 52 percent d. 60 percent e. 72 percent ANSWER: b Exhibit 3.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You sell 100 shares short of AMF Corporation when it is selling at $45 per share. Your margin requirement is 60 percent and the commission on the sale is $50 and the broker charges 10 percent annual interest. AMF Corporation paid a $0.50 per share dividend while you were short the stock.

After one year, you cover your short sale at $35 per share with a $50 commission for the purchase.

80. Refer to Exhibit 3.8. What is your total dollar return on this investment? a. $1,000 b. $900 c. $850 d. $670 e. $520 ANSWER: d 81. Refer to Exhibit 3.8. What is your annual rate of return on this investment? a. 18 percent b. 24 percent c. 25 percent d. 36 percent richard@qwconsultancy.com

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e. 37 percent ANSWER: b 82. Suppose you purchase 200 shares of Best Hat Corporation at $52 a share by making a margin deposit of 50 percent. If the maintenance margin is 30 percent, at what price will you receive a margin call? a. $37.14 b. $37.95 c. $38.23 d. $38.76 e. $39.42 ANSWER: a 83. You purchased 75 shares of Basket Company for $42 a share. One share of the stock is currently trading between $52 and $53, and you placed a stop loss order at $47. If the stock price drops to $40 a share, what is your return on this investment? a. 8.7 percent b. 9.2 percent c. 10.3 percent d. 11.9 percent e. 12.8 percent ANSWER: d 84. You sell short 100 shares of Hi-Light Corporation when it is trading at $70. Your margin requirement is 50 percent. Assuming there was no commission and the maintenance margin is 25 percent, at what stock price would you receive a margin call? a. $76 b. $80 c. $84 d. $88 e. $92 ANSWER: c 85. An order that specifies the highest buy or lowest sell price is a a. limit order. b. short sale. c. market order. d. margin call. e. stop loss.

ANSWER: a 86. When an investor borrows part of the investment cost it is known as a. a short sale. b. a fill or kill order. c. a margin transaction. richard@qwconsultancy.com

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d. a limit order. e. going long.

ANSWER: c 87. Investors can leverage their stock transactions with the use of a. margin orders. b. stop loss orders. c. limit orders. d. market orders. e. specialists.

ANSWER: a

Chapter 04 - Security Market Indexes and Index Funds True / False 1. The general purpose of a market indicator series is to provide an overall indication of aggregate market changes or movements. a. True b. False ANSWER: True 2. An aggregate market index can be used as a benchmark to judge the performance of professional money managers. a. True b. False ANSWER: True 3. When constructing an index, a small percentage of the total population will provide valid indications of the behavior of the total population if the sample is properly selected. a. True b. False ANSWER: True 4. A price weighted series is disproportionately influenced by larger capitalization companies. a. True b. False ANSWER: False 5. The Dow Jones Industrial Average is a value weighted average. a. True b. False ANSWER: False

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6. A two for one stock split causes the divisor in a price-weighted series to decline. a. True b. False ANSWER: True 7. The Dow Jones Industrial Average has been criticized for being blue-chip biased. a. True b. False ANSWER: True 8. Unlike the Dow Jones Industrial Average, the Nikkei-Dow Jones Average is price weighted. a. True b. False ANSWER: False 9. A value weighted index automatically adjusts for stock splits. a. True b. False ANSWER: True 10. The New York Stock Exchange Index is based on a sample of all of the New York Stock Exchange stocks. a. True b. False ANSWER: False 11. An equally weighted indicator series is also known as an unweighted indicator series. a. True b. False ANSWER: True 12. The Standard & Poor's 500 index is an example of a value weighted index. a. True b. False ANSWER: True 13. The Standard & Poor's International Index consists of three international, 19 national, and 38 international industry indexes. a. True b. False ANSWER: False 14. A price-weighted index such as the DJIA is a geometric mean of current stock prices. a. True b. False richard@qwconsultancy.com

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ANSWER: False 15. The Morgan Stanley group index for Europe, Australia, and the Far East (EAFE) is a price weighted index. a. True b. False ANSWER: False 16. The major U.S. stock indexes are highly correlated. a. True b. False ANSWER: True 17. To solve comparability problems across countries, global equity indexes with consistent sample selection, weighting, and computational procedures have been developed. a. True b. False ANSWER: True 18. Bond-market indicator series have been around much longer than stock-market indicator series. a. True b. False ANSWER: False 19. It is easier to construct an indicator series for bonds because of their relatively stable returns pattern. a. True b. False ANSWER: False 20. A bond market index is easier to create than a stock market index because the universe of bonds is much broader than that of stocks. a. True b. False ANSWER: False 21. The correlations among the U.S. investment-grade-bond series were very high because all rates of return for investment-grade bonds over time are impacted by common macroeconomic variables. a. True b. False ANSWER: True 22. There are no composite series currently available that will measure the performance of all securities (i.e. stocks and bonds) in a given country. a. True richard@qwconsultancy.com

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b. False ANSWER: False 23. The NYSE series should have higher rates of return and risk measures than the AMEX and OTC series. a. True b. False ANSWER: False 24. There is a high correlation between the Wilshire 5000 index and the alternative NYSE series (S&P 500 and the NYSE), which represents the substantial influence of large NYSE stocks on the Wilshire 5000 index. a. True b. False ANSWER: True 25. The low correlations between the U.S. and Japan confirm the benefit of global diversification. a. True b. False ANSWER: True 26. The most common way to test a portfolio manager's performance is to compare the portfolio return to a benchmark. a. True b. False ANSWER: True 27. A benchmark measures the performance by portfolio managers. a. True b. False ANSWER: True 28. For an indexed portfolio, the fund manager will typically attempt to replicate the composition of the particular index exactly. a. True b. False ANSWER: True 29. 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 ANSWER: True Multiple Choice richard@qwconsultancy.com

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30. Which of the following is NOT a use of security market indicator series? a. to use as a benchmark of individual portfolio performance b. to develop an index portfolio c. to determine factors influencing aggregate security price movements d. to use in the measurement of systematic risk e. to use in the measurement of diversifiable risk ANSWER: e 31. A properly selected sample for use in constructing a market indicator series will consider the sample's source, size, and a. breadth. b. average beta. c. value. d. variability. e. dividend record.

ANSWER: a 32. 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.

ANSWER: a 33. What effect does a stock substitution or stock split have on a price-weighted series? a. Index remains the same; divisor will increase/decrease. b. Divisor remains the same; index will increase/decrease. c. Index and divisor will both remain the same. d. Index and divisor will both reflect the changes (immediately). e. None of these are correct.

ANSWER: a 34. Which of the following is NOT a value-weighted series? a. NASDAQ Industrial Index b. Dow Jones Industrial Average c. Wilshire 5000 Equity Index d. American Stock Exchange Series e. NASDAQ Composite Index ANSWER: b 35. An example of a value weighted stock market indicator series is the a. Dow Jones Industrial Average. b. Nikkei Dow Jones Average. richard@qwconsultancy.com

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c. S & P 500 Index. d. Value Line Index. e. Shearson Lehman Hutton Index.

ANSWER: c 36. In a value weighted index, a. exchange rate fluctuations have a large impact. b. exchange rate fluctuations have a small impact. c. large companies have a disproportionate influence on the index. d. small companies have an exaggerated effect on the index. e. None of these are correct.

ANSWER: c 37. Of the following indices, which includes the most comprehensive list of stocks? a. New York Exchange Index b. Standard and Poor's Index c. American Stock Exchange Index d. NASDAQ Series Index e. Wilshire Equity Index ANSWER: e 38. The Value Line Composite Average is calculated using the ____ of percentage price changes. a. arithmetic average b. harmonic average c. expected value d. geometric average e. logarithmic average ANSWER: d 39. Which of the following is NOT a global equity indicator series? a. Morgan Stanley Capital International Indexes b. Dow Jones World Stock Index c. FT/S & P-Actuaries World Indexes d. Merrill Lynch-Wilshire World Indexes e. Brinson Partner Global Security Market Index (GSMI) ANSWER: d 40. Which is an example of a Style Index? a. small-cap growth b. mid-cap value c. small-cap value d. mid-cap growth e. All of these are correct.

ANSWER: d richard@qwconsultancy.com

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41. Index movements are influenced by differential prices of the components in a(n) a. equally-weighted index. b. price-weighted index. c. unweighted index. d. value-weighted index. e. over-weighted index.

ANSWER: b 42. A style index created to track ethical funds is known as the a. green index. b. SRI index. c. EAFE index. d. freedom index. e. ethical index.

ANSWER: b 43. Which index is created by first deriving the initial total market value of all stocks used in the index? a. equally-weighted index. b. price-weighted index. c. unweighted index. d. value-weighted index. e. over-weighted index.

ANSWER: d 44. The actual index movements are typically based on the arithmetic mean of the percent changes in price or value for the stocks in the a. equally-weighted index. b. price-weighted index. c. unweighted index. d. value-weighted index. e. over-weighted index.

ANSWER: c 45. Which of the fundamental factors was NOT used in the Fundamental Index created by Research Affiliates, Inc.? a. sales b. profits (cash flow) c. leverage (debt/equity) d. net assets (book value) e. dividends ANSWER: c Exhibit 4.1 richard@qwconsultancy.com

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USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Number of shares outstanding 2,000 7,000 5,000 4,000

Companies 1 2 3 4

Closing Prices Day T $30.00 55.00 20.00 40.00

(per share) Day T + 1 $25.00 60.00 25.00 45.00

46. Refer to Exhibit 4.1. Assume that a stock price-weighted indicator consisted of the four issues with their prices. What are the values of the stock indicator for Day T and T + 1, and what is the percentage change? a. 36.25, 38.75, 6.9 percent b. 38.75, 36.25, −6.9 percent c. 100, 106.9, 6.9 percent d. 107.48, 106.33, 1.15 percent e. 106.9, 100, 5.7 percent ANSWER: a 47. Refer to Exhibit 4.1. For a value-weighted series, assume that Day T is the base period and the base value is 100. What is the new index value for Day T + 1, and what is the percentage change in the index from Day T? a. 106.33, 6.33 percent b. 107.48, 7.48 percent c. 109.93, 9.93 percent d. 108.7, 8.7 percent e. 107.56, 7.3 percent ANSWER: c 48. Refer to Exhibit 4.1. Compute an unweighted price indicator series, using geometric means. What is the percentage change in the index from Day T to Day T+1? Assume a base index value of 100 on Day T. a. 5.35 percent b. 7.48 percent c. 9.93 percent d. 6.33 percent e. 0 percent ANSWER: d Exhibit 4.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Jan. 13, 2005 Jan. 14, 2005 Jan. 15, 2005 Jan. 16, 2005

X 20 25 27 20

Stock Price Y 40 42 45 40

richard@qwconsultancy.com

Z 30 18 8 10

X 1000 1000 1000** 3000

# Shares Y 2000 2000 2000 2000

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*2:1 Split on Stock Z after Close on Jan. 13, 2005 **3:1 Split on Stock X after Close on Jan. 15, 2005 The base date for index calculations is January 13, 2005

49. Refer to Exhibit 4.2. Calculate a price weighted average for January 13th. a. 32 b. 30 c. 36.13 d. 34 e. 56 ANSWER: b 50. Refer to Exhibit 4.2. What is the divisor at the beginning of January 14th? a. 3.0 b. 2.5 c. 2.2734 d. 1.9375 e. 3.2852 ANSWER: b 51. Refer to Exhibit 4.2. Calculate a price weighted average for January 14th. a. 32 b. 30 c. 36.13 d. 34 e. 37 ANSWER: d 52. Refer to Exhibit 4.2. Calculate a price weighed average for January 15th. a. 30 b. 36.13 c. 32 d. 34 e. 37 ANSWER: c 53. Refer to Exhibit 4.2. What is the divisor at the beginning of January 16th? a. 1.9375 b. 3.0 c. 2.5 d. 2.2734 e. 3.2852 ANSWER: a richard@qwconsultancy.com

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54. Refer to Exhibit 4.2. Calculate a price weighted average for January 16th. a. 30 b. 32 c. 34 d. 36.13 e. No37 ANSWER: d 55. Refer to Exhibit 4.2. Calculate a value weighted index for Jan. 13th if the initial index value is 100. a. 111.54 b. 100 c. 102.31 d. 123.07 e. 143.25 ANSWER: b 56. Refer to Exhibit 4.2. Calculate a value weighted index for Jan. 14th if the initial index value is 100. a. 100 b. 102.31 c. 123.07 d. 111.54 e. 121.32 ANSWER: d 57. Refer to Exhibit 4.2. Calculate a value weighted index for January 15th if the initial index value is 100. a. 102.31 b. 100 c. 123.07 d. 111.54 e. 121.32 ANSWER: a 58. Refer to Exhibit 4.2. Calculate a value weighted index for January 16th if the initial index value is 100. a. 123.07 b. 100.00 c. 102.31 d. 111.54 e. 121.32 ANSWER: a

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Exhibit 4.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Year 2000 2001 2002 2003 2004

% Price Change for GB Industries 10.0% 12.0% 10.0% 11.0% 6.0%

59. Refer to Exhibit 4.3. Calculate the average annual rate of change for GB Industries for the fiveyear period using the arithmetic mean. a. 0.098% b. 9.80% c. 8.50% d. 8.00% e. 89.00% ANSWER: b 60. Refer to Exhibit 4.3. Calculate the average annual rate of change for GB Industries for the fiveyear period using the geometric mean. a. 9.7800% b. 0.0978% c. 9.0700% d. 0.0970% e. 3.6400% ANSWER: a Exhibit 4.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Year 2000 2001 2002 2003 2004

% Price Change for Stock Index 8.0% 10.0% −14.0% 20.0% −10.0%

61. Refer to Exhibit 4.4. Calculate the average annual rate of change for this index for the five-year period using the arithmetic mean. a. 0.28% b. 1.28% c. 2.80% d. 3.58% e. 6.38% ANSWER: c

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62. Refer to Exhibit 4.4. Calculate the average annual rate of change for this index for the five-year period using the geometric mean. a. 0.09% b. 1.99% c. 3.99% d. 4.50% e. 4.67% ANSWER: b Exhibit 4.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Stock W X Y Z

31-Dec-03 Price $ 75.00 $150.00 $ 25.00 $ 40.00

31-Dec-03 Shares 10000 5000 20000 25000

31-Dec-04 Price $50.00 $65.00 $35.00 $50.00

31-Dec-04 Shares 20000 10000 20000 25000

Stocks W and X had 2 for 1 splits after the close on Dec 31, 2003.

63. Refer to Exhibit 4.5. Calculate the price weighted series for Dec 31, 2003, prior to the splits. a. 81.69 b. 100.0 c. 72.5 d. 121.25 e. 119.25 ANSWER: c 64. Refer to Exhibit 4.5. Calculate the price weighted series for Dec 31, 2003, after the splits. a. 72.5 b. 100.0 c. 119.25 d. 121.25 e. 81.69 ANSWER: a 65. Refer to Exhibit 4.5. Calculate the price weighted series for Dec 31, 2004. a. 121.25 b. 119.25 c. 100.0 d. 72.5 e. 81.69 ANSWER: e

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66. Refer to Exhibit 4.5. Calculate the percentage return in the price weighted series for the period Dec 31, 2000 to Dec 31, 2004. a. 12.68 percent b. 20.00 percent c. 21.76 percent d. 33.33 percent e. 40.00 percent ANSWER: a 67. Refer to Exhibit 4.5. Calculate the value weighted index for Dec 31, 2003, prior to the splits.

Assume a base index value of 100. The base year is Dec 31, 2003. a. 120.0 b. 81.69 c. 72.5 d. 100.0 e. 121.25 ANSWER: d 68. Refer to Exhibit 4.5. Calculate the value weighted index for Dec 31, 2003, after the splits. Assume a base index value of 100. The base year is Dec 31, 2003. a. 72.5 b. 81.69 c. 100.0 d. 120.0 e. 121.25 ANSWER: c 69. Refer to Exhibit 4.5. Calculate the value weighted index for Dec 31, 2004. Assume a base index value of 100. The base year is Dec 31, 2003. a. 121.25 b. 100.0 c. 81.69 d. 72.5 e. 120.0 ANSWER: e 70. Refer to Exhibit 4.5. Calculate the percentage return in the value weighted index for the period Dec 31, 2003 to Dec 31, 2004. a. 12.68 percent b. 20.00 percent c. 21.76 percent d. 33.33 percent e. 40.00 percent ANSWER: b

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71. Refer to Exhibit 4.5. Calculate the unweighted index for Dec 31, 2003, prior to the splits. Assume a base index value of 100. The base year is Dec 31, 2003. a. 100.0 b. 200.0 c. 150.0 d. 120.0 e. 175.0 ANSWER: a 72. Refer to Exhibit 4.5. Calculate the unweighted index for Dec 31, 2003, after the splits. Assume a base index value of 100. The base year is Dec 31, 2003. a. 110.0 b. 200.0 c. 100.0 d. 120.0 e. 150.0 ANSWER: c 73. Refer to Exhibit 4.5. Calculate the unweighted index (geometric mean) for Dec 31, 2004. Assume a base index value of 100. The base year is Dec 31, 2003. a. 119.25 b. 121.25 c. 151.25 d. 95.25 e. 100.25 ANSWER: a 74. Refer to Exhibit 4.5. Calculate the percentage return in the unweighted index (geometric mean) for the period Dec 31, 2003 to Dec 31, 2004. Assume a base index value of 100. The base year is Dec 31, 2003. a. 19.25 percent b. 21.25 percent c. 51.25 percent d. 5.25 percent e. 100.25 percent ANSWER: a Exhibit 4.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Price Stock Q R S

Number of Shares 5,000,000 8,000,000 15,000,000

richard@qwconsultancy.com

Day T 80 60 20

Day T + 1 95 55 24

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75. Refer to Exhibit 4.6. Calculate a price weighted average for Day T. a. 46.20 b. 53.33 c. 54.12 d. 92.39 e. 108.23 ANSWER: b 76. Refer to Exhibit 4.6. Calculate a value weighted average for Day T + 1. Assume a base index value of 100 on Day T. a. 46.20 b. 53.33 c. 54.12 d. 92.39 e. 108.23 ANSWER: d 77. Refer to Exhibit 4.6. If an equal-weighted index is constructed on Day T with $10,000 in each stock, what is the percentage change in wealth for this index on Day T + 1? Assume a base index value of 100 on Day T. a. 8.65 percent b. 10.14 percent c. 15.69 percent d. 30.42 percent e. 47.08 percent ANSWER: b 78. Refer to Exhibit 4.6. Compute the arithmetic mean of the price change of Stocks Q, R, and S from days T to T + 1. a. 8.65 percent b. 10.14 percent c. 15.69 percent d. 30.42 percent e. 47.08 percent ANSWER: b 79. Refer to Exhibit 4.6. Compute the geometric mean of the price change of Stocks Q, R, and S from days T to T + 1. a. 9.32 percent b. 10.14 percent c. 15.57 percent d. 30.63 percent e. 54.37 percent ANSWER: a

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Exhibit 4.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Stock A B C

Number of Shares 5,000 8,000 15,000

December 31, 2011 Price Value $20 $100,000 $40 $320,000 $10 $150,000

December 31, 2012 Price Value $25 $125,000 $42 $304,000 $15 $225,000

80. Refer to Exhibit 4.7. What would be the total percentage change in an equally weighted portfolio of ABC? a. 13.33 percent b. 18.67 percent c. 23.41 percent d. 26.67 percent e. 36.83 percent ANSWER: d 81. Refer to Exhibit 4.7. If the December 31, 2011 equal weighted index for ABC was 100, what is the equal weighted index for ABC on December 31, 2012? a. 108.35 b. 114.74 c. 120.19 d. 126.67 e. 131.54 ANSWER: d 82. Refer to Exhibit 4.7. If the December 31, 2011 value weighted index for ABC was 100, what is the value weighted index for ABC on December 31, 2012? a. 108.35 b. 114.74 c. 120.19 d. 126.67 e. 131.54 ANSWER: b 83. The Ryan Treasury Index is an example of a a. bond market indicator series. b. stock market indicator series. c. composite security market series. d. world market series. e. commodity market series.

ANSWER: a 84. Which of the following are factors that make it difficult to create and maintain a bond index? a. The universe of bonds is broader than stocks. richard@qwconsultancy.com

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b. The universe of bonds is constantly changing due to new issues, bond maturities, calls, and bond sinking funds. c. It is difficult to derive valuable, up-to-date prices. d. Bond price volatility is affected by duration, which is constantly changing. e. All of these are correct.

ANSWER: e 85. Which of the following is TRUE of the various market index series? a. A low correlation exists between the U.S. indexes and those of Japan. b. The NYSE series have higher rates of return and risk measures than the AMEX and OTC series. c. A low correlation exists between alternative series that include almost all NYSE stocks. d. A low correlation exists between alternative bond series. e. None of these are correct.

ANSWER: a 86. Studies of correlations among monthly equity price index returns have found a. low correlations between various U.S. equity indexes. b. high correlations between various U.S. equity indexes. c. high correlations between U.S. and non-U.S. equity indexes. d. negative correlations between various U.S. equity indexes. e. high correlations between equity and bond indexes.

ANSWER: b 87. Studies of correlations among monthly U.S. bond price index returns have found a. low correlations between investment grade bonds and high yield bonds. b. high correlations between investment grade bonds and high yield bonds. c. low correlations between various investment grade bond indexes. d. negative correlations between investment grade bonds and high yield bonds. e. None of these are correct.

ANSWER: a 88. For an indexed portfolio, the fund manager will typically a. attempt to replicate the composition of the particular index exactly. b. not replicate the composition of the particular index. c. not alter the weights when the index composition is changed. d. generate high trading expense ratios. e. generate high management expense ratios.

ANSWER: a 89. Exchange traded funds a. are exactly the same as index mutual funds. b. can be bought and sold like common stocks. c. cannot be sold short. d. have a high management fee. richard@qwconsultancy.com

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e. cannot be timed for capital gain tax realizations.

ANSWER: b

Chapter 05 - Efficient Capital Markets, Behavioral Finance, and Technical Analysis True / False 1. Prices in efficient capital markets fully reflect all available information and rapidly adjust to new information. a. True b. False ANSWER: True 2. An efficient market requires a large number of profit-maximizing investors. a. True b. False ANSWER: True 3. If the efficient market hypothesis is true, price changes are independent and biased. a. True b. False ANSWER: False 4. The random walk hypothesis contends that stock prices occur randomly. a. True b. False ANSWER: True 5. The weak form of the efficient market hypothesis contends that stock prices fully reflect all public and private information. a. True b. False ANSWER: False 6. The weak form of the efficient market hypothesis contends that technical trading rules are of little value. a. True b. False ANSWER: True 7. Tests have shown that if small filters are used in simulating trading rules, these trading rules have produced above average returns after transactions costs are factored in. a. True b. False richard@qwconsultancy.com

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ANSWER: False 8. In tests of the semistrong-form EMH, it is not necessary to use risk-adjusted rates of return. a. True b. False ANSWER: False 9. Results of initial public offering (IPOs) studies tend to support the semi-strong EMH because it appears that prices adjusted rapidly after initial underpricing. a. True b. False ANSWER: True 10. Results from studies on the effects of unexpected world events have consistently indicated that the price change is so rapid that it takes place between the close of one day and the opening of the next day. a. True b. False ANSWER: True 11. Studies concerning quarterly earnings reports indicate that information in quarterly statements is of value and can provide an above-average, risk-adjusted return. a. True b. False ANSWER: True 12. Results of studies concerning corporate insider trading indicate that corporate insiders generally enjoy above-average returns. a. True b. False ANSWER: True 13. The strong form of the efficient market hypothesis contends that only insiders can earn abnormal returns. a. True b. False ANSWER: False 14. Technical analysis and the efficient market hypothesis have a consistent set of assumptions concerning stock market behavior. a. True b. False ANSWER: False 15. Even when fees and costs are considered, most mutual fund managers outperform the aggregate market. richard@qwconsultancy.com

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a. True b. False ANSWER: False 16. When considering markets in Europe, it is inappropriate to assume a level of efficiency similar to that for U.S. markets. a. True b. False ANSWER: False 17. The weak-form efficient market hypothesis assumes all publicly available information is reflected in current stock prices. a. True b. False ANSWER: False 18. Studies examining stock splits support the semistrong-form efficient market hypothesis. a. True b. False ANSWER: True 19. There is little evidence from studies examining initial public offerings (IPOs) that suggest markets are semistrong-form efficient. a. True b. False ANSWER: False 20. There is empirical evidence that low P/E stocks have outperformed high P/E stocks for some historical time periods. a. True b. False ANSWER: True 21. Recent studies indicate that due to lower transaction costs, intraday patterns of returns and volume persisted and result in profitable momentum trading strategies. a. True b. False ANSWER: True 22. Behavioral finance considers how various psychological traits affect how individuals or groups act as investors, analysts, and portfolio managers. a. True b. False ANSWER: True

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23. The prospect theory contends that utility depends on deviations from moving reference points rather than absolute wealth. a. True b. False ANSWER: True 24. Fusion investing is the integration of two elements of investment valuation—fundamental value and investor sentiment. a. True b. False ANSWER: True 25. To take advantage of long-run price movements in an efficient market, you must do a superior job of estimating the relevant variables that cause these long-run movements. a. True b. False ANSWER: True 26. An investor who can do a superior job of estimating intrinsic value can consistently make superior market timing (asset allocation) decisions or acquire undervalued securities and generate aboveaverage returns. a. True b. False ANSWER: True 27. Fundamentalists contend that past price movements will indicate future price movements. a. True b. False ANSWER: False 28. Technical analysts believe that security prices do not adjust rapidly. a. True b. False ANSWER: True 29. One of the potential disadvantages of technical analysis is that it can lead to investing too early, even before fundamental analysts do. a. True b. False ANSWER: False 30. Because technicians are suspicious of financial statements, they consider it advantageous not to depend on them. a. True b. False ANSWER: True richard@qwconsultancy.com

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31. The use of trading rules requires a great deal of subjective judgment. a. True b. False ANSWER: True 32. If a technical trading rule is successful, then more traders use it, causing the rule to become even more successful. a. True b. False ANSWER: False 33. For technical trading rules to consistently generate superior returns, the market would have to be inefficient. a. True b. False ANSWER: True 34. The majority of technicians follow many trading rules and attempt to arrive at a consensus among their rules. a. True b. False ANSWER: True 35. Contrary trading rules assert that investors tend to be wrong except at market peaks and troughs. a. True b. False ANSWER: False 36. A high put/call ratio indicates a pervasive bearish attitude by sophisticated investors, so it is a bearish indicator. a. True b. False ANSWER: False 37. Two major classes of technicians include the contrarians and those who "follow the smart money" a. True b. False ANSWER: True 38. The confidence index increases as the yield on lower grade bonds decreases, everything else being constant. a. True b. False ANSWER: True richard@qwconsultancy.com

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39. The T-Bill-Eurodollar yield spread widens during periods of international crisis. a. True b. False ANSWER: True 40. An increase in debit balances in brokerage accounts is viewed by technicians as a bullish sign. a. True b. False ANSWER: True 41. The Confidence Index increases as the yield on lower grade bonds decreases, everything else being constant. a. True b. False ANSWER: True 42. A rise in the Confidence Index published by Barron's is an indication that investors will purchase more lower-quality bonds. a. True b. False ANSWER: True 43. An increase in debit balances means more investing by naive investors and would be a bearish indicator. a. True b. False ANSWER: False 44. The Dow Theory contends that stock price movements are similar to the movement of tides, waves, and ripples. a. True b. False ANSWER: True 45. A resistance level is the price range at which the technician would expect an increase in the demand of stock and a price reversal. a. True b. False ANSWER: False 46. If the aggregate market is rising but the breadth index is declining, then it is a bearish signal. a. True b. False ANSWER: True richard@qwconsultancy.com

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47. The breadth of the market measures the daily volume for a particular market. a. True b. False ANSWER: False 48. 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 ANSWER: False 49. Candlestick charts indicate the price change from open to close by shading whether the market went down or up for the day. a. True b. False ANSWER: True 50. If the 50-day moving average line crosses the 200-day moving average line from below on good volume, then this would be a bullish signal. a. True b. False ANSWER: True 51. The relative strength ratio for a stock can be computed by dividing the value of the S&P 500 stock index by the price of a stock. a. True b. False ANSWER: False 52. When the 50-day MA line crosses the 200-day MA line from above, it is considered a buy signal. a. True b. False ANSWER: False 53. If 10 percent of the stocks are selling above their 200-day moving average, the market is considered to be oversold. a. True b. False ANSWER: True Multiple Choice 54. Which of the following would be inconsistent with an efficient market? a. Information arrives randomly and independently. richard@qwconsultancy.com

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b. Stock prices adjust rapidly to new information. c. Price changes are independent. d. Price changes are random. e. Price adjustments are biased.

ANSWER: e 55. The weak form of the efficient market hypothesis states that a. successive price changes are dependent. b. successive price changes are independent. c. successive price changes are biased. d. successive price changes depend on trading volume. e. properly specified trading rules are of value.

ANSWER: b 56. Which statement is true concerning alternative efficient market hypothesis? a. The weak hypothesis encompasses the semi-strong hypothesis. b. The weak hypothesis encompasses the strong hypothesis. c. The semi-strong hypothesis encompasses the weak hypothesis. d. The strong hypothesis relates only to public information. e. The semi-strong hypothesis encompasses the strong hypothesis.

ANSWER: c 57. According to the strong-form efficient market hypothesis, stock prices fully reflect a. all security market information only. b. all public information only. c. all public and private information. d. all private information only. e. limited public and private information.

ANSWER: c 58. According to the semistrong-form efficient market hypothesis, which of the following types of information are fully reflected in stock prices? a. rates of return, trading volume, and news about the economy b. dividend and earnings announcements c. rates of return, trading volume, and block trades d. earnings announcements and rates of return e. All of these are correct.

ANSWER: e 59. According to the weak-form efficient market hypothesis, which of the following types of information are fully reflected in stock prices? a. rates of return, trading volume, and news about the economy b. dividend and earnings announcements c. rates of return, trading volume, and block trades d. earnings announcements and rates of return richard@qwconsultancy.com

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e. insider information ANSWER: c 60. A trading rule which signals purchase of a stock if it rises X percent and sale of a stock if it falls X percent is known as a a. breakout. b. short sale. c. sieve. d. filter. e. relative strength.

ANSWER: d 61. Which of the following has NOT been involved in a direct test of the semi-strong form of the efficient market hypothesis? a. stock splits b. new Issues c. exchange listing d. accounting changes e. NYSE specialists' returns ANSWER: e 62. Examples of anomalies providing contrary evidence to the semi-strong efficient market hypothesis include studies of all of the following EXCEPT a. quarterly earnings reports. b. price earnings ratios. c. total market value. d. stocks ranked by Standard & Poor's. e. the January effect.

ANSWER: d 63. The opportunity to take advantage of the downward pressure on stock prices that result from endof-the-year tax selling is known as the a. End-of-the-Year Effect. b. December Anomaly. c. End-of-the-Year Anomaly. d. January Anomaly. e. New Year Anomaly.

ANSWER: d 64. Banz and Reinganum found that small firms consistently outperformed large firms. This anomaly is referred to as the a. large firm effect. b. size effect. c. small firm effect. d. earnings effect. richard@qwconsultancy.com

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e. growth firm effect.

ANSWER: b 65. The performance of four major groups of investors has been studied in connection with tests of the strong-form of the efficient market hypothesis. These include all of the following EXCEPT a. professional money managers. b. stock exchange specialists. c. securities Exchange officers. d. security analysts. e. corporate insiders.

ANSWER: c 66. Some studies have attempted to determine whether it is possible to predict future returns for a stock based on publicly available quarterly earnings reports. The results of these studies indicate a. stock prices adjust to reflect quarterly earnings reports. b. stock prices do not adjust to reflect quarterly earnings reports. c. support for the semistrong-EMH. d. stock prices adjust if earnings reports are released in January. e. stock prices do not adjust if earnings reports are released in January.

ANSWER: b 67. The January anomaly refers to the phenomenon where stock prices a. decline in December. b. decline in January. c. rise in January. d. decline in December and rise in January. e. rise in December and decline in January.

ANSWER: d 68. Abnormal returns associated with rankings by a major advisory service are associated with a. the earnings effect. b. the Value-Line Enigma. c. the Value-Line Effect. d. the Standard and Poor's Anomaly. e. the rankings anomaly.

ANSWER: b 69. Researchers have found a positive relationship between default spread and stock returns in the long run because a large default spread implies a a. high risk premium and higher expected returns. b. high risk premium and lower expected returns. c. low risk premium and higher expected returns. d. low risk premium and lower expected returns. e. low risk premium and the same expected returns.

ANSWER: a richard@qwconsultancy.com

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70. In tests of the semistrong-form efficient market hypothesis, an adjustment for market effects is carried out by a. calculating the historical return. b. calculating the market rate of return. c. calculating the abnormal rate of return. d. calculating the cross-sectional return. e. calculating the monthly return.

ANSWER: c 71. In an event study the objective is to a. determine whether it is possible to predict stock prices. b. determine how fast stock prices adjust to news. c. examine the cross-sectional distributions of returns. d. conduct a time series analysis of returns. e. determine normal P/E ratios.

ANSWER: b 72. In order to confirm the weak-form efficient market hypothesis, an examination of stock price runs over time would reveal that stock price changes over time were a. highly positively correlated. b. moderately positively correlated. c. highly negatively correlated. d. moderately negatively correlated. e. not correlated.

ANSWER: e Exhibit 5.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stock C E

Rit 12 10

Rmt 10 8.0

ai 0 0

Beta 0.8 1.1

Rit = return for stock i during period t Rmt = return for the aggregate market during period t

73. Refer to Exhibit 5.1. What is the abnormal rate of return for Stock C during period t using only the aggregate market return (ignore differential systematic risk)? a. 4.0 percent b. 1.2 percent c. −1.05 percent d. 2.0 percent e. −8.5 percent richard@qwconsultancy.com

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ANSWER: d 74. Refer to Exhibit 5.1. What is the abnormal rate of return for Stock E during period t using only the aggregate market return (ignore differential systematic risk)? a. 4.0 percent b. 2.0 percent c. 1.2 percent d. −1.05 percent e. −8.5 percent ANSWER: b 75. Refer to Exhibit 5.1. What is the abnormal rate of return for Stock C when you consider its systematic risk measure (beta)? a. 4.0 percent b. 1.2 percent c. 2.0 percent d. −1.05 percent e. −8.5 percent ANSWER: a 76. Refer to Exhibit 5.1. What is the abnormal rate of return for Stock E when you consider its systematic risk measure (beta)? a. 2.0 percent b. 1.2 percent c. 4.0 percent d. −1.05 percent e. −8.5 percent ANSWER: b Exhibit 5.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stock ABC XYZ

Rit 11.5 9.0

Rmt 13.0 7.0

ai 0 0

Beta 0.7 1.1

Rit = return for stock i during period t Rmt = return for the aggregate market during period t

77. Refer to Exhibit 5.2. What is the abnormal rate of return for Stock ABC during period t using only the aggregate market return (ignore differential systematic risk)? a. 3.2 percent b. 2.4 percent c. 1.3 percent richard@qwconsultancy.com

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d. −1.5 percent e. 2.0 percent ANSWER: d 78. Refer to Exhibit 5.2. What is the abnormal rate of return for Stock XYZ during period t using only the aggregate market return (ignore differential systematic risk)? a. −3.2 percent b. 2.4 percent c. 2.0 percent d. 1.3 percent e. −1.5 percent ANSWER: c 79. Refer to Exhibit 5.2. What is the abnormal rate of return for Stock ABC when you consider its systematic risk measure (beta)? a. 2.4 percent b. 1.5 percent c. −1.5 percent d. 2.0 percent e. −3.2 percent ANSWER: a 80. Refer to Exhibit 5.2. What is the abnormal rate of return for Stock XYZ when you consider its systematic risk measure (beta)? a. 2.0 percent b. −1.5 percent c. 2.4 percent d. 1.3 percent e. −3.2 percent ANSWER: d Exhibit 5.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stock Elliot Hemlick

Rit 9.9 9.1

Rmt 15.0 8.0

ai 0 0

Beta 0.8 1.1

Rit = return for stock i during period t Rmt = return for the aggregate market during period t

81. Refer to Exhibit 5.3. What is the abnormal rate of return for Elliot during period t using only the aggregate market return (ignore differential systematic risk)? a. 1.50 richard@qwconsultancy.com

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b. 1.10 c. −1.50 d. −5.10 e. −8.00 ANSWER: d 82. Refer to Exhibit 5.3. What is the abnormal rate of return for Hemlick during period t using only the aggregate market return (ignore differential systematic risk)? a. 0.11 b. 1.10 c. −1.80 d. −1.80 e. −4.60 ANSWER: b 83. Refer to Exhibit 5.3. What is the abnormal rate of return for Elliot when you consider its systematic risk measure (beta)? a. −2.10 percent b. −2.00 percent c. 5.20 percent d. 14.10 percent e. 3.00 percent ANSWER: a 84. Refer to Exhibit 5.3. What is the abnormal rate of return for Hemlick when you consider its systematic risk measure (beta)? a. 0.1 percent b. 0.3 percent c. 0.5 percent d. 1.5 percent e. 3.0 percent ANSWER: b Exhibit 5.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stock A B

Rit 10.3 9.4

Rmt 12 9.0

ai 0 0

Beta 0.6 1.2

Rit = return for stock i during period t Rmt = return for the aggregate market during period t

richard@qwconsultancy.com

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85. Refer to Exhibit 5.4. What is the abnormal rate of return for Stock A during period t using only the aggregate market return (ignore differential systematic risk)? a. 3.34 b. 1.75 c. −1.75 d. −3.70 e. −1.70 ANSWER: e 86. Refer to Exhibit 5.4. What is the abnormal rate of return for Stock B during period t using only the aggregate market return (ignore differential systematic risk)? a. 0.40 b. 1.40 c. −1.10 d. −4.40 e. −6.40 ANSWER: a 87. Refer to Exhibit 5.4. What is the abnormal rate of return for Stock A when you consider its systematic risk measure (beta)? a. 2.30 percent b. 2.10 percent c. 3.10 percent d. 12.40 percent e. 17.25 percent ANSWER: c 88. Refer to Exhibit 5.4. What is the abnormal rate of return for Stock B when you consider its systematic risk measure (beta)? a. 0.1 percent b. −1.4 percent c. 0.5 percent d. 1.5 percent e. 2.0 percent ANSWER: b Exhibit 5.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stock A Z

Rit 10.6 9.8

Rmt 15 8.0

ai 0 0

Beta 0.8 1.1

Rit = return for stock i during period t Rmt = return for the aggregate market during period t richard@qwconsultancy.com

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89. Refer to Exhibit 5.5. What is the abnormal rate of return for Stock A during period t using only the aggregate market return (ignore differential systematic risk)? a. 3.40 b. 4.40 c. −1.86 d. −4.40 e. −1.70 ANSWER: d 90. Refer to Exhibit 5.5. What is the abnormal rate of return for Stock Z during period t using only the aggregate market return (ignore differential systematic risk)? a. 1.80 b. 1.40 c. −1.80 d. −4.80 e. −8.80 ANSWER: a 91. Refer to Exhibit 5.5. What is the abnormal rate of return for Stock A when you consider its systematic risk measure (beta)? a. 1.40 percent b. −1.40 percent c. 2.80 percent d. −2.80 percent e. 0 percent ANSWER: b 92. Refer to Exhibit 5.5. What is the abnormal rate of return for Stock Z when you consider its systematic risk measure (beta)? a. 0.1 percent b. 1.0 percent c. 0.5 percent d. −1.0 percent e. −2.0 percent ANSWER: b Exhibit 5.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stock A B

Rit 9.7 10.4

Rmt 10.0 8.0

ai 0 0

Beta 0.7 1.4

Rit = return for stock i during period t richard@qwconsultancy.com

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Rmt = return for the aggregate market during period t

93. Refer to Exhibit 5.6. What is the abnormal rate of return for Stock A during period t using only the aggregate market return (ignore differential systematic risk)? a. −2.3 percent b. −0.3 percent c. 0.3 percent d. 2.3 percent e. 3.0 percent ANSWER: b 94. Refer to Exhibit 5.6. What is the abnormal rate of return for Stock A when you consider its systematic risk measure (beta)? a. −2.3 percent b. −0.3 percent c. 0.3 percent d. 2.3 percent e. 3.0 percent ANSWER: d 95. Refer to Exhibit 5.6. What is the abnormal rate of return for Stock B when you consider its systematic risk measure (beta)? a. −0.8 percent b. −1.2 percent c. 1.3 percent d. 2.4 percent e. 6.6 percent ANSWER: a 96. Refer to Exhibit 5.6. Stock X had an actual return of 14 percent, and Stock X's normal return based on the market's return for the same period was 13.6 percent. What is Stock X's abnormal rate of return? a. −0.4 percent b. 0.1 percent c. 0.4 percent d. 4.0 percent e. 6.4 percent ANSWER: c 97. Based on Stock Z's beta of 0.9 the normal return is 9 percent. However, the actual return for Stock Z was 8 percent. What is Stock Z's abnormal rate of return? a. −1.0 percent b. −0.1 percent c. 0.1 percent richard@qwconsultancy.com

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d. 1.0 percent e. 1.1 percent ANSWER: a 98. If statistical tests of stock returns over time support the efficient market hypothesis, then the resulting correlations should be a. positive. b. negative. c. zero. d. lagged. e. skewed.

ANSWER: c 99. A "runs test" on successive stock price changes which supports the efficient market hypothesis would show the actual number of runs a. falls into the range expected of a random series. b. falls into the range expected of a dependent series. c. is small. d. is large. e. would approximate N/2.

ANSWER: a 100. Escalation bias refers to the situation in which a. investors have a propensity to sell winners too soon and hang on to losers too long. b. investors ignore bad news and overemphasize good news. c. investors tend to follow the herd. d. investors put more money into a failure rather than into a success. e. investors are all noise traders.

ANSWER: d 101. Confirmation bias refers to the situation in which a. investors have a propensity to sell winners too soon and hang on to losers too long. b. investors ignore bad news and overemphasize good news. c. investors tend to follow the herd. d. investors put more money into a failure rather than into a success. e. investors are all noise traders.

ANSWER: b 102. According to prospect theory, a. investors have a propensity to sell winners too soon and hang on to losers too long. b. investors ignore bad news and overemphasize good news. c. investors tend to follow the herd. d. investors put more money into a failure rather than into a success. e. investors are all noise traders.

ANSWER: a richard@qwconsultancy.com

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103. Behavioral finance differs from the standard model of finance because behavioral finance a. precludes the impact of investor psychology. b. includes the impact of investor psychology. c. accepts the Efficient Markets Hypothesis. d. rejects the idea of market anomalies. e. rejects the idea of technical analysis.

ANSWER: b 104. Which of the following behaviors is consistent with escalation bias? a. buying more of a stock as it increases in value b. buying more of a stock as it decreases in value c. selling a stock as it decreases in value d. selling a stock as it increases in value e. buying or selling a stock as it increases in value ANSWER: b 105. According to Wood (2010), which three tributaries form the river of behavioral finance? a. Behavioral psychology, social psychology, and quantum physics. b. Behavioral psychology, social psychology, and neurofinance. c. Behavioral psychology, contrary psychology, and quantum physics. d. Behavioral psychology, smart money psychology, and brain plasticity. e. Behavioral psychology, contrary psychology, and neurofinance.

ANSWER: b 106. Fusion investing is the integration of the following elements of investment valuation: a. fundamental value and investor sentiment. b. fads and fashions. c. technical analysis and investor sentiment. d. historical prices and returns. e. transaction costs and fundamental value.

ANSWER: a 107. Fusion investing refers to the combination of a. technical analysis and fundamental analysis. b. behavioral analysis and technical analysis. c. fundamental analysis and investor sentiment. d. technical analysis and investor sentiment. e. behavioral analysis and market anomalies.

ANSWER: c 108. A portfolio manager without superior analytical skills should a. determine and quantify the risk preferences of a client. b. minimize transaction costs. richard@qwconsultancy.com

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c. maintain the specified risk level. d. ensure that the portfolio is completely diversified. e. All of these are correct.

ANSWER: e 109. The implication of efficient capital markets and a lack of superior analysts have led to the introduction of a. balanced funds. b. naive funds. c. January funds. d. index funds. e. futures and options.

ANSWER: d 110. Which is NOT an implication of the EMH? a. To do superior industry or company analysis, you must understand the variables that affect returns and do a superior job of estimating these variables. b. Aggregate market analysis that involves very detailed analysis of reliable historical economic data should outperform a simple buy-and-hold policy. c. A superior analyst is one who can consistently select stocks that provide positive abnormal returns on a risk-adjusted basis. d. If a portfolio manager does not have any superior analysts, he/she should consider investing funds in an index fund. e. If a portfolio manager has some superior analytical skills, they should be encouraged to concentrate in second tier stocks which have liquidity but may be neglected.

ANSWER: b 111. The results of studies that have looked at the relationship between PEG ratios and subsequent stock returns find a. an inverse relationship, with annual rebalancing. b. no relationship, with monthly or quarterly rebalancing. c. an inverse relationship, with monthly or quarterly rebalancing. d. a direct relationship, with monthly or quarterly rebalancing. e. a direct relationship with annual rebalancing.

ANSWER: c 112. Fama and French examined the relationship between the Book Value to Market Value ratio and average stock returns and found a. no evidence of a relationship for U.S. stocks. b. evidence of a negative relationship in U.S. stocks only. c. evidence of a positive relationship for Japanese stocks only. d. evidence of a negative relationship for U.S. and Japanese stocks. e. evidence of a positive relationship for U.S. and Japanese stocks.

ANSWER: e

richard@qwconsultancy.com

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113. Investigators have tested the strong form EMH by examining the performance of the following type of investor: a. corporate insiders. b. stock exchange specialists. c. security analysts. d. professional money managers. e. All of these are correct.

ANSWER: e 114. Studies of the relationship between P/E ratios and stock returns have found that a. low P/E stocks of large cap stocks outperformed low P/E stocks of small cap stocks. b. low P/E stocks of small cap stocks outperformed high P/E stocks of large cap stocks. c. high P/E stocks of large cap stocks outperformed low P/E stocks of small cap stocks. d. high P/E stocks of large cap stocks outperformed high P/E stocks of small cap stocks. e. low P/E stocks of small cap stocks equaled the performance high P/E stocks of large cap stocks.

ANSWER: b 115. Tests of the efficient market hypothesis (EMH) are sometimes based on examining its abnormal rate of return. The abnormal rate of return is calculated by a. subtracting the expected rate of return from the actual return, where the expected return is based on the stock's beta and the CAPM. b. subtracting the actual rate of return from the expected return, where the expected return is based on the stock's beta and the CAPM. c. subtracting the expected rate of return from the actual return, where the expected return is based on the stock's projected dividend yields. d. subtracting the expected rate of return from the actual return, where the expected return is based on the stock's projected dividend yields. e. adding the expected rate of return to the actual return, where the expected return is based on the stock's projected dividend yields.

ANSWER: a 116. Which of the following ratios is the most commonly used ratio for predicting the performance of a growth company? a. PE ratio b. PG ratio c. PEG ratio d. MV/BV ratio e. BV/MV ratio ANSWER: c 117. Technical analysis differs from fundamental analysis in that a. technical analysts contend that in-depth assessments of basic aggregate market, industry, and company performance is necessary; past price movements indicate future price movements. b. technical analysts believe the market value of common stocks is determined by the interaction of supply and demand. richard@qwconsultancy.com

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c. technical analysts argue that the market constantly weighs rational and irrational factors and that both of these affect price. d. technical analysts depend far more heavily on objective, data-based approaches than the fundamentalists do. e. technical analysts hold that the price of a security is determined by an expected return risk.

ANSWER: b 118. Which of the following is NOT considered an assumption of technical analysis? a. Market value is determined solely by supply and demand. b. Supply and demand are governed by both rational and irrational factors. c. Security prices tend to move in trends that persist for an appreciable length of time. d. Stock prices follow a random walk. e. Changes in trend are caused by the shifts in supply and demand relationships.

ANSWER: d 119. For technical trading rules to generate returns that are superior to a buy-and-hold strategy, net of transaction costs, the market would have to be a. rising. b. falling. c. inefficient. d. overvalued. e. undervalued.

ANSWER: c 120. An advantage of technical analysis over fundamental analysis is that technical analysis a. has an increased amount of data that allows the analyst to process the information. b. can more thoroughly investigate accounting information. c. adjusts for differences in GAAP accounting procedures across the industry. d. can capture non-quantifiable variables such as psychological factors. e. can capture variables such as macroeconomic factors.

ANSWER: d 121. Which of the following is NOT an advantage of technical analysis identified by technicians? a. Fundamental analysis depends heavily on financial accounting statements. b. The majority of investors cannot consistently process new information correctly. c. Fundamental analysis may not time the investment properly when trading under- or overvalued securities. d. The majority of investors cannot process new information quickly enough. e. All of these are correct.

ANSWER: e 122. The following are classified as contrary trading rules EXCEPT a. odd lot short sales. b. investment advisory opinions. c. relative OTC volume. richard@qwconsultancy.com

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d. CBOE put/call ratio. e. confidence index.

ANSWER: e 123. According to contrary opinion technicians, the ratio of mutual funds cash to total assets ____ near troughs in the market cycle and ____ near peaks. a. levels out, spikes b. remains low, remains high c. is published near, is not published d. increases, decreases e. decreases, increases ANSWER: d 124. The ratio of OTC volume versus NYSE volume is a measure of ____. This ratio typically ____ at a market ____. a. speculative activity, bottoms, peak. b. hedging activity, bottoms, peak. c. speculative activity, peaks, peak d. speculative activity, bottoms, bottoms. e. hedging activity, peaks, peak.

ANSWER: c 125. A technical analyst might consider the following a bearish signal. a. The percentage of speculators in stock index futures exceeds 70 percent. b. The percentage of speculators in stock index futures exceeds 30 percent. c. The percentage of speculators in stock index futures falls to 30 percent. d. The percentage of speculators in stock index futures remains flat. e. The percentage of speculators in stock index futures exceeds 20 percent.

ANSWER: a 126. Which of the following is NOT a technical trading rule category? a. contrary-opinion rules b. follow the smart money rules c. anti-fundamental and anti-portfolio approaches d. stock price and volume techniques e. other market environment indicators ANSWER: c 127. Which of the following is NOT considered a contrary trading rule? a. futures traders bullish on stock index futures b. investment advisory opinions c. credit balance in brokerage accounts d. CBOE put/call ratio e. confidence index ANSWER: e richard@qwconsultancy.com

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128. According to technical analysts, which mutual fund cash position guides 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. A low cash ratio position is a bearish indicator.

ANSWER: b 129. Technicians using the confidence index published by Barron’s to make investment decisions a. believe the ratio is a bullish indicator because during periods of high confidence investors will invest in higher quality bonds. b. believe the ratio is a bearish indicator because during periods of high confidence investors will invest in higher quality bonds. c. believe the ratio is a bearish indicator because during periods of high confidence investors will invest in lower quality bonds. d. believe the ratio is a bullish indicator because during periods of high confidence investors will invest in lower quality bonds. e. believe the ratio is a bullish indicator because during periods of high confidence investors will not invest in bonds.

ANSWER: d 130. A contrary opinion technician would buy stock when mutual funds a. are at the market peak. b. are fully invested. c. have a cash ratio approaching 4 percent. d. have a cash ratio approaching 7 percent. e. have a cash ratio approaching 11 percent.

ANSWER: e 131. A technical analyst would consider a put call ratio of ____ as a bearish indicator. a. 30 percent b. 40 percent c. 50 percent d. 60 percent e. 70 percent ANSWER: a 132. A narrowing of the T-bill-Eurodollar is a ____ signal, because ____. a. bearish, it signals falling investor confidence b. bullish, it signals rising investor confidence c. bearish, it signals a flight to quality d. bullish, it signals a flight to quality e. neutral, it signals no change in investor confidence ANSWER: b richard@qwconsultancy.com

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133. Analysts following what the smart, sophisticated investor is doing would examine a. mutual fund cash positions. b. debit balances in brokerage houses. c. investment advisory opinions. d. breadth of market. e. stocks above their 200-day moving average.

ANSWER: b 134. Indicators that tell what smart investors are doing include a. the put/call ratio. b. mutual fund cash position. c. the Dow theory. d. short sales by specialists. e. head and tail indicator.

ANSWER: d 135. The confidence index published by Barron's is the ratio of the average yield on 10 top-grade corporate bonds to the a. average yield on 30 blue chip corporate stocks. b. average yield on 40 convertible corporate bonds. c. yield on U.S. Treasury bills. d. yield on the Dow Jones average of 40 bonds. e. yield on the Shearson Lehman Hutton Corporate Bond Index.

ANSWER: d 136. The Dow Theory describes stock prices as moving in trends analogous to the movement of water. Which of the following statements is NOT true? a. Major trends resemble tides. b. Intermediate trends resemble waves. c. Short-run movements are like ripples. d. Waves are the most important. e. There are three types of price movement over time.

ANSWER: d 137. According to Dow Theory, a major market a. advance has few price fluctuations indicate a new upward trend. b. advance does not go straight up, because some investors will take profits. c. decline is easier to predict than an advance. d. decline typically has a higher level of volume than a major market advance. e. advance goes straight up because most investors ride momentum.

ANSWER: b 138. A type of charting that normally disregards both time and volume is the a. bar chart. richard@qwconsultancy.com

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b. point and figure chart. c. pie chart. d. histogram. e. linear regression graph.

ANSWER: b 139. A price range at which technicians would expect a substantial increase in the demand for a stock is called a. demand threshold. b. resistance level. c. support level. d. resistance limit. e. technical restraint.

ANSWER: c 140. A price range at which technicians feel that a significant increase in the price of the stock will be resisted is referred to as a. supply threshold. b. support level. c. short interest level. d. advancement level. e. resistance level.

ANSWER: e 141. Advances and declines are associated with market a. efficiency. b. position. c. diffusion. d. depth. e. breadth.

ANSWER: e 142. To a technician that believed in the importance of volume, a bullish signal would occur when a. prices increase on light volume. b. prices decrease on light volume. c. prices increase on heavy volume. d. prices decrease on heavy volume. e. prices increase on declining volume.

ANSWER: c 143. A chart used to show only significant price changes, regardless of their timing, is the a. candlestick chart. b. multiple indicator chart. c. bar chart. d. point-and-figure chart. richard@qwconsultancy.com

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e. point-and-click chart.

ANSWER: d 144. A divergence between an increase in a stock market series and the rest of the stock market can be detected using a. debit balances in brokerage accounts. b. short interest. c. the advance-decline line. d. confidence index. e. investor sentiment.

ANSWER: c 145. When the 50-day moving average crosses the 200-day moving average from ____ on ____ volume, this would be a ____ signal. a. above, low, bullish. b. below, high, bearish. c. below, low, bullish. d. above, high, bullish. e. below, high, bullish.

ANSWER: e 146. When ____ of stocks are trading above the 200-day moving average, the market is considered ____ and subject to a ____. a. 20 percent, oversold, negative correction b. 80 percent, overbought, negative correction c. 80 percent, oversold, positive correction d. 20 percent, overbought, positive correction e. 0 percent, overbought, positive correction ANSWER: b 147. When the 50-day moving average crosses the 200-day moving average from below on good volume, a. this would be a bearish indicator because it signals a change to a negative trend. b. this would be a bullish indicator because it signals a change to a negative trend. c. this would be a bullish indicator because it signals a change to a positive trend. d. this would be a bearish indicator because it signals a change to a positive trend. e. this would be a neutral indicator because it signals a change to a trend.

ANSWER: c 148. Technicians believe that an industry or stock that is outperforming the market will tend to a. continue to outperform the market. b. return to normal. c. reverse trend. d. meet a resistance level. e. form head and shoulder patterns. richard@qwconsultancy.com

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ANSWER: a 149. The ratio of the price of a stock or an industry group to the value of the market index is called the a. company to market ratio. b. composite stock ratio. c. relational proportion ratio. d. stock to market ratio. e. relative strength ratio.

ANSWER: e 150. ____ charts show time series of price, while ____ charts only reflect change regardless of time. a. Relative strength, bar b. Relative strength, advance/decline c. Point and bar, figure d. Bar, point and figure e. Bar, multiple indicator ANSWER: d 151. Technicians believe that when the relative strength index is stable or ____ during a ____ market, the stock should do well during a ____ market. a. decreases, bull, bear b. increases, bear, bull c. decreases, bear, bull d. increases, bull, bear e. crosses, bull, bear ANSWER: b 152. The relative strength index for a stock is equal to the price of the stock a. divided by the value of a stock-market index. b. multiplied by the value of a stock-market index. c. divided by the value of a group of industry stocks. d. multiplied by an industry peer group and divided by a market index. e. divided by the 30-day moving average of prior stock movements.

ANSWER: a 153. The market is considered to be overbought and subject to a negative correction when more than a. 60 percent of the stocks are selling above their 90-day average. b. 70 percent of the stocks are selling above their 100-day average. c. 80 percent of the stocks are selling above their 200-day average. d. 70 percent of the stocks are selling above their 150-day average. e. 90 percent of the stocks are selling above their 150-day average.

ANSWER: c 154. A technical analyst would consider the following a strong buy signal: richard@qwconsultancy.com

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a. a graph of declining prices ends in a trough followed by an upward trend that breaks through the declining trend channel. b. a graph of increasing prices ends in a peak followed by a downward trend that breaks through the rising trend channel. c. a graph begins to trade in a flat trend after it breaks out of its rising trend channel. d. a graph begins to trade in a declining trend after it breaks out of its flat trend channel. e. a graph begins to trade in a flat trend with high volume.

ANSWER: a 155. Based on the daily closings for the Dow Jones Industrial Average given in the table below, calculate a four-day moving average for Day 4.

Day 1 2 3 4

Price 10500 10025 10125 10210

a. 10,500 b. 10,210 c. 10,215 d. 10,000 e. 11,000 ANSWER: c 156. Given the following three days of data, compute the daily net advance-decline line and cumulative advance-decline line for each day. What is the final value at the end of the third day?

Issues Traded 8540 7535 6545

Day 1 2 3

Advances 6500 5500 4554

Declines 1500 1230 1324

Unchanged 540 805 667

a. 5,000 b. 9,270 c. 12,500 d. 13,250 e. 11,667 ANSWER: c Exhibit 5.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Daily closings for the Dow Jones Industrial Average are given in the table below.

Day 1

Price 9867

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2 3 4 5 6

10025 10524 10210 10104 9925

157. Refer to Exhibit 5.7. Calculate a 5-day moving average for day 6. a. 10,102.3 b. 9905.6 c. 9875.4 d. 10,215.7 e. 10,157.6 ANSWER: e 158. Refer to Exhibit 5.7. Calculate a four-day moving average for day 5. a. 10,102.3 b. 9905.6 c. 9875.4 d. 10,215.7 e. 10,157.6 ANSWER: d Exhibit 5.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The table below provides five days of trade data.

Day 1 2 3 4 5

Issues Traded 22456 23013 23124 22678 21897

Advances 15698 14560 10324 9867 8678

Declines 6158 8210 12678 11567 12561

Unchanged 600 243 122 1244 658

159. Refer to Exhibit 5.8. Calculate the net advance-decline for day 5. a. −3,883 b. 9,540 c. −2,354 d. 13,356 e. 7,953 ANSWER: a 160. Refer to Exhibit 5.8. Calculate the final value of the cumulative advance-decline line at the end of the fifth day. richard@qwconsultancy.com

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a. −3,883 b. 9,540 c. −2,354 d. 13,356 e. 7,953 ANSWER: e 161. Daily closings for the Dow Jones Industrial Average are provided in the table below.

Day 1 2 3 4 5 6

DJIA 13,500 13,395 13,505 13,750 13,820 13,910

Calculate a five-day moving average for day 6. a. 11,397 b. 13,565 c. 13,594 d. 13,647 e. 13,676 ANSWER: e 162. Calculate the net advance-decline for day 5 using the trade data in the table below.

Day 1 2 3 4 5

Issues Traded 32456 43013 33124 32678 31897

Advances 25698 24560 20324 19867 18678

Declines 6058 17210 12378 11367 12278

Unchanged 700 1243 422 1444 941

a. −5,459 b. 941 c. 5,459 d. 6,400 e. 7,853 ANSWER: d

Chapter 06 - An Introduction to Portfolio Management True / False 1. A good portfolio is a collection of individually good assets. richard@qwconsultancy.com

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a. True b. False ANSWER: False 2. Risk is defined as the uncertainty of future outcomes. a. True b. False ANSWER: True 3. Prior to the work of Markowitz in the late 1950's and early 1960's, portfolio managers did NOT have a well-developed, quantitative means of measuring risk. a. True b. False ANSWER: True 4. A basic assumption of the Markowitz model is that investors base decisions solely on expected return and risk. a. True b. False ANSWER: True 5. Markowitz assumed that, given an expected return, investors prefer to minimize risk. a. True b. False ANSWER: True 6. The correlation coefficient and the covariance are measures of the extent to which two random variables move together. a. True b. False ANSWER: True 7. For a two stock portfolio containing Stocks i and j, the correlation coefficient of returns (rij) is equal to the square root of the covariance (covij). a. True b. False ANSWER: False 8. If the covariance of two stocks is positive, these stocks tend to move together over time. a. True b. False ANSWER: True 9. The expected return and standard deviation of a portfolio of risky assets is equal to the weighted average of the individual asset's expected returns and standard deviation. richard@qwconsultancy.com

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a. True b. False ANSWER: False 10. The combination of two assets that are completely negatively correlated provides maximum returns. a. True b. False ANSWER: False 11. Increasing the correlation among assets in a portfolio results in an increase in the standard deviation of the portfolio. a. True b. False ANSWER: True 12. Combining assets that are NOT perfectly correlated does affect both the expected return of the portfolio as well as the risk of the portfolio. a. True b. False ANSWER: False 13. In a three-asset portfolio, the standard deviation of the portfolio is one-third of the square root of the sum of the individual standard deviations. a. True b. False ANSWER: False 14. As the number of risky assets in a portfolio increases, the total risk of the portfolio decreases. a. True b. False ANSWER: True 15. Assuming that everyone agrees on the efficient frontier (given a set of costs), there would be consensus that the optimal portfolio on the frontier would be where the ratio of return per unit of risk was greatest. a. True b. False ANSWER: False 16. An investor is risk neutral if she chooses the asset with lower risk given a choice of several assets with equal returns. a. True b. False ANSWER: False

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17. A portfolio is efficient if no other asset or portfolios offer higher expected return with the same (or lower) risk or lower risk with the same (or higher) expected return. a. True b. False ANSWER: True 18. A measure that only considers deviations above the mean is semi-variance. a. True b. False ANSWER: False 19. The set of portfolios with the maximum rate of return for every given risk level is known as the optimal frontier. a. True b. False ANSWER: False 20. Investors choose a portfolio on the efficient frontier based on their utility functions that reflect their attitudes towards risk. a. True b. False ANSWER: True 21. One of the assumptions of capital market theory is that investors can borrow or lend at the riskfree rate. a. True b. False ANSWER: True 22. Because many of the assumptions made by the capital market theory are unrealistic, the theory is NOT applicable in the real world. a. True b. False ANSWER: False 23. A risk-free asset is one in which the return is completely guaranteed; there is no uncertainty. a. True b. False ANSWER: True 24. The market portfolio consists of all risky assets. a. True b. False ANSWER: True

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25. The introduction of lending and borrowing severely limits the available risk/return opportunities. a. True b. False ANSWER: False 26. The capital market line is the tangent line between the risk-free rate of return and the efficient frontier. a. True b. False ANSWER: True 27. The portfolios on the capital market line are combinations of the risk-free asset and the market portfolio. a. True b. False ANSWER: True 28. If you borrow money at the RFR and invest the money in the market portfolio, the rate of return on your portfolio will be higher than the market rate of return. a. True b. False ANSWER: True 29. Studies have shown that a well-diversified investor needs as few as five stocks. a. True b. False ANSWER: False Multiple Choice 30. When individuals evaluate their portfolios, they should evaluate a. all the U.S. and non-U.S. stocks. b. all marketable securities. c. all marketable securities and other liquid assets. d. all assets. e. all assets and liabilities.

ANSWER: e 31. The probability of an adverse outcome is a definition of a. statistics. b. variance. c. random. d. risk. e. semi-variance above the mean.

ANSWER: d richard@qwconsultancy.com

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32. The Markowitz model is based on several assumptions regarding investor behavior. Which of the following is NOT such any assumption? a. Investors consider each investment alternative as being represented by a probability distribution of expected returns over some holding period. b. Investors maximize one-period expected utility. c. Investors estimate the risk of the portfolio on the basis of the variability of expected returns. d. Investors base decisions solely on expected return and risk. e. None of these are correct (that is, all are assumptions of the Markowitz model).

ANSWER: e 33. All of the following are assumptions of the Markowitz model EXCEPT a. risk is measured based on the variability of returns. b. investors maximize one-period expected utility. c. investors' utility curves demonstrate properties of diminishing marginal utility of wealth. d. investors base decisions solely on expected return and time. e. there are no tax costs involved.

ANSWER: d 34. Markowitz believes that any asset or portfolio of assets can be described by ____ parameter(s). a. one b. two c. three d. four e. five ANSWER: b 35. Semivariance, when applied to portfolio theory, is concerned with a. the square root of deviations from the mean. b. all deviations below the mean. c. all deviations above the mean. d. all deviations. e. the summation of the squared deviations from the mean.

ANSWER: b 36. What is the expected return of the three-stock portfolio described below?

Common Stock Ando Inc. Bee Co. Cool Inc.

Market Value 95,000 32,000 65,000

Expected Return 12.0% 8.75% 17.7%

a. 18.45% b. 12.82% c. 13.38% richard@qwconsultancy.com

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d. 15.27% e. 16.67% ANSWER: c 37. What is the expected return of the three-stock portfolio described below?

Common Stock Xerox Yelcon Zwiebal

Market Value 125,000 250,000 175,000

Expected Return 8% 25% 16%

a. 18.27% b. 14.33% c. 16.33% d. 12.72% e. 16.45% ANSWER: a 38. What is the expected return of the three-stock portfolio described below?

Common Stock Alko Inc. Belmont Co. Cardo Inc.

Market Value 25,000 100,000 75,000

Expected Return 38% 10% 16%

a. 21.33% b. 12.50% c. 32.00% d. 15.75% e. 16.80% ANSWER: d 39. 16.99%What is the expected return of the three-stock portfolio described below?

Common Stock Delton Inc. Efley Co. Grippon Inc.

Market Value 50,000 40,000 60,000

Expected Return 10% 11% 16%

a. 14.89% b. 16.22% c. 12.66% d. 13.85% e. 16.99% ANSWER: c 40. What is the expected return of the three-stock portfolio described below? richard@qwconsultancy.com

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Common Stock Lupko Inc. Mackey Co. Nippon Inc.

Market Value 50,000 25,000 75,000

Expected Return 13% 9% 14%

a. 12.04% b. 12.83% c. 13.07% d. 15.89% e. 17.91% ANSWER: b Exhibit 6.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 10% E(RB) = 15% (A) = 8% (B) = 9.5% WA = 0.25 WB = 0.75 CovA,B = 0.006

41. Refer to Exhibit 6.1. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 8.79% b. 12.5% c. 13.75% d. 7.72% e. 12% ANSWER: c 42. a. b. c. d. e.

ANSWER: a Exhibit 6.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 25% (A) = 18%

E(RB) = 15% (B) = 11%

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WA = 0.75 WB = 0.25 COVA,B = −0.0009

43. Refer to Exhibit 6.2. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 18.64% b. 20.0% c. 22.5% d. 13.65% e. 11% ANSWER: c 44. Refer to Exhibit 6.2. What is the standard deviation of this portfolio? a. 5.45% b. 18.64% c. 20.0% d. 22.5% e. 13.65% ANSWER: e Exhibit 6.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 9% E(RB) = 11% (A) = 4% (B) = 6% WA = 0.4 WB = 0.6 COVA,B = 0.0011

45. Refer to Exhibit 6.3. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 8.95% b. 9.30% c. 9.95% d. 10.20% e. 10.70% ANSWER: d 46. Refer to Exhibit 6.3. What is the standard deviation of this portfolio? a. 3.68% b. 4.56% c. 4.99% richard@qwconsultancy.com

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d. 5.16% e. 6.02% ANSWER: b Exhibit 6.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 10% E(RB) = 8% (A) = 6% (B) = 5% WA = 0.3 WB = 0.7 COVA,B = 0.0008

47. Refer to Exhibit 6.4. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 8.6% b. 8.1% c. 9.3% d. 10.2% e. 11.6% ANSWER: a 48. a. b. c. d. e.

ANSWER: e Exhibit 6.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 8% E(RB) = 15% (A) = 7% (B) = 10% WA = 0.4 WB = 0.6 COVA,B = 0.0006

49. Refer to Exhibit 6.5. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 8.0% b. 12.2% richard@qwconsultancy.com

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c. 7.4% d. 9.1% e. 11.6% ANSWER: b 50. Refer to Exhibit 6.5. What is the standard deviation of this portfolio? a. 3.89% b. 4.61% c. 5.02% d. 6.83% e. 6.09% ANSWER: d Exhibit 6.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 16% E(RB) = 10% (A) = 9% (B) = 7% WA = 0.5 WB = 0.5 COVA,B = 0.0009

51. Refer to Exhibit 6.6. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 10.6% b. 10.2% c. 13.0% d. 11.9% e. 14.0% ANSWER: c 52. Refer to Exhibit 6.6. What is the standard deviation of this portfolio? a. 6.08% b. 5.89% c. 7.06% d. 6.54% e. 7.26% ANSWER: a Exhibit 6.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 7%

E(RB) = 9%

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(A) = 6% (B) = 5% WA = 0.6 WB = 0.4 COVA,B = 0.0014

53. Refer to Exhibit 6.7. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 5.8% b. 6.1% c. 6.9% d. 7.8% e. 8.9% ANSWER: d 54. a. b. c. d. e.

ANSWER: a Exhibit 6.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 10% E(RB) = 14% (A) = 7% (B) = 8% WA = 0.7 WB = 0.3 COVA,B = 0.0013

55. Refer to Exhibit 6.8. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 6.4% b. 9.1% c. 10.2% d. 10.8% e. 11.2% ANSWER: e 56. Refer to Exhibit 6.8. What is the standard deviation of this portfolio? a. 4.51% b. 5.94% richard@qwconsultancy.com

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c. 6.75% d. 7.09% e. 8.62% ANSWER: b Exhibit 6.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 18% E(RB) = 13% (A) = 7% (B) = 6% WA = 0.3 WB = 0.7 COVA,B = 0.0011

57. Refer to Exhibit 6.9. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 10.10% b. 11.60% c. 13.88% d. 14.50% e. 15.37% ANSWER: d 58. Refer to Exhibit 6.9. What is the standard deviation of this portfolio? a. 5.16% b. 5.89% c. 6.11% d. 6.57% e. 7.02% ANSWER: a Exhibit 6.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A)

Asset (B)

E(RA) = 16% E(RB) = 14% (A) = 3% (B) = 8% WA = 0.5 WB = 0.5 COVA,B = 0.0014

59. Refer to Exhibit 6.10. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 11% richard@qwconsultancy.com

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b. 12% c. 13% d. 14% e. 15% ANSWER: e 60. a. b. c. d. e.

ANSWER: c Exhibit 6.11 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset 1

Asset 2

E(R1) = 0.28 E(1) = 0.15 W1 = 0.42

E(R2) = 0.12 E(2) = 0.11 W2 = 0.58 r1,2 = 0.7

61. Refer to Exhibit 6.11. Calculate the expected return of the two-stock portfolio. a. 0.107 b. 0.1367 c. 0.1169 d. 0.1872 e. 0.20 ANSWER: d 62. Refer to Exhibit 6.11. Calculate the expected standard deviation of the two-stock portfolio. a. 0.1367 b. 0.1872 c. 0.1169 d. 0.20 e. 0.3950 ANSWER: c Exhibit 6.12 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset 1 Asset 2 E(R1) = .12 E(1) = .04

E(R2) = .16 E(2) = .06

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63. Refer to Exhibit 6.12. Calculate the expected return and expected standard deviation of a twostock portfolio when r1,2 = −.60 and w1 = .75. a. .13 and .0024 b. .13 and .0455 c. .12 and .0585 d. .12 and .5585 e. .13 and .6758 ANSWER: a Exhibit 6.12 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset 1 Asset 2 E(R1) = .12 E(1) = .04

E(R2) = .16 E(2) = .06

64. Refer to Exhibit 6.12. Calculate the expected returns and expected standard deviations of a twostock portfolio when r1,2 = .80 and w1 = .60. a. .144 and .0002 b. .144 and .0018 c. .136 and .0045 d. .136 and .0455 e. .136 and .4554 ANSWER: d 65. Consider two securities, A and B. Security A and B have a correlation coefficient of 0.65. Security A has standard deviation of 12, and security B has standard deviation of 25. Calculate the covariance between these two securities. a. 300 b. 461.54 c. 261.54 d. 195 e. 200 ANSWER: d 66. Calculate the expected return for a three-asset portfolio with the following Asset A B C

Exp. Ret. 0.0675 0.1235 0.1425

Std. Dev 0.12 0.1675 0.1835

Weight 0.25 0.35 0.40

a. 11.71 percent richard@qwconsultancy.com

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b. 11.12 percent c. 15.70 percent d. 14.25 percent e. 6.75 percent ANSWER: a 67. Given the following weights and expected security returns, calculate the expected return for the portfolio.

Weight .20 .25 .30 .25

Expected Return .06 .08 .10 .12

a. 0.085 b. 0.090 c. 0.092 d. 0.097 e. 0.099 ANSWER: c Exhibit 6.13 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A financial analyst covering Magnum Oil has determined the following four possible returns given four different states of the economy over the next period.

Probability Return 0.10 −.20 0.25 −.05 0.40 0.15 0.25 0.30

68. Refer to Exhibit 6.13. Calculate the expected return for Magnum Oil. a. 5.0 percent b. 10.3 percent c. 13.7 percent d. 17.5 percent e. 20.0 percent ANSWER: b 69. a. b. c. d. richard@qwconsultancy.com

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e.

ANSWER: c Exhibit 6.14 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stocks A and B have a correlation coefficient of −0.8. The stocks' expected returns and standard deviations are in the table below. A portfolio consisting of 40% of stock A and 60% of stock B is constructed.

Stock A B

Expected Return 20% 15%

Standard Deviation 25% 19%

70. Refer to Exhibit 6.14. What is the expected return of the stock A and B portfolio? a. 17.0% b. 17.5% c. 18.0% d. 18.5% e. 19.0% ANSWER: a 71. Refer to Exhibit 6.14. What is the standard deviation of the stock A and B portfolio? a. 0.0% b. 0.5% c. 4.1% d. 6.9% e. 20.3% ANSWER: d 72. a. b. c. d. e.

ANSWER: b 73. What is the standard deviation of an equally weighted portfolio of two stocks with a covariance of 0.009, if the standard deviation of the first stock is 15% and the standard deviation of the second stock is 20%? a. 2.0% b. 2.1% c. 7.8% d. 14.2% richard@qwconsultancy.com

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e. 14.7% ANSWER: d Exhibit 6.15 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A) Asset (B) E(RA) = 14% E(RB) = 16% (A) = 13% (B) = 18% WA = 0.4 WB = 0.6 COVA,B = 0.0024

74. Refer to Exhibit 6.15. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 13.8% b. 14.6% c. 15.0% d. 15.2% e. 16.8% ANSWER: d 75. a. b. c. d. e.

ANSWER: b Exhibit 6.16 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Based on the economic outlook for the industry, a financial analyst covering Top Choice Corporation has determined the following three possible returns given three different states of the economy over the next period.

Probability 0.25 0.50 0.25

Return 0.02 0.14 0.30

76. Refer to Exhibit 6.16. What is the expected return for Top Choice Corporation? a. 5.2 percent b. 10.4 percent c. 13.7 percent richard@qwconsultancy.com

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d. 15.0 percent e. 17.6 percent ANSWER: d 77. Refer to Exhibit 6.16. What is the standard deviation for Top Choice Corporation? a. 0.1 percent b. 6.3 percent c. 7.9 percent d. 9.4 percent e. 12.1 percent ANSWER: c 78. The purpose of calculating the covariance between two stocks is to provide a(n) ____ measure of their movement together. a. absolute b. relative c. indexed d. loglinear e. squared ANSWER: a 79. In a two-stock portfolio, if the correlation coefficient between two stocks were to decrease over time, everything else remaining constant, the portfolio's risk would a. decrease. b. remain constant. c. increase. d. fluctuate positively and negatively. e. be a negative value.

ANSWER: a 80. All of the following are common risk measurements EXCEPT a. standard deviation. b. variance. c. semivariance. d. covariance. e. range of returns.

ANSWER: d 81. Between 1990 and 2000, the standard deviation of the returns for the NIKKEI and the DJIA indexes were 0.18 and 0.16, respectively, and the covariance of these index returns was 0.003. What was the correlation coefficient between the two market indicators? a. 9.6 b. 0.0187 c. 0.1042 d. 0.0166 richard@qwconsultancy.com

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e. 0.343 ANSWER: c 82. Between 1994 and 2004, the standard deviation of the returns for the S&P 500 and the NYSE indexes were 0.27 and 0.14, respectively, and the covariance of these index returns was 0.03. What was the correlation coefficient between the two market indicators? a. 1.26 b. 0.7937 c. 0.2142 d. 0.1111 e. 0.44 ANSWER: b 83. Between 1980 and 1990, the standard deviation of the returns for the NIKKEI and the DJIA indexes were 0.19 and 0.06, respectively, and the covariance of these index returns was 0.0014. What was the correlation coefficient between the two market indicators? a. 8.1428 b. 0.0233 c. 0.0073 d. 0.2514 e. 0.1228 ANSWER: e 84. Between 1975 and 1985, the standard deviation of the returns for the NYSE and the S&P 500 indexes were 0.06 and 0.07, respectively, and the covariance of these index returns was 0.0008. What was the correlation coefficient between the two market indicators? a. .1525 b. .1388 c. .1458 d. .1622 e. .1064 ANSWER: c 85. Between 1986 and 1996, the standard deviation of the returns for the NYSE and the DJIA indexes were 0.10 and 0.09, respectively, and the covariance of these index returns was 0.0009. What was the correlation coefficient between the two market indicators? a. .1000 b. .1100 c. .1258 d. .1322 e. .1164 ANSWER: a 86. Between 1980 and 2000, the standard deviation of the returns for the NIKKEI and the DJIA indexes were 0.08 and 0.10, respectively, and the covariance of these index returns was 0.0007. What was the correlation coefficient between the two market indicators? richard@qwconsultancy.com

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a. .0906 b. .0985 c. .0796 d. .0875 e. .0654 ANSWER: d 87. Which of the following statements about the correlation coefficient is FALSE? a. The values range between −1 to +1. b. A value of +1 implies that the returns for the two stocks move together in a completely linear manner. c. A value of −1 implies that the returns move in a completely opposite direction. d. A value of zero means that the returns are independent. e. A value of zero means that the returns had no linear relationship.

ANSWER: d 88. You are given a two-asset portfolio with a fixed correlation coefficient. If the weights of the two assets are varied the expected portfolio return would be ____ and the expected portfolio standard deviation would be ____. a. nonlinear, elliptical b. nonlinear, circular c. linear, elliptical d. linear, circular e. circular, elliptical ANSWER: c 89. Given a portfolio of stocks, the envelope curve containing the set of best possible combinations is known as the a. efficient portfolio. b. utility curve. c. efficient frontier. d. last frontier. e. capital asset pricing model.

ANSWER: c 90. If equal risk is added moving along the envelope curve containing the best possible combinations the return will a. decrease at an increasing rate. b. decrease at a decreasing rate. c. increase at an increasing rate. d. increase at a decreasing rate. e. remain constant.

ANSWER: d 91. A portfolio is considered to be efficient if richard@qwconsultancy.com

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a. no other portfolio offers higher expected returns with the same risk. b. no other portfolio offers lower risk with the same expected return. c. there is no portfolio with a higher return. d. it is the risk-minimizing portfolio. e. it is the risk-maximizing portfolio.

ANSWER: d 92. The optimal portfolio is identified at the point of tangency between the efficient frontier and the a. highest possible utility curve. b. lowest possible utility curve. c. middle range utility curve. d. steepest utility curve. e. flattest utility curve.

ANSWER: a 93. An individual investor's utility curves specify the tradeoffs he or she is willing to make between a. high risk and low risk assets. b. high return and low return assets. c. covariance and correlation. d. return and risk. e. efficient portfolios.

ANSWER: d 94. As the correlation coefficient between two assets decreases, the shape of the efficient frontier a. approaches a horizontal straight line. b. bends out. c. bends in. d. approaches a vertical straight line. e. shifts to the right.

ANSWER: c 95. A portfolio manager is considering adding another security to his portfolio. The correlations of the five alternatives available are listed below. Which security would enable the highest level of risk diversification? a. 0.0 b. 0.25 c. − 0.25 d. − 0.75 e. 1.0 ANSWER: d 96. A positive covariance between two variables indicates that a. the two variables move in different directions. b. the two variables move in the same direction. c. the two variables are low risk. richard@qwconsultancy.com

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d. the two variables are high risk. e. the two variables are risk free.

ANSWER: b 97. The slope of the efficient frontier is calculated as follows a. E(Rportfolio)/E(portfolio) b. E(portfolio)/ E(Rportfolio) c. E(Rportfolio)/E(portfolio) d. E(portfolio)/E(Rportfolio) e. None of the above ANSWER: c 98. The most important criteria when adding new investments to a portfolio is the a. expected return of the new investment. b. standard deviation of the new investment. c. correlation of the new investment with the portfolio. d. selection of the risk-free asset. e. variance of the risk-free asset.

ANSWER: c 99. The slope of the utility curves for a strongly risk-averse investor, relative to the slope of the utility curves for a less risk-averse investor, will a. be steeper. b. be flatter. c. be vertical. d. be horizontal. e. not change.

ANSWER: a 100. Which of the following is NOT 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.

ANSWER: d 101. The rate of return on a risk-free asset should equal the a. long-run real growth rate of the economy. b. long-run nominal growth rate of the economy. c. short-run real growth rate of the economy. d. short-run nominal growth rate of the economy. e. prime rate of interest.

ANSWER: a richard@qwconsultancy.com

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102. What does WRF = - 0.50 mean? a. The investor can borrow money at the risk-free rate. b. The investor can lend money at the current market rate. c. The investor can borrow money at the current market rate. d. The investor can borrow money at the prime rate of interest. e. The investor can lend money at the prime rate of interest.

ANSWER: a 103. The market portfolio consists of all a. New York Stock Exchange stocks. b. high grade stocks and bonds. c. stocks and bonds. d. U.S. and non-U.S. stocks and bonds. e. risky assets.

ANSWER: e 104. When identifying undervalued and overvalued assets, which of the following statements is FALSE? a. An asset is properly valued if its estimated rate of return is equal to its required rate of return. b. An asset is considered overvalued if its estimated rate of return is below its required rate of return. c. An asset is considered undervalued if its estimated rate of return is above its required rate of return. d. An asset is considered overvalued if its required rate of return is below its estimated rate of return. e. An asset is considered undervalued if its estimated rate of return is equal to its required rate of return.

ANSWER: d 105. All of the following questions remain to be answered in the real world EXCEPT a. What is a good proxy for the market portfolio? b. What happens when you cannot borrow or lend at the risk-free rate? c. How good is the capital asset model as a predictor? d. What is the beta of the market portfolio of risky assets? e. What is the stability of beta for individual stocks?

ANSWER: d 106. The correlation coefficient between the market return and a risk-free asset would a. be +. b. be −. c. be +1. d. be −1. e. be zero. richard@qwconsultancy.com

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ANSWER: e 107. The separation theorem divides decisions on ____ from decisions on ____. a. lending, borrowing b. risk, return c. investing, financing d. risky assets, risk free assets e. buying stocks, buying bonds ANSWER: c 108. As the number of securities in a portfolio increases, the amount of systematic risk a. remains constant. b. decreases. c. increases. d. changes. e. resets to zero.

ANSWER: a 109. Theoretically, the correlation coefficient between a completely diversified portfolio and the market portfolio should be a. −1.0. b. +1.0. c. 0.0. d. −0.5. e. +0.5.

ANSWER: b 110. All portfolios on the capital market line are a. perfectly positively correlated. b. perfectly negatively correlated. c. unique from each other. d. weakly correlated. e. unrelated except that they contain the risk-free asset.

ANSWER: a 111. Which of the following is NOT a relaxation of the assumptions for the CAPM? a. differential lending and borrowing rates b. a zero-beta model c. transaction costs d. taxes e. homogeneous expectations and fixed planning periods ANSWER: e 112. Which of the following would most closely resemble the true market portfolio? richard@qwconsultancy.com

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a. stocks b. stocks and bonds c. stocks, bonds, and foreign securities d. stocks, bonds, foreign securities, and options e. stocks, bonds, foreign securities options, and coins ANSWER: e 113. A completely diversified portfolio would have a correlation with the market portfolio that is a. equal to zero because it has only unsystematic risk. b. equal to one because it has only systematic risk. c. less than zero because it has only systematic risk. d. less than one because it has only unsystematic risk. e. less than one because it has only systematic risk.

ANSWER: b 114. All of the following are assumptions of the Capital Asset Pricing Model (CAPM) EXCEPT a. investors can borrow and lend any amount at the risk-free rate. b. investors all have homogeneous expectations regarding expected returns. c. investors can have different time horizons, daily, weekly, annual, or some other period. d. all investments are infinitely divisible. e. capital markets are in equilibrium.

ANSWER: c

Chapter 6 - Appendix A Multiple Choice Exhibit 6A.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The general equation for the weight of the first security to achieve the minimum variance (in a twostock portfolio) is given by: W1 = [E(2)2 − r1.2 E(1)E(2)]  [E(1)2 + E(2)2 − 2 r1.2E(1)E(2)]

1. Refer to Exhibit 6A.1. What weight of security 1 gives the minimum portfolio variance when r1.2 = .60, E(1) = .10 and E(2) = .16? a. .0244 b. .3679 c. .5697 d. .6309 e. .9756 ANSWER: e richard@qwconsultancy.com

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Chapter 6 - Appendix B Multiple Choice Exhibit 6B.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The general equation for the weight of the first security to achieve the minimum variance (in a twostock portfolio) is given by: W1 = [E(1)2 − r1.2 E(1) E(2)]  [E(1)2 + E(2)2 − 2 r1.2 E(1) E(2)]

1. Refer to Exhibit 6B.1. Show the minimum portfolio variance for a portfolio of two risky assets when r1.2 = −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 these are correct.

ANSWER: c 2. a. b. c. d. e.

ANSWER: d

Chapter 07 - Asset Pricing Models True / False 1. The capital asset pricing model (CAPM) extends capital market theory in a way that allows investors to evaluate the risk–return trade-off for both diversified portfolios and individual securities. a. True b. False ANSWER: True 2. Beta can be thought of as indexing the asset’s systematic risk to that of the market portfolio. a. True richard@qwconsultancy.com

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b. False ANSWER: True 3. Beta is a measure of unsystematic risk. a. True b. False ANSWER: False 4. CAPM states that only the overall market risk premium matters. a. True b. False ANSWER: True 5. The CAPM can also be illustrated as the security market line (SML). a. True b. False ANSWER: True 6. CML and SML measure total risk by the standard deviation of the investment. a. True b. False ANSWER: False 7. CML can be applied only to portfolio holdings that are already fully diversified, whereas the SML can be applied to any individual asset or collection of assets. a. True b. False ANSWER: True 8. Securities with returns that lie above the security market line are undervalued. a. True b. False ANSWER: True 9. Securities with returns that lie below the security market line are undervalued. a. True b. False ANSWER: False 10. Correlation of the market portfolio and the zero-beta portfolio will be linear. a. True b. False ANSWER: True 11. There can be only one zero-beta portfolio. richard@qwconsultancy.com

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a. True b. False ANSWER: False 12. The existence of transaction costs indicates that at some point the additional cost of diversification relative to its benefit would be excessive for most investors. a. True b. False ANSWER: True 13. Studies have shown the beta is more stable for portfolios than for individual securities. a. True b. False ANSWER: True 14. Fama and French suggest a four-factor model approach that explains many prior market anomalies. a. True b. False ANSWER: True 15. If the market portfolio is mean-variance efficient, it has the lowest risk for a given level of return among the attainable set of portfolios. a. True b. False ANSWER: True 16. Using the S&P index as the proxy market portfolio when evaluating a portfolio manager relative to the SML will tend to underestimate the manager's performance. a. True b. False ANSWER: False 17. If an incorrect proxy market portfolio such as the S&P index is used when developing the security market line, the slope of the line will tend to be underestimated. a. True b. False ANSWER: True 18. Because the market portfolio is reasonable in theory, it is easy to implement when testing or using the CAPM. a. True b. False ANSWER: False

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19. The planning period for the CAPM is the same length of time for every investor. a. True b. False ANSWER: False 20. 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 ANSWER: False 21. The "true" market portfolio is unknown. a. True b. False ANSWER: True 22. The usefulness of CAPM theory is limited in practice due to benchmark error. a. True b. False ANSWER: True 23. Overall, the correlation coefficients of industries to the market portfolio vary widely, which is expected due to the wide variance of industry Betas. a. True b. False ANSWER: False 24. The Capital Market Line (CML) refers only to those portfolios that lie on the line segment that extends from the risk-free asset to the point of tangency on the efficient frontier known as the market portfolio. a. True b. False ANSWER: False 25. Studies strongly suggest that the CAPM be abandoned and replaced with the APT. a. True b. False ANSWER: False 26. The APT does not require a market portfolio. a. True b. False ANSWER: True

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27. Studies indicate that neither firm size nor the time interval used is important when computing beta. a. True b. False ANSWER: False 28. Arbitrage Pricing Theory (APT) specifies the exact number of risk factors and their identity. a. True b. False ANSWER: False 29. A major advantage of the Arbitrage Pricing Theory is the risk factors are clearly and universally identifiable. a. True b. False ANSWER: False 30. Findings by Fama and French that stocks with high Book Value to Market Price ratios tended to produce larger risk adjusted returns than stocks with low Book Value to Market Price ratios challenge the efficacy of the CAPM. a. True b. False ANSWER: True 31. Findings by Basu that stocks with high P/E ratios tended to outperform stocks with low P/E ratios challenge the efficacy of the CAPM. a. True b. False ANSWER: False 32. The APT assumes that capital markets are perfectly competitive. a. True b. False ANSWER: True 33. The APT assumes that security returns are normally distributed. a. True b. False ANSWER: False 34. In the APT model, the identity of all the factors is known. a. True b. False ANSWER: False

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35. According to the APT model, all securities should be priced such that riskless arbitrage is possible. a. True b. False ANSWER: False 36. Empirical tests of the APT model have found that as the size of a portfolio increased, so did the number of factors. a. True b. False ANSWER: True 37. The January Effect is an anomaly in that returns in January are significantly smaller than in any other month. a. True b. False ANSWER: False 38. Multifactor models of risk and return can be broadly grouped into models that use macroeconomic factors and models that use microeconomic factors. a. True b. False ANSWER: True 39. Two approaches to defining factors for multifactor models are to use macroeconomic variables or individual characteristics of the securities. a. True b. False ANSWER: True Multiple Choice 40. All of the following are assumptions of the Capital Asset Pricing Model (CAPM) EXCEPT a. investors can borrow and lend any amount at the risk-free rate. b. investors all have homogeneous expectations regarding expected returns. c. investors can have different time horizons, daily, weekly, annual, or some other period. d. all investments are infinitely divisible. e. capital markets are in equilibrium.

ANSWER: c 41. A completely diversified portfolio would have a correlation with the market portfolio that is a. equal to zero because it has only unsystematic risk. b. equal to one because it has only systematic risk. c. less than zero because it has only systematic risk. d. less than one because it has only unsystematic risk. richard@qwconsultancy.com

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e. less than one because it has only systematic risk.

ANSWER: b 42. Which of the following is NOT a major difference between the capital market line (CML) and the capital asset pricing model (CAPM)? a. Definitions of portfolio risk are based on systematic and total risk. b. One is related to the market portfolio, and the other is not. c. The number of calculations to determine risk is significantly greater for one method. d. One requires a tangency point on the efficient frontier, and the other does not. e. CML measures total risk by the standard deviation of the investment, while the SML considers only the systematic component of an investment’s volatility.

ANSWER: b 43. The capital market line (CML) uses ____ as a risk measurement, whereas the capital asset pricing model (CAPM) uses ____. a. beta; total risk b. standard deviation; total risk c. standard deviation; systematic risk d. unsystematic risk; total risk e. systematic risk; beta ANSWER: c 44. If the assumption that there are no transaction costs is relaxed, the SML will be a a. straight line. b. band of securities. c. convex curve. d. concave curve. e. parabolic curve.

ANSWER: b 45. In the presence of transactions costs, the SML will be a. a single straight line. b. a kinked line. c. a set of lines rather than a single straight line. d. a curve rather than a single straight line. e. impossible to determine.

ANSWER: c 46. The ____ the number of stocks in a portfolio and the ____ the time period, the ____ the portfolio beta. a. larger, longer, less stable b. larger, longer, more stable c. larger, shorter, less stable d. larger, shorter, more stable e. smaller, longer, more stable richard@qwconsultancy.com

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ANSWER: b 47. Beta is a measure of a. company specific risk. b. industry risk. c. diversifiable risk. d. systematic risk. e. unique risk.

ANSWER: c 48. If an individual owns only one security the most appropriate measure of risk is a. standard deviation. b. correlation. c. beta. d. covariance. e. the risk-free rate.

ANSWER: a 49. The betas for the market portfolio and risk-free security are: Market Risk-free a.

0 1 b.

1 0 c. −1 1 d.

1 −1 e.

2 1 ANSWER: b 50. Calculate the expected return for A Industries, which has a beta of 1.75 when the risk free rate is 0.03 and you expect the market return to be 0.11. a. 11.13 percent b. 14.97 percent c. 16.25 percent d. 22.25 percent e. 17.0 percent ANSWER: e 51. Calculate the expected return for B Services which has a beta of 0.83 when the risk-free rate is 0.05 and you expect the market return to be 0.12. a. 14.96 percent b. 16.15 percent c. 10.81 percent d. 17.00 percent e. 15.25 percent ANSWER: c

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52. Calculate the expected return for C Inc., which has a beta of 0.8 when the risk-free rate is 0.04 and you expect the market return to be 0.12. a. 8.10 percent b. 9.60 percent c. 10.40 percent d. 11.20 percent e. 12.60 percent ANSWER: c 53. Calculate the expected return for D Industries, which has a beta of 1.0 when the risk-free rate is 0.03 and you expect the market return to be 0.13. a. 8.6 percent b. 9.2 percent c. 11.0 percent d. 12.0 percent e. 13.0 percent ANSWER: e 54. Calculate the expected return for E Services, which has a beta of 1.5 when the risk-free rate is 0.05 and you expect the market return to be 0.11. a. 10.6 percent b. 12.1 percent c. 13.6 percent d. 14.0 percent e. 16.2 percent ANSWER: d 55. Calculate the expected return for F Inc., which has a beta of 1.3 when the risk-free rate is 0.06 and you expect the market return to be 0.125. a. 12.65 percent b. 13.55 percent c. 14.45 percent d. 15.05 percent e. 16.34 percent ANSWER: c Exhibit 7.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Year 1 2 3 4 5 6

Rates of Return RA Computer Market Index 13 17 9 15 6 −11 10 8 11 10 6 12

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56. Refer to Exhibit 7.1. Compute the beta for RA Computer using the historic returns presented above. a. 0.7715 b. 1.2195 c. 1.3893 d. 1.1023 e. −0.7715 ANSWER: c 57. Refer to Exhibit 7.1. Compute the correlation coefficient between RA Computer and the Market Index. a. −0.32 b. 0.78 c. 0.66 d. 0.58 e. 0.32 ANSWER: c 58. a. b. c. d. e.

ANSWER: a Exhibit 7.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You expect the risk-free rate (RFR) to be 3 percent and the market return to be 8 percent. You also have the following information about three stocks.

Stock X Y Z

Beta 1.25 1.50 0.90

Current Price $20 $27 $35

Expected Price $23 $29 $38

Expected Dividend $1.25 $0.25 $1.00

59. Refer to Exhibit 7.2. What are the expected (required) rates of return for the three stocks (in the order X, Y, Z)? a. 16.50 percent, 5.50 percent, 22.00 percent b. 9.25 percent, 10.5 percent, 7.5 percent c. 21.25 percent, 8.33 percent, 11.43 percent richard@qwconsultancy.com

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d. 6.20 percent, 2.20 percent, 8.20 percent e. 15.00 percent, 3.50 percent, 7.30 percent ANSWER: b 60. Refer to Exhibit 7.2. What are the estimated rates of return for the three stocks (in the order X, Y, Z)? a. 21.25 percent, 8.33 percent, 11.43 percent b. 6.20 percent, 2.20 percent, 8.20 percent c. 16.50 percent, 5.50 percent, 22.00 percent d. 9.25 percent, 10.5 percent, 7.5 percent e. 15.00 percent, 3.50 percent, 7.30 percent ANSWER: a 61. a. b. c. d. e.

ANSWER: e 62. Recently you have received a tip that the stock of Bubbly Incorporated is going to rise from $57 to $61 per share over the next year. You know that the annual return on the S&P 500 has been 9.25 percent and the 90-day T-bill rate has been yielding 3.75 percent per year over the past 10 years. If beta for Bubbly is 0.85, will you purchase the stock? a. Yes, because it is overvalued. b. No, because it is overvalued. c. No, because it is undervalued. d. Yes, because it is undervalued. e. Yes, because the expected return equals the estimated return.

ANSWER: b 63. Your broker has advised you that he believes that the stock of Brat Inc. is going to rise from $20 to $22.15 per share over the next year. You know that the annual return on the S&P 500 has been 11.25 percent and the 90-day T-bill rate has been yielding 4.75 percent per year over the past 10 years. If beta for Brat is 1.25, will you purchase the stock? a. Yes, because it is overvalued. b. No, because it is overvalued. c. No, because it is undervalued. d. Yes, because it is undervalued. e. Yes, because the expected return equals the estimated return.

ANSWER: b 64. Recently you have received a tip that the stock of Buttercup Industries is going to rise from $76.00 to $85.00 per share over the next year. You know that the annual return on the S&P 500 has been 13

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percent and the 90-day T-bill rate has been yielding 3 percent per year over the past 10 years. If beta for Buttercup is 1.0, will you purchase the stock? a. Yes, because it is overvalued. b. Yes, because it is undervalued. c. No, because it is undervalued. d. No, because it is overvalued. e. Yes, because the expected return equals the estimated return.

ANSWER: d 65. A friend has some reliable information that the stock of Puddles Company is going to rise from $43.00 to $50.00 per share over the next year. You know that the annual return on the S&P 500 has been 11 percent and the 90-day T-bill rate has been yielding 5 percent per year over the past 10 years.

If beta for Puddles is 1.5, will you purchase the stock? a. Yes, because it is overvalued. b. Yes, because it is undervalued. c. No, because it is undervalued. d. No, because it is overvalued. e. Yes, because the expected return equals the estimated return.

ANSWER: b 66. Recently your broker has advised you that he believes that the stock of Casey Incorporated is going to rise from $55.00 to $70.00 per share over the next year. You know that the annual return on the S&P 500 has been 12.5 percent and the 90-day T-bill rate has been yielding 6 percent per year over the past 10 years. If beta for Casey is 1.3, will you purchase the stock? a. Yes, because it is overvalued. b. Yes, because it is undervalued. c. No, because it is undervalued. d. No, because it is overvalued. e. Yes, because the expected return equals the estimated return.

ANSWER: b 67. A friend has information that the stock of Zip Incorporated is going to rise from $62.00 to $65.00 per share over the next year. You know that the annual return on the S&P 500 has been 10 percent and the 90-day T-bill rate has been yielding 6 percent per year over the past 10 years. If beta for Zip is 0.9, will you purchase the stock? a. Yes, because it is overvalued. b. Yes, because it is undervalued. c. No, because it is undervalued. d. No, because it is overvalued. e. Yes, because the expected return equals the estimated return.

ANSWER: d 68. Assume that as a portfolio manager the beta of your portfolio is 0.85 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML? (1)

RFR = 0.0475

Rm(proxy) = 0.0975

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(2)

RK = 0.0325

Rm(true) = 0.0845

a. 1.33% higher b. 2.35% lower c. 8% lower d. 1.33% lower e. 2.35% higher ANSWER: a 69. Assume that as a portfolio manager the beta of your portfolio is 1.15 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML? (1) (2)

RFR = 0.0625 RK = 0.078

Rm(proxy) = 0.12 Rm(true) = 0.10

a. 2.53 percent lower b. 3.85 percent lower c. 2.53 percent higher d. 4.4 percent higher e. 3.85 percent higher ANSWER: c 70. Assume that as a portfolio manager the beta of your portfolio is 1.3 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML? (1) (2)

RFR = .08 RK = .07

Rm(proxy) = .11 Rm(true) = .14

a. 4.2 percent lower b. 3.6 percent lower c. 3.8 percent lower d. 4.2 percent higher e. 3.6 percent higher ANSWER: a 71. Assume that as a portfolio manager the beta of your portfolio is 1.2 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML? (1) (2)

RFR = .09 RK = .10

Rm(proxy) = .12 Rm(true) = .13

a. 2 percent lower b. 1 percent lower richard@qwconsultancy.com

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c. 5 percent lower d. 1 percent higher e. 2 percent higher ANSWER: b 72. Assume that as a portfolio manager the beta of your portfolio is 1.1 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML? (1) (2)

RFR = .07

Rm(proxy) = .15 Rm(true) = .12

RK = .06

a. 3.2 percent lower b. 6.4 percent lower c. 4.9 percent lower d. 3.2 percent higher e. 6.4 percent higher ANSWER: d 73. Assume that as a portfolio manager the beta of your portfolio is 1.4 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML? (1) (2)

RFR = .06

Rm(proxy) = .12 Rm(true) = .11

RK = .05

a. 2.0 percent lower b. 0.5 percent lower c. 0.5 percent lower d. 1.0 percent higher e. 2.0 percent higher ANSWER: d Exhibit 7.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Period 1 2 3 4

Return of Radtron (Percent) 10 12 −10 −4

Proxy Specific Index (Percent) 12 10 −8 −10

True General Index (Percent) 15 13 −8 0

74. Refer to Exhibit 7.3. The average true return is a. 1 percent. richard@qwconsultancy.com

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b. 2 percent. c. 3 percent. d. 4 percent. e. 5 percent.

ANSWER: a 75. Refer to Exhibit 7.3. The average proxy return is a. 1 percent. b. 2 percent. c. 3 percent. d. 4 percent. e. 5 percent.

ANSWER: b 76. Refer to Exhibit 7.3. The average return for Radtron is a. 1 percent. b. 2 percent. c. 3 percent. d. 4 percent. e. 5 percent.

ANSWER: a 77. a. b. c. d. e.

ANSWER: c 78. a. b. c. d. e.

ANSWER: b 79. a. b. c. d. e. richard@qwconsultancy.com

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ANSWER: a 80. a. b. c. d. e.

ANSWER: b 81. Consider an asset that has a beta of 1.5. The return on the risk-free asset is 6.5 percent and the expected return on the stock index is 15 percent. The estimated return on the asset is 20 percent.

Calculate the alpha for the asset. a. 19.25 percent b. 0.75 percent c. −0.75 percent d. 9.75 percent e. 9.0 percent ANSWER: b 82. The variance of returns for a risky asset is 25 percent. The variance of the error term, Var(e), is 8 percent. What portion of the total risk of the asset, as measured by variance, is systematic? a. 32 percent b. 8 percent c. 68 percent d. 25 percent e. 75 percent ANSWER: c 83. An investor wishes to construct a portfolio consisting of a 70 percent allocation to a stock index and a 30 percent allocation to a risk-free asset. The return on the risk-free asset is 4.5 percent, and the expected return on the stock index is 12 percent. The standard deviation of returns on the stock index is 6 percent. Calculate the expected standard deviation of the portfolio. a. 4.20 percent b. 25.20 percent c. 3.29 percent d. 10.80 percent e. 5.02 percent ANSWER: a 84. An investor wishes to construct a portfolio by borrowing 35 percent of his original wealth and investing all the money in a stock index. The return on the risk-free asset is 4.0 percent, and the expected return on the stock index is 15 percent. Calculate the expected return on the portfolio. a. 18.25 percent b. 18.85 percent c. 9.50 percent richard@qwconsultancy.com

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d. 15.00 percent e. 11.15 percent ANSWER: b 85. An investor wishes to construct a portfolio consisting of a 70 percent allocation to a stock index and a 30 percent allocation to a risk-free asset. The return on the risk-free asset is 4.5 percent, and the expected return on the stock index is 12 percent. Calculate the expected return on the portfolio. a. 8.25 percent b. 16.50 percent c. 17.50 percent d. 9.75 percent e. 14.38 percent ANSWER: d 86. A stock has a beta of 1.25. The risk-free rate is 5 percent and the return on the market is 6 percent.

The estimated return for the stock is 14 percent. According to the CAPM, you should a. sell because it is overvalued. b. sell because it is undervalued. c. buy because it overvalued. d. buy because it is undervalued. e. short because it is undervalued.

ANSWER: d 87. Consider a risky asset that has a standard deviation of returns of 15. Calculate the correlation between the risky asset and a risk-free asset. a. 1.0 b. 0.0 c. −1.0 d. 0.5 e. −0.5 ANSWER: b 88. The expected return for a stock, calculated using the CAPM, is 10.5 percent. The market return is 9.5 percent, and the beta of the stock is 1.50. Calculate the implied risk-free rate. a. 7.50 percent b. 13.91 percent c. 17.50 percent d. 21.88 percent e. 14.38 percent ANSWER: a 89. The expected return for a stock, calculated using the CAPM, is 25 percent. The risk-free rate is 7.5 percent, and the beta of the stock is 0.80. Calculate the implied return on the market. a. 7.50 percent b. 13.91 percent richard@qwconsultancy.com

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c. 17.50 percent d. 21.88 percent e. 14.38 percent ANSWER: e 90. The expected return for Zbrite stock calculated using the CAPM is 15.5 percent. The risk-free rate is 3.5 percent and the beta of the stock is 1.2. Calculate the implied market risk premium. a. 5.5 percent b. 6.5 percent c. 10.0 percent d. 15.5 percent e. 12.0 percent ANSWER: c Exhibit 7.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stock X Y Z

Beta 0.8 1.1 2.1

Current Price $12.50 $ 8.25 $25.70

Expected Price $13.10 $ 9.76 $30.04

Expected Dividend $0.80 $0.20 $0.00

91. Refer to Exhibit 7.4. What are the expected returns for stocks X, Y, and Z for the next period based on the above prices and dividends?

X Y Z a. 4.8% 18.3% 16.9% b. 10.7% 17.5% 14.4% c. 11.2% 20.7% 16.9% d. 12.3% 22.5% 22.3% e. 13.1% 24.3% 18.2% ANSWER: a 92. Refer to Exhibit 7.4. If the expected return on the market is 11.5% and the risk-free rate of return is 4.5%, then what are the required rates of return for stocks X, Y, and Z based on the CAPM? X Y Z a. 4.8% 18.3% 16.9% b. 7.2% 20.7% 22.3% c. 10.7% 17.5% 14.4% d. 10.1% 12.2% 19.2% e. 11.1% 12.2% 21.3% ANSWER: c Exhibit 7.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) richard@qwconsultancy.com

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Portfolio A B C

Expected Return 9.8% 6.7% 11.2%

Standard Deviation 14.0% 9.8% 18.5%

93. Refer to Exhibit 7.5. Calculate the risk premium per unit of risk for the three portfolios above assuming the risk-free rate is 4.0%.

A B C a. 0.068 0.027 0.072 b. 0.414 0.276 0.389 c. 0.700 0.680 0.605 d. 0.300 0.280 0.205 e. 0.650 0.580 0.480 ANSWER: b 94. Assume that the risk-free rate of return is 3 percent and the market portfolio on the Capital Market Line (CML) has an expected return of 11 percent and a standard deviation of 14 percent. How should you invest $100,000 if you are only willing to accept a total portfolio risk of 8 percent? a. invest $140,000 in the market portfolio and by borrowing $40,000 at the risk-free rate b. invest $80,000 in the market portfolio and the remainder in the risk-free security c. invest $63,636.36 in the market portfolio and the remainder in the risk-free security d. invest $36,363.64 in the market portfolio and the remainder in the risk-free security e. invest $100,000 on another portfolio on the CML that does not contain any of the market portfolio or the risk-free security but has a standard deviation of 8 percent.

ANSWER: d Exhibit 7.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Jonathan Crowley is a portfolio manager for a large pension fund. Last year his portfolio had an actual return of 12.6 percent with a standard deviation of 13 percent and a beta of 1.3. The market risk premium for this period of time was 6 percent, and the risk-free rate of return was 5 percent.

95. Refer to Exhibit 7.6. Based on the Capital Asset Pricing Model (CAPM), what is the required rate of return for this portfolio? a. 6.3 percent b. 7.8 percent c. 10.6 percent d. 12.8 percent e. 15.4 percent ANSWER: d 96. Refer to Exhibit 7.6. How does Jonathan Crowley's portfolio compare to the market portfolio? a. Crowley's portfolio is less risky than the market portfolio. richard@qwconsultancy.com

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b. Crowley's portfolio significantly outperformed the market portfolio. c. On a risk-adjusted basis Crowley's portfolio performed similar to the market portfolio. d. On a risk-adjusted basis Crowley's portfolio significantly underperformed the market. e. On a risk-adjusted basis Crowley's portfolio significantly outperformed the market.

ANSWER: c 97. Assume the risk-free rate is 4.5 percent and the expected return on the market is 11 percent. You anticipate Stock XYZ to sell for $28 at the end of next year and pay a dividend of $2. The stock is currently selling for $26.50 with a beta of 1.2. You currently hold stock XYZ in a well-diversified portfolio. Assuming you have money to invest, you should a. buy stock XYZ. b. sell stock XYZ. c. do nothing because it is properly valued. d. invest your money in the risk-free rate of return. e. buy a put option.

ANSWER: a Exhibit 7.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You expect the risk-free rate (RFR) to be 4 percent and the market return to be 10 percent. You also have the following information about three stocks.

Stock A B C

Beta 1.5 1.1 0.8

Current Price $10 $27 $35

Expected Price $11.50 $30 $36

Expected Dividend $1.00 $0.00 $1.50

98. Refer to Exhibit 7.7. What are the required rates of return for the three stocks (in the order A, B, C)? a. 13.0 percent, 10.6 percent, 8.8 percent b. 15.0 percent, 11.1 percent, 2.9 percent c. 18.7 percent, 11.1 percent, 8.8 percent d. 21.7 percent, 10.0 percent, 6.9 percent e. 25.0 percent, 11.1 percent, 7.1 percent ANSWER: a 99. Refer to Exhibit 7.7. What are the estimated rates of return for the three stocks (in the order A, B, C)? a. 13.0 percent, 10.6 percent, 8.8 percent b. 15.0 percent, 11.1 percent, 2.9 percent c. 18.7 percent, 11.1 percent, 8.8 percent d. 21.7 percent, 10.0 percent, 6.9 percent e. 25.0 percent, 11.1 percent, 7.1 percent ANSWER: e richard@qwconsultancy.com

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100. Refer to Exhibit 7.7. What is your investment strategy concerning the three stocks? a. buy A and B; sell C b. sell A, B, and C c. sell A and B; buy C d. buy A, B, and C e. buy A and C; sell B ANSWER: a 101. An investor constructs a portfolio with a 75 percent allocation to a stock index and a 25 percent allocation to a risk-free asset. The expected returns on the risk-free asset and the stock index are 3 percent and 10 percent, respectively. The standard deviation of returns on the stock index is 14 percent. Calculate the expected standard deviation of the portfolio. a. 7.5 percent b. 9.0 percent c. 10.5 percent d. 11.5 percent e. 13.0 percent ANSWER: c 102. An investor wishes to construct a portfolio by borrowing 30 percent of his initial wealth at the risk-free rate of 3 percent and investing all the money in a stock index. The expected return on the stock index is 12 percent. Calculate the expected return on the portfolio. a. 14.7 percent b. 15.6 percent c. 17.1 percent d. 18.9 percent e. 19.7 percent ANSWER: a 103. The fact that tests have shown the CAPM intercept to be greater than the RFR is consistent with a(n) a. zero beta model. b. unstable beta or a higher borrowing rate. c. zero beta model or a higher borrowing rate. d. higher borrowing rate. e. unstable beta.

ANSWER: c 104. Which of the following is NOTa relaxation of the assumptions for the CAPM? a. differential lending and borrowing rates b. a zero-beta model c. transaction costs d. taxes e. fixed planning periods richard@qwconsultancy.com

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ANSWER: e 105. A portfolio manager uses two different proxies for the market portfolio, the S&P 500 index, and the MSCI World index. Differences in the manager's portfolio performance resulting from the different market portfolios is referred to as a. the size effect. b. the market effect. c. measurement error. d. benchmark error. e. manager's performance error.

ANSWER: d 106. The error caused by NOT using the true market portfolio has become known as the a. portfolio deviation. b. CAPM shift. c. benchmark error. d. market error. e. beta error.

ANSWER: c Exhibit 7.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) (1) (2) (3) (4) (5) (6)

Capital markets are perfectly competitive. quadratic utility function Investors prefer more wealth to less wealth with certainty. normally distributed security returns representation as a K factor model a market portfolio that is mean-variance efficient

107. Refer to Exhibit 7.8. In the list above, which are assumptions of the Arbitrage Pricing Model? a. (1) and (4) b. (1), (2), and (3) c. (1), (3), and (5) d. (2), (3), (4), and (6) e. (1), (2), (3), (4), (5), and (6) ANSWER: c 108. Refer to Exhibit 7.8. In the list above, which are NOT assumptions of the Arbitrage Pricing model? a. (1) and (3) b. (1), (2), and (3) c. (1), (2), and (5) d. (2), (4), and (6) e. (1), (2), (3), (4), (5), and (6) richard@qwconsultancy.com

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ANSWER: d 109. To date, the results of empirical tests of the Arbitrage Pricing Model have been a. clearly favorable. b. clearly unfavorable. c. mixed. d. unavailable. e. biased.

ANSWER: c 110. Unlike the capital asset pricing model, the arbitrage pricing theory requires only the following assumption(s): a. a quadratic utility function. b. normally distributed returns. c. the stochastic process generating asset returns can be represented by a factor model. d. a mean-variance efficient market portfolio consisting of all risky assets. e. capital markets are imperfectly competitive.

ANSWER: c 111. Consider the following two factor APT model: E(R) = 0 + 1b1 + 2b2 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.

ANSWER: d 112. In the APT model the idea of riskless arbitrage is to assemble a portfolio that a. requires some initial wealth, will bear no risk, and still earn a profit. b. requires no initial wealth, will bear no risk, and still earn a profit. c. requires no initial wealth, will bear no systematic risk, and still earn a profit. d. requires no initial wealth, will bear no unsystematic risk, and still earn a profit. e. requires some initial wealth, will bear no systematic risk, and still earn a profit.

ANSWER: b 113. In one of their empirical tests of the APT, Roll and Ross examined the relationship between a security's returns and its own standard deviation. A finding of a statistically significant relationship would indicate that a. APT is valid because a security's unsystematic component would be eliminated by diversification.

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b. APT is valid because non-diversifiable components should be explained by factor sensitivities. c. APT is invalid because a security's unsystematic component would be eliminated by diversification. d. APT is invalid because standard deviation is not an appropriate factor. e. None of these are correct.

ANSWER: c 114. Cho, Elton, and Gruber tested the APT by examining the number of factors in the return generating process and found that a. five factors were required using Roll-Ross procedures. b. six factors were present when using historical beta. c. fundamental betas indicated a need for three factors. d. All of these are correct. e. None of these are correct.

ANSWER: d 115. 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 these are correct.

ANSWER: b 116. Assume that you are embarking on a test of the small-firm effect using APT. You form 10 sizebased portfolios. Which of the following finding would suggest that there is evidence supporting APT? a. The top five size-based portfolios should have excess returns that exceed the bottom five size based portfolios. b. The bottom five size-based portfolios should have excess returns that exceed the top five size-based portfolios. c. The ten portfolios must have excess returns not significantly different from zero. d. The ten portfolios must have excess returns significantly different from zero. e. None of these are correct.

ANSWER: c 117. The equation for the single-index market model is a. RFRit = ai + bRmt + et. b. Rit = ai + bRmt + et. c. Rit = ai + bRFRt + et.

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d. Rmt = ai + bRit + et. e. Rit = ai + b(Rmt − RFRt) + et.

ANSWER: b 118. The excess return form of the single-index market model is a. Rit =  + b(Rmt − Rit) + eit. b. RFRt =  + b(Rmt − RFRt) + eit. c. Rit − RFRt =  + b(Rmt) + eit. d. Rit =  + b(Rmt − RFRt) + eit. e. Rit − RFRt =  + b(Rmt − RFRt) + eit.

ANSWER: e 119. Consider the following list of risk factors: (1) (2) (3) (4) (5) (6)

monthly growth in industrial production return on high book to market value portfolio minus return on low book to market value portfolio change in inflation excess return on stock market portfolio return on small cap portfolio minus return on big cap portfolio unanticipated change in bond credit spread

Which of the following factors would you use to develop a macroeconomic-based risk factor model? a. (1), (2), and (3) b. (1), (3), and (5) c. (2), (4), and (5) d. (1), (3), and (6) e. (4), (5), and (6) ANSWER: d 120. Consider the following list of risk factors: (1) (2) (3) (4) (5) (6)

monthly growth in industrial production return on high book to market value portfolio minus return on low book to market value portfolio change in inflation excess return on stock market portfolio return on small cap portfolio minus return on big cap portfolio unanticipated change in bond credit spread

Which of the following factors would you use to develop a microeconomic-based risk factor model? a. (1), (2), and (3) b. (1), (3), and (5) c. (2), (4), and (5) d. (1), (3), and (6) e. (4), (5), and (6) richard@qwconsultancy.com

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ANSWER: c 121. In a macroeconomic-based risk factor model, the following factor would be one of many appropriate factors: a. confidence risk. b. maturity risk. c. expected inflation risk. d. call risk. e. return difference between small capitalization and large capitalization stocks.

ANSWER: a 122. In a multifactor model, confidence risk represents a. unanticipated changes in the level of overall business activity. b. unanticipated changes in investors' desired time to receive payouts. c. unanticipated changes in short-term and long-term inflation rates. d. unanticipated changes in the willingness of investors to take on investment risk. e. None of these are correct.

ANSWER: d 123. In a multifactor model, time horizon risk represents a. unanticipated changes in the level of overall business activity. b. unanticipated changes in investors' desired time to receive payouts. c. unanticipated changes in short-term and long-term inflation rates. d. unanticipated changes in the willingness of investors to take on investment risk. e. None of these are correct.

ANSWER: b 124. In a microeconomic (or characteristic)-based risk factor model, the following factor would be one of many appropriate factors: a. confidence risk. b. maturity risk. c. expected inflation risk. d. call risk. e. return difference between small capitalization and large capitalization stocks.

ANSWER: e 125. A study by Chen, Roll, and Ross in 1986 examined all of the following factors in applying the Arbitrage Pricing Theory (APT) EXCEPT a. the return on a market value-weighted return. b. the monthly growth rate in U.S. industrial production. c. the change in the consumer price index (CPI). d. the expected change in the bond credit spread. e. the return of foreign stock indices.

ANSWER: d

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126. A 1994 study by Burmeister, Roll, and Ross defined all of the following risk factors EXCEPT a. confidence risk b. market risk. c. inflation risk. d. market-timing risk. e. business cycle risk.

ANSWER: b 127. Which of the following is not a step required for a multifactor risk model to estimate expected return for an individual stock position? a. identify a set of K common risk factors b. estimate the risk premia for the factors c. estimate the sensitivities of each stock to these K factors d. calculate the expected returns using linear programming analysis e. All of these are correct.

ANSWER: d 128. One approach for using multifactor models is to use factors that capture systematic risk. Which of the following is NOT a common factor used in this approach? a. unexpected changes in inflation b. consumer confidence c. yield curve shifts d. unexpected changes in real GDP e. All of these are correct.

ANSWER: e 129. Fama and French suggest a three-factor model approach. Which of the following is NOT included in their approach? a. excess returns to a broad market index b. return differences between small-cap and large-cap portfolios c. return differences between industry characteristics d. return differences between value and growth stocks e. return differences between foreign stocks ANSWER: c 130. Under the following conditions, what are the expected returns for stocks X and Y? 0 = 0.04 k1 = 0.035 k2 = 0.045

bx,1 = 1.2 bx,2 = 0.75 by,1 = 0.65 by,2 = 1.45

a. 11.58 percent and 12.8 percent b. 15.65 percent and 18.23 percent c. 13.27 percent and 15.6 percent richard@qwconsultancy.com

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d. 18.2 percent and 16.45 percent e. 22.35 percent and 13.25 percent ANSWER: a 131. Under the following conditions, what are the expected returns for stocks Y and Z? 0 = 0.05 k1 = 0.06 k2 = 0.05

by,1 = 0.75 by,2 = 1.35 bz,1 = 1.5 bz,2 = 0.85

a. 17.61 percent and 13.23 percent b. 16.25 percent and 18.25 percent c. 13.24 percent and 28.46 percent d. 14.83 percent and 17.69 percent e. 15.35 percent and 19.25 percent ANSWER: b 132. Under the following conditions, what are the expected returns for stocks A and B? 0 = 0.035 k1 = 0.05 k2 = 0.06

ba,1 = 1.00 ba,2 = 1.40 bb,1 = 1.70 bb,2 = 0.65

a. 14.8 percent and 13.8 percent b. 19.8 percent and 29.5 percent c. 16.0 percent and 19.8 percent d. 16.9 percent and 15.9 percent e. 19.5 percent and 17.5 percent ANSWER: d 133. Under the following conditions, what are the expected returns for stocks X and Y? 0 = 0.05 k1 = 0.03 k2 = 0.04

bx,1 = 0.90 bx,2 = 1.60 by,1 = 1.50 by,2 = 0.85

a. 14.1 percent and 12.9 percent b. 12.5 percent and 19.5 percent c. 19.5 percent and 18.5 percent d. 21.2 percent and 18.5 percent e. 11.5 percent and 15.5 percent ANSWER: a richard@qwconsultancy.com

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134. Under the following conditions, what are the expected returns for stocks A and C? 0 = 0.07 k1 = 0.04 k2 = 0.03

ba,1 = 0.95 ba,2 = 1.10 bc,1 = 1.10 bc,2 = 2.35

a. 14.1 percent and 17.65 percent b. 14.1 percent and 18.45 percent c. 17.65 percent and 18.45 percent d. 18.45 percent and 17.52 percent e. 19.55 percent and 17.25 percent ANSWER: b 135. Consider a two-factor APT model in which the first factor is changes in the 30-year T-bond rate, and the second factor is the percent growth in GNP. Based on historical estimates, you determine that the risk premium for the interest rate factor is 0.02, and the risk premium on the GNP factor is 0.03.

For a particular asset, the response coefficient for the interest rate factor is −1.2, and the response coefficient for the GNP factor is 0.80. The rate of return on the zero-beta asset is 0.03. Calculate the expected return for the asset. a. 5.0 percent b. 2.4 percent c. −3.0 percent d. −2.4 percent e. 3.0 percent ANSWER: e Exhibit 7.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the three stocks, stock X, stock Y, and stock Z, that have the following factor loadings (or factor betas).

Stock X Y Z

Factor 1 Loading −0.55 −0.10 0.35

Factor 2 Loading 1.2 0.85 0.5

The zero-beta return (0) = 3 percent, and the risk premia are 1 = 10 percent and 2 = 8 percent.

Assume that all three stocks are currently priced at $50.

136. Refer to Exhibit 7.9. The expected returns for stock X, stock Y, and stock Z are a. 3 percent, 8 percent, 10 percent b. 7.1 percent, 10.5 percent, 8.8 percent c. 7.1 percent, 8.8 percent, 10.5 percent richard@qwconsultancy.com

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d. 10 percent, 5.5 percent, 14 percent e. 14 percent, 5.5 percent, 12 percent ANSWER: c 137. Refer to Exhibit 7.9. The expected prices one year from now for stocks X, Y, and Z are a. $53.55, $54.4, $55.25 b. $45.35, $54.4, $55.25 c. $55.55, $56.35, $57.15 d. $50, $50, $50 e. $51.35, $47.79, $51.58.

ANSWER: a 138. Refer to Exhibit 7.9. If you know that the actual prices one year from now are stock X $55, stock Y $52, and stock Z $57, then a. stock X is undervalued, stock Y is undervalued, and stock Z is undervalued. b. stock X is undervalued, stock Y is overvalued, and stock Z is overvalued. c. stock X is overvalued, stock Y is undervalued, and stock Z is undervalued. d. stock X is undervalued, stock Y is overvalued, and stock Z is undervalued. e. stock X is overvalued, stock Y is overvalued, and stock Z is undervalued.

ANSWER: d 139. Refer to Exhibit 7.9. Assume that you wish to create a portfolio with no net wealth invested. The portfolio that achieves this has 50 percent in stock X, −100 percent in stock Y, and 50 percent in stock Z. The weighted exposure to risk factor 2 for stocks X, Y, and Z are a. 0.50, −1.0, 0.50. b. −0.50, 1.0, −0.50. c. 0.60, −0.85, 0.25. d. −0.275, 0.10, 0.175. e. 0.40, −0.75, 0.25.

ANSWER: c 140. Refer to Exhibit 7.9. Assume that you wish to create a portfolio with no net wealth invested and the portfolio that achieves this has 50 percent in stock X, −100 percent in stock Y, and 50 percent in stock Z. The net arbitrage profit is a. $8. b. $5. c. $7. d. $12. e. $15.

ANSWER: a 141. Refer to Exhibit 7.9. The new prices now for stocks X, Y, and Z that will not allow for arbitrage profits are a. $53.55, $54.4, and $55.25. b. $45.35, $54.4, and $55.25. richard@qwconsultancy.com

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c. $55.55, $56.35, and $57.15. d. $50, $50, and $50. e. $51.35, $47.79, and $51.58.

ANSWER: e 142. The table below provides factor risk sensitivities and factor risk premia for a three-factor model for a particular asset, where factor 1 is MP (the growth rate in U.S. industrial production), factor 2 is UI (the difference between actual and expected inflation), and factor 3 is UPR (the unanticipated change in bond credit spread).

Risk Factor MP UI UPR

Factor Sensitivity() 1.76 −0.8 0.87

Risk Premium() 0.0259 −0.0432 0.0149

Calculate the expected excess return for the asset. a. 12.32 percent b. 9.32 percent c. 4.56 percent d. 6.32 percent e. 8.02 percent ANSWER: a Exhibit 7.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stocks A, B, and C have two risk factors with the following beta coefficients. The zero-beta return (0) = .025 and the risk premiums for the two factors are (1) = .12 and (0) = .10.

Stock

Factor 1 bi1

A B C

−0.25 −0.05 0.01

Factor 2 bi2 1.1 0.9 0.6

143. Refer to Exhibit 7.10. Calculate the expected returns for stocks A, B, and C. A B C a. 0.082 0.091 0.033 b. 0.105 0.109 0.032 c. 0.132 0.128 0.033 d. 0.165 0.121 0.032 e. 0.850 0.850 0.610 ANSWER: b

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144. Refer to Exhibit 7.10. Assume that stocks A, B, and C never pay dividends and stocks A, B, and C are currently trading at $10, $20, and $30, respectively. What is the expected price next year for each stock?

A B C a. $10.82 $21.82 $30.99 b. $11.05 $22.18 $30.96 c. $11.32 $22.56 $30.99 d. $11.65 $22.42 $30.96 e. $18.50 $37.00 $48.30 ANSWER: b 145. Refer to Exhibit 7.10. Suppose that you know that the prices of stocks A, B, and C will be $10.95, 22.18, and $30.89, respectively. Based on this information, a. all three stocks are overvalued. b. all three stocks are undervalued. c. stock a is undervalued, stock b is properly valued, and stock c is undervalued. d. stock a is undervalued, stock b is properly valued, and stock c is overvalued. e. stock a is overvalued, stock b is overvalued, and stock c is undervalued.

ANSWER: c 146. Under the following conditions, what are the expected returns for stocks Y and Z? 0 = 0.04 k1 = 0.07 k2 = 0.05

by,1 = 0.5 by,2 = 1.3 bz,1 = 1.2 bz,2 = 0.9

a. 12.0 percent and 13.3 percent b. 13.5 percent and 14.2 percent c. 13.9 percent and 15.6 percent d. 14.0 percent and 16.9 percent e. 15.8 percent and 17.3 percent ANSWER: d 147. Under the following conditions, what are the expected returns for stocks A and B? 0 = 0.03 k1 = 0.09 k2 = 0.07

ba,1 = 1.5 ba,2 = 0.8 bb,1 = 1.20 bb,2 = 0.6

a. 24.8 percent and 19.7 percent b. 22.1 percent and 18.0 percent c. 20.3 percent and 17.8 percent d. 19.9 percent and 16.9 percent richard@qwconsultancy.com

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e. 18.7 percent and 15.3 percent ANSWER: b

Chapter 08 - Equity Valuation True / False 1. A fair investment is one that gives us a return that is greater than the risk. a. True b. False ANSWER: False 2. An overvalued investment is so expensive that we will not receive a fair return if we bought it. a. True b. False ANSWER: True 3. An undervalued investment is so expensive that we will not receive a fair return if we bought it. a. True b. False ANSWER: False 4. Fundamentalists typically use the "Bottom-Up Approach", whereas technicians use the "Top-Down Approach" to the valuation process. a. True b. False ANSWER: False 5. Those who employ the bottom-up approach start their search immediately at the company level. a. True b. False ANSWER: True 6. Given an optimistic economic and stock-market outlook for a country, the investor should underweight the allocation to this country in his/her portfolio. a. True b. False ANSWER: False 7. Within a specific market, the top-down analyst then searches for the best industries. a. True b. False ANSWER: True

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8. The importance of an industry's performance on an individual stock's performance varies across industries. a. True b. False ANSWER: True 9. If the estimated value of an asset is greater than the market price, you would want to buy the investment. a. True b. False ANSWER: True 10. If the intrinsic value of an asset is greater than the market price, you would want to buy the investment. a. True b. False ANSWER: True 11. The three-step valuation process consists of (1) analysis of alternative economies and markets, (2) analysis of alternative industries, and (3) analysis of industry influences. a. True b. False ANSWER: False 12. The two components that are required in order to carry out asset valuation are (1) the stream of expected cash flows and (2) the required rate of return. a. True b. False ANSWER: True 13. Growth companies are those firms that consistently earn higher rates of return by assuming greater amounts of risk. a. True b. False ANSWER: False 14. Discounted cash flow techniques for equity valuation may use one of the following: (1) dividends, (2) free cash flow, or (3) coupons. a. True b. False ANSWER: False 15. The real risk-free rate depends on the real growth in the economy and can be affected for short time periods by temporary tightness or ease in the capital markets. a. True b. False richard@qwconsultancy.com

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ANSWER: True 16. The dividend growth models are only meaningful for companies that have a required rate of return that exceeds their dividend growth rate. a. True b. False ANSWER: True 17. In dividend discount models (DDM) with supernormal growth, supernormal growth may continue indefinitely. a. True b. False ANSWER: False 18. An equity investor's required rate of return is influenced by the economy's real risk-free rate, the expected rate of inflation, and a risk premium. a. True b. False ANSWER: True 19. The required rate of return is determined by (1) the real risk-free rate, (2) the expected rate of inflation, and (3) liquidity risk. a. True b. False ANSWER: False 20. The growth rate in equity without any external financing is determined by multiplying the payout ratio by the return on equity (ROE). a. True b. False ANSWER: False 21. The dividend discount model (DDM) can be used to value preferred stock by simply using a growth rate of zero in the DDM model. a. True b. False ANSWER: True 22. The infinite period dividend discount model (DDM) can be used to value a supernormal growth company. a. True b. False ANSWER: False 23. An example of a relative valuation technique is the Price/Cash Flow ratio. a. True richard@qwconsultancy.com

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b. False ANSWER: True 24. A relative valuation technique is appropriate to consider when you have a good set of comparable entities. a. True b. False ANSWER: True 25. The growth rate of dividends and profit margin are the main determinants of the P/E ratio. a. True b. False ANSWER: False 26. As an analyst performs ratio analysis, he hopes to determine whether earnings represent cash flows and whether those cash flows will recur. a. True b. False ANSWER: True 27. The gross margin is defined as Gross Profit/Sales. a. True b. False ANSWER: True 28. Operating margins are defined as Operating Profit/Sales a. True b. False ANSWER: True 29. Management may “under-reserve” in order to meet earnings expectations, or they may “overreserve” in order to smooth future earnings. a. True b. False ANSWER: True 30. Quality financial statements are a good reflection of reality; accounting tricks and one-time changes are not used to make the firm appear stronger than it really is. a. True b. False ANSWER: True 31. Many analysts recommend that you should read an annual report forwards, that is, you would read the footnotes last. a. True richard@qwconsultancy.com

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b. False ANSWER: False Multiple Choice 32. Which of the following is NOT a consideration in the three-step valuation process? a. analysis of alternative economies b. analysis of security markets c. analysis of alternative industries d. analysis of individual companies e. All of these are considerations in the three-step valuation process.

ANSWER: e 33. Which of the following is NOT considered a basic economic force? a. fiscal policy b. monetary policy c. inflation d. P/E ratio e. All of these are basic economic forces.

ANSWER: d 34. The process of fundamental valuation requires estimates of all the following factors, EXCEPT for the a. time pattern of returns. b. economy's real risk-free rate. c. risk premium for the asset. d. times series of stock prices. e. expected rate of inflation.

ANSWER: d 35. Which of the following is correct? a. if estimated value > Market price, you should buy. b. if estimated value > Market price, you should sell. c. if estimated value < Market price, you should do nothing. d. if estimated value < Market price, you should buy. e. if estimated value > Market price, you should do nothing.

ANSWER: a 36. Which securities can be valued by dividing the annual dividend by the required rate of return? a. low coupon bonds b. junk bonds c. common stocks d. preferred stocks e. constant growth common stocks richard@qwconsultancy.com

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ANSWER: d 37. The most appropriate discount rate to use when applying the Operating Free Cash Flows model is the firm's a. required rate of return based on the capital asset pricing model (CAPM). b. required rate of return based on the dividend discount model (DDM). c. weighted average cost of capital (WACC). d. historical cost of debt and equity. e. All of these are correct.

ANSWER: c 38. According to the dividend growth model, if a company were to declare that it would never pay dividends, its value would be a. based on earnings. b. based on expectations regarding. c. higher than similar firms because it could reinvest a greater amount in new projects. d. zero. e. based on the capital asset pricing model.

ANSWER: d 39. Growth rates of the (1) labor force, (2) average number of hours worked, and (3) labor productivity are the main determinants of a foreign country's a. dividend payout ratio. b. beta. c. real risk free rate. d. nominal risk free rate. e. risk premium.

ANSWER: c 40. The growth rate of equity earnings without external financing is equal to a. retention rate plus return on equity. b. retention rate minus return on equity. c. retention rate divided by return on equity. d. retention rate times return on equity. e. return on equity divided by retention rate.

ANSWER: d 41. In 2018, Montpelier Inc. issued a $100 par value preferred stock that pays a 9 percent annual dividend. Due to changes in the overall economy and in the company's financial condition, investors are now requiring a 10 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now? a. $100 b. $110 c. $75 d. $90 richard@qwconsultancy.com

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e. $85 ANSWER: d 42. In 2018, Smiths Corp. issued a $50 par value preferred stock that pays a 6 percent annual dividend. Due to changes in the overall economy and in the company's financial condition, investors are now requiring a 7 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now? a. $42.86 b. $30.00 c. $31.54 d. $33.38 e. $38.37 ANSWER: a 43. In 2018, Venus Fly Co. issued a $75 par value preferred stock that pays a 7 percent annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring a 5 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now? a. $125 b. $84 c. $91 d. $145 e. $105 ANSWER: e 44. In 2018, Swisten Inc. issued a $150 par value preferred stock that pays an 8 percent annual dividend. Due to changes in the overall economy and in the company's financial condition, investors are now requiring a 15 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now? a. $80 b. $75 c. $59 d. $95 e. $110 ANSWER: a 45. Using the constant growth model, a decrease in the required rate of return from 15 to 13 percent combined with an increase in the growth rate from 5 to 6 percent would cause the price to a. rise more than 50 percent. b. rise less than 50 percent. c. remain constant. d. fall more than 50 percent. e. fall less than 50 percent.

ANSWER: b

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46. Using the constant growth model, an increase in the required rate of return from 19 to 17 percent combined with an increase in the growth rate from 11 to 9 percent would cause the price to a. fall more than 2 percent. b. fall less than 2 percent. c. remain constant. d. rise more than 2 percent. e. rise less than 3 percent.

ANSWER: b 47. Using the constant growth model, an increase in the required rate of return from 14 to 15 percent combined with an increase in the growth rate from 6 to 7 percent would cause the price to a. rise more than 1%. b. rise less than 1%. c. remain constant. d. fall more than 1%. e. fall less than 1%.

ANSWER: b 48. Using the constant growth model, an increase in the required rate of return from 17 to 20 percent combined with an increase in the growth rate from 8 to 11 percent would cause the price to a. rise more than 3%. b. rise less than 3%. c. remain constant. d. fall more than 3%. e. fall less than 3%.

ANSWER: b 49. Using the constant growth model, an increase in the required rate of return from 14 to 18 percent combined with an increase in the growth rate from 8 to 12 percent would cause the price to a. fall more than 4%0 b. fall less than 4%. c. rise more than 4%. d. rise less than 4%. e. remain constant.

ANSWER: d Exhibit 8.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Davenport Corporation's last dividend was $2.70, and the directors expect to maintain the historic 3 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 5 percent for the next three years and the stock will then reach $25 per share.

50. Refer to Exhibit 8.1. How much should you be willing to pay for the stock if you require a 17 percent return? richard@qwconsultancy.com

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a. $16.97 b. $22.16 c. $21.32 d. $32.63 e. $23.63 ANSWER: b 51. Refer to Exhibit 8.1. How much should you be willing to pay for the stock if you feel that the 5 percent growth rate can be maintained indefinitely and you require a 17 percent return? a. $22.16 b. $19.28 c. $21.32 d. $23.63 e. $25.46 ANSWER: d Exhibit 8.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The National Motor Company's last dividend was $1.25, and the directors expect to maintain the historic 4 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 7 percent for the next three years and the stock will then reach $25.00 per share.

52. Refer to Exhibit 8.2. How much should you be willing to pay for the stock if you require a 16 percent return? a. $17.34 b. $18.90 c. $19.09 d. $19.21 e. $20.35 ANSWER: d 53. Refer to Exhibit 8.2. How much should you be willing to pay for the stock if you feel that the 7 percent growth rate can be maintained indefinitely and you require a 16 percent return? a. $11.15 b. $14.44 c. $14.86 d. $18.90 e. $19.24 ANSWER: c 54. Ross Corporation paid dividends per share of $1.20 at the end of 1990. At the end of 2000, it paid dividends per share of $3.50. Calculate the compound annual growth rate in dividends. a. 52.17 percent richard@qwconsultancy.com

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b. 34.28 percent c. 23 percent d. 19.17 percent e. 11.29 percent ANSWER: e 55. Hunter Corporation had a dividend payout ratio of 63 percent in 1999. The retention rate in 1999 was a. 37 percent. b. 63 percent. c. 50 percent. d. 0 percent. e. 100 percent.

ANSWER: a 56. The beta for the DAK Corporation is 1.25. The yield on 30-year T-bonds is 5.65 percent, and the long-term average return on the S&P 500 is 11 percent. Calculate the required rate of return for DAK Corporation. a. 12.34 percent b. 7.06 percent c. 13.74 percent d. 5.35 percent e. 5.65 percent ANSWER: a 57. Micro Corp. just paid dividends of $2 per share. Assume that over the next three years dividends will grow as follows, 5 percent next year, 15 percent in year two, and 25 percent in year 3. After that growth is expected to level off to a constant growth rate of 10 percent per year. The required rate of return is 15 percent. Calculate the intrinsic value using the multistage model. a. $5.56 b. $66.4 c. $49.31 d. $43.66 e. $35.21 ANSWER: c Exhibit 8.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8 percent per year for the next five years. After that dividends are expected to grow at a normal rate of 5 percent per year. Assume that the appropriate discount rate is 7 percent.

58. Refer to Exhibit 8.3. The dividends for years 1, 2, and 3 are a. $2, $2.08, and $2.16. richard@qwconsultancy.com

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b. $2, $2.05, and $2.10. c. $2.16, $2.24, and $2.32. d. $2.16, $2.33, and $2.52. e. $2.07, $2.14, and $2.21.

ANSWER: d 59. Refer to Exhibit 8.3. The future price of the stock in year 5 is a. $113.40. b. $122.47. c. $132.27. d. $142.85. e. $154.35.

ANSWER: e 60. Refer to Exhibit 8.3. The present value today of dividends for years 1 to 5 is a. $4.06. b. $10.28. c. $12.40. d. $14.52. e. $10.0.

ANSWER: b 61. Refer to Exhibit 8.3. The price of the stock today (P0) is a. $136.29. b. $133.03. c. $120.33. d. $123.43. e. $126.60.

ANSWER: c Exhibit 8.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9 percent per year for the next three years. After that dividends are expected to grow at a normal rate of 5 percent per year. Assume that the appropriate discount rate is 7 percent.

62. Refer to Exhibit 8.4. The dividends for years 1, 2, and 3 are a. $1.5, $2.0, and $2.05. b. $1.64, $1.78, and $1.94. c. $1.64, $1.94, and $2.24. d. $1.5, $2.40, and $3.30. e. $2.07, $2.14, and $2.21.

ANSWER: b richard@qwconsultancy.com

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63. Refer to Exhibit 8.4. The future price of the stock in year 3 is a. $81.75. b. $84.81. c. $92.56. d. $101.85. e. $111.16.

ANSWER: d 64. Refer to Exhibit 8.4. The present value today of dividends for years 1 to 3 is a. $4.67. b. $3.08. c. $5.67. d. $4.5. e. $1.53.

ANSWER: a 65. Refer to Exhibit 8.4. The price of the stock today (P0) is a. $84.81. b. $87.81. c. $91.09. d. $94.32. e. $97.61.

ANSWER: b 66. Tayco Corporation has just paid dividends of $3 per share. The earnings per share for the company was $4. If you believe that the appropriate discount rate is 15 percent and the long-term growth rate in dividends is 6 percent, and earnings is 6 percent, then the firm's P/E ratio is a. 8.33. b. 33.33. c. 44.44. d. 11.11. e. 10.10.

ANSWER: a 67. What is the value of a 10 percent semi-annual coupon bond with a par value of $1,000 that matures in 5 years and has a required rate of return of 9 percent? a. $1,021.95 b. $1,038.90 c. $1,039.56 d. $1,064.18 e. $1,078.23 ANSWER: c

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68. What is the value of a preferred stock that has a par value of $100, a required rate of return of 11 percent, and pays a 7 percent annual dividend? a. $63.64 b. $157.14 c. $909.09 d. $1,428.57 e. $2,500.00 ANSWER: a 69. XCEL Corporation paid a dividend yesterday for $1.50. They expect to pay dividends annually at a constant 6 percent annual growth rate indefinitely. If the required rate of return on this investment is 12 percent, what is the current value of this common stock? a. $1.50 b. $12.50 c. $13.25 d. $25.00 e. $26.50 ANSWER: e Exhibit 8.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Fast Grow Corporation is expecting dividends to grow at a 20 percent rate for the next two years. The corporation just paid a $2 dividend, and the next dividend will be paid one year from now. After two years of rapid growth, dividends are expected to grow at a constant rate of 9 percent forever.

70. Refer to Exhibit 8.5. If the required return is 14 percent, what is the value of Fast Grow Corporation common stock today? a. $40.26 b. $42.38 c. $46.70 d. $52.63 e. $62.78 ANSWER: d 71. Refer to Exhibit 8.5. Assume that the annual dividend grows at a constant rate of 9 percent indefinitely instead of the supernormal growth. How much is the stock worth if dividends grow annually at 9 percent? a. $40.00 b. $43.60 c. $45.60 d. $47.80 e. $52.40 ANSWER: b

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72. What is the value to you of a 10 percent coupon bond with semi-annual coupon payments and a par value of $10,000 that matures in 20 years if you require an 8 percent return? a. $9,652.89 b. $10,356.65 c. $11,359.03 d. $11,979.28 e. $12,385.62 ANSWER: d 73. The Absolute Finance Company (AFC) earned $5 a share last year and paid a dividend of $2 per share. Next year, you expect AFC to earn $6 a share next year and continue its payout ratio. Assume that you expect to sell the stock for $45 a year from now. If you require a 13 percent return on this stock, how much would you be willing to pay for it? a. $41.95 b. $43.21 c. $45.13 d. $46.72 e. $47.40 ANSWER: a 74. A company has a dividend payout ratio of 35 percent. If the company's return on equity is 15 percent, what is the expected growth rate if no new outside financing is used? a. 4.50 percent b. 5.25 percent c. 7.75 percent d. 8.25 percent e. 9.75 percent ANSWER: e 75. A company's dividend last year was $3.00. Dividends are expected to grow indefinitely at 7 percent, and the required rate of return for the stock is 13 percent. What is the value of the stock today? a. $2.83 b. $23.08 c. $24.69 d. $50.00 e. $53.50 ANSWER: e 76. Which of the following statements regarding fundamental and relative valuation techniques is TRUE? a. Both techniques require an appropriate estimate of the required rate of return and the growth rate. b. Both techniques require an estimate of a discount rate. c. Both techniques require an estimate of future cash flows and a discount rate. d. Both techniques require an estimate of future cash flows and a growth rate. richard@qwconsultancy.com

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e. Both techniques require an estimate of future cash flows, the required rate of return, and a growth estimate.

ANSWER: a 77. All of the following are ways in which a firm can increase its growth rate of equity earnings without any external financing EXCEPT a. decreasing its dividend payments. b. increasing its retention ratio. c. increasing its return on equity (ROE). d. increasing its return on assets (ROA). e. All of these are correct.

ANSWER: e 78. The P/E ratio for BMI Corporation is 21, and the P/S ratio is 5.2. The industry P/E ratio is 35, and the industry P/S ratio is 7.5. Based on relative valuation, BMI is a. undervalued on the basis of relative P/E and relative P/S. b. overvalued on the basis of relative P/E and undervalued on the basis of relative P/S. c. undervalued on the basis of relative P/E and overvalued on the basis of relative P/S. d. overvalued on the basis of relative P/E and relative P/S. e. overvalued on the basis of relative P/E. ANSWER: a 79. The gross margin is defined as a. Gross Profit/Sales. b. Operating Profit/Sales. c. Net Income/Sales. d. Sales/Gross Profit. e. Debt/Long-Term Capital.

ANSWER: a 80. Operating margins are defined as a. Gross Profit/Sales. b. Operating Profit/Sales. c. Net Income/Sales. d. Sales/Gross Profit. e. Debt/Long-Term Capital.

ANSWER: b 81. Net margins are defined as a. Gross Profit/Sales. b. Operating Profit/Sales. c. Net Income/Sales. d. Sales/Average Accounts Receivable. e. Debt/Long-Term Capital.

ANSWER: c richard@qwconsultancy.com

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82. Accounts receivable turnover is defined as a. Gross Profit/Sales. b. Operating Profit/Sales. c. Net Income/Sales. d. Sales/Average Accounts Receivable. e. Debt/Long-Term Capital.

ANSWER: c 83. A high-quality balance sheet typically has a. limited footnotes. b. a poor reflection of reality. c. repeatable earnings. d. over use of debt or leverage. e. limited use of debt or leverage.

ANSWER: e

Chapter 09 - The Top-Down Approach to Market, Industry, and Company Analysis 1. Returns from the overall market (or an individual stock) can be thought of as a combination of three factors: earnings growth, multiple expansion (or contraction), and dividend yield. a. True b. False ANSWER: True 2. Earnings growth and dividend yield will be impacted by GDP growth. a. True b. False ANSWER: True 3. Stock prices move coincidentally with the economy. a. True b. False ANSWER: False 4. The cyclical indicator approach to market analysis is based on the belief that the economy expands and contracts in a random manner. a. True b. False ANSWER: False 5. Leading indicators of the business cycle include economic series that reach peaks or troughs before the peaks and troughs of the overall economy. a. True richard@qwconsultancy.com

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b. False ANSWER: True 6. Coincident indicators include economic time series that have peaks and troughs that roughly occur at the same time as the peaks and troughs of overall economic activity. a. True b. False ANSWER: True 7. The economy and the stock market have a strong, consistent relationship, but the stock market generally turns before the economy does. a. True b. False ANSWER: True 8. The University of Michigan Consumer Sentiment Index is an example of a leading indicator. a. True b. False ANSWER: True 9. The best known monetary variable is the level of taxes. a. True b. False ANSWER: False 10. In well developed economies, markets are not affected by changes in expected inflation. a. True b. False ANSWER: False 11. One of the economic series included in the Conference Board coincident indicator is the index of industrial production. a. True b. False ANSWER: True 12. Interest rate spread, 10-year Treasury bonds less federal funds, is listed as a lagging indicator in the Conference Board. a. True b. False ANSWER: False 13. Building permits for new private housing units are listed as a leading indicator by the Conference Board. a. True richard@qwconsultancy.com

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b. False ANSWER: True 14. Recent studies show that money supply changes have an important impact on stock price movements. a. True b. False ANSWER: True 15. Recent studies indicate that one can earn excess returns in the stock market by forecasting unanticipated changes in the money supply. a. True b. False ANSWER: True 16. The economic factor assumed to be closely related to stock prices is productivity. a. True b. False ANSWER: False 17. It is important to analyze the economies and security markets before analyzing alternative industries or companies. a. True b. False ANSWER: False 18. Over the last 20 years, increases in the return on equity for the S&P Index have been associated with decreases in return of assets. a. True b. False ANSWER: False 19. It is more important to estimate future earnings than the future earnings multiplier. a. True b. False ANSWER: False 20. An analysis of U.S. equity markets using the cash flow techniques concludes that the market is not fully valued. a. True b. False ANSWER: False 21. There is a negative relationship between the capacity utilization rate and the profit margin. a. True richard@qwconsultancy.com

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b. False ANSWER: False 22. Estimating net profit margin directly is difficult because it is so volatile. a. True b. False ANSWER: True 23. An increase in the required rate of return k will increase the P/E ratio. a. True b. False ANSWER: False 24. Future tax rates are difficult to estimate because they are politically influenced. a. True b. False ANSWER: True 25. As the market's return on equity increases so will the P/E ratio. a. True b. False ANSWER: True 26. It is reasonable to expect corporate sales to be closely related to GNP. a. True b. False ANSWER: True 27. Dividend growth is positively related to the return on equity. a. True b. False ANSWER: True 28. Changes in the dividend payout ratio are positively related to changes in the retention rate. a. True b. False ANSWER: False 29. A major advantage of the cyclical indicator approach is that it spans all important major economic sectors, including the service sector and import-exports. a. True b. False ANSWER: False

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30. When estimating a major stock market value using the earnings multiplier approach, near-term estimates of the required rate of return and growth rate are essential due to the impact of near-term events on cash flows. a. True b. False ANSWER: False 31. The authors of the text prefer forward valuation ratios as opposed to historical valuation variables in relative valuation methods. a. True b. False ANSWER: True 32. An increase in the retention ratio will cause a decrease in the growth rate. a. True b. False ANSWER: False 33. Present value of free cash flow to equity resembles the present value of earnings concept except that it includes the capital expenditures required to maintain and grow the firm and the change in working capital required for a growing firm. a. True b. False ANSWER: True 34. In the present value of operating free cash flow technique, the firm's operating free cash flow to the firm is discounted at the firm's weighted average cost of capital (WACC). a. True b. False ANSWER: True 35. The best-known measure of relative value for common stock is the P/E ratio. a. True b. False ANSWER: True 36. Price-to-book value ratio cannot be used to estimate the value of firms with negative earnings or negative cash flows. a. True b. False ANSWER: False 37. The price/cash flow ratio has grown in prominence and use for valuing firms because many analysts contend that a firm's cash flow is less subject to manipulation than the firm's earnings per share. a. True richard@qwconsultancy.com

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b. False ANSWER: True 38. Price-to-sales ratio is still considered the predominant firm valuation technique. a. True b. False ANSWER: False 39. The constant growth dividend growth model is not appropriate for the valuation of growth companies. a. True b. False ANSWER: True 40. The sustainable growth rate can be calculated by taking the dividend payout ratio time return on equity (ROE). a. True b. False ANSWER: False 41. A growth company is one whose stock is undervalued by the market. a. True b. False ANSWER: False 42. A cyclical company's sales and earnings are heavily influenced by aggregate business activity. a. True b. False ANSWER: True 43. By definition growth companies have growth stocks. a. True b. False ANSWER: False 44. A stock with low systematic risk is considered to be a defensive stock. a. True b. False ANSWER: True 45. A growth company is a firm that has the opportunities and ability to invest capital in projects that generate rates of return greater than the firm's cost of debt. a. True b. False ANSWER: False richard@qwconsultancy.com

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46. An undervalued stock is a growth stock. a. True b. False ANSWER: True 47. An overvalued stock is a non-growth stock. a. True b. False ANSWER: True 48. A cyclical stock's rate of return is not expected to decline during an overall market decline. a. True b. False ANSWER: False 49. With a differentiation strategy, a firm seeks to identify itself as unique in its industry in an area that is important to buyers. a. True b. False ANSWER: True 50. A defensive company is one whose sales, earnings, and cash flows are strongly correlated with the business cycle. a. True b. False ANSWER: False 51. A firm's competitive strategy can be either defensive or offensive. a. True b. False ANSWER: True 52. To benefit from cost leadership, a firm must command prices near the industry average. a. True b. False ANSWER: True 53. Two major competitive strategies are low-cost leadership and low-price leadership. a. True b. False ANSWER: False 54. An offensive competitive strategy involves positioning the firm to deflect the effect of the competitive forces in the industry. richard@qwconsultancy.com

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a. True b. False ANSWER: False 55. Low-cost leadership and differentiation are two major competitive strategies suggested by Porter. a. True b. False ANSWER: True 56. Underpriced stocks can be ranked using the excess return ratio, which is calculated as the Market price/Risk free rate. a. True b. False ANSWER: False 57. Operating free cash flow and free cash flow to equity are equivalent cash flow concepts. a. True b. False ANSWER: False 58. One way to measure a company's intrinsic value is to divide the company's current dividends by the required return less the dividend growth rate. a. True b. False ANSWER: False 59. According to Peter Lynch, a favorable attribute of a firm that may result in favorable stock performance is when a firm's product is the latest craze. a. True b. False ANSWER: False 60. According to Peter Lynch, a favorable attribute of a firm that may result in favorable stock performance is when a firm buys back its shares. a. True b. False ANSWER: False 61. Returns from the overall market (or an individual stock) can be thought of as a combination of which of the following factors? a. earnings growth, multiple expansion, and dividend yield b. earnings growth, multiple expansion, and annualized return c. earnings growth, interest rates, and dividend yield d. inflation, multiple contraction, and dividend yield e. inflation, contraction, and annualized return richard@qwconsultancy.com

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ANSWER: a 62. The index of leading indicators includes all of the following, EXCEPT a. M2 money supply. b. S&P 500 index. c. orders for plant and equipment. d. changes in the sensitive materials price. e. index of industrial production.

ANSWER: d 63. Which of the following are NOT cyclical indicators? a. selected series b. coincident indicators c. diffusion indicators d. leading indicators e. lagging indicators ANSWER: c 64. In the U.S. balance of payments, the federal deficit and military contract awards are ____ of aggregate economic activity. a. leading indicators b. coincident indicators c. lagging indicators d. lot categorized indicators e. lot indicators ANSWER: d 65. Which of the following series does NOT include the long-leading index? a. Dow Jones Industrial Average b. Dow Jones Bond Prices, Percent Face Value c. Price to Unit Labor Cost d. M2 Money Supply, Deflated e. New Building Permits ANSWER: a 66. Which of the following variables was NOT considered significant in explaining stock returns? a. industrial production b. changes in the risk premium c. consumption d. twists in the yield curve e. inflation ANSWER: c 67. The correlation of stock market returns between the U.S. and Japan is ____ and ____. richard@qwconsultancy.com

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a. high, increasing. b. high, decreasing. c. low, increasing. d. low, decreasing. e. low, remaining constant.

ANSWER: c 68. Which of the following is NOT an analytical measure used by the Conference Board to examine behavior within a series? a. diffusion indexes b. rates of change c. direction of change d. ratios among series e. comparison with previous cycles ANSWER: d 69. Excess liquidity is defined as a. the year-to year percentage change in the M2 money supply less the year-to-year percentage change in the nominal GNP. b. the growth rate in the M2 money supply less the growth rate in the M1 money supply. c. the year-to-year percentage change in the M1 money supply less the year-to-year percentage. d. the year-to-year percentage change in the "real" GNP less the year-to-year percentage change in the nominal GNP. e. None of these are correct.

ANSWER: d 70. Which of the following is NOT normally associated with cyclical indicators? a. the Securities and Exchange Commission b. the Conference Board c. Business Week d. Center for International Business Cycle Research e. All of these are correct.

ANSWER: c 71. Which of the following is NOT a reason given for why forecasters 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, as they try to include a number of ideas in their forecasts. e. None of these are correct (that is, all are reasons cited for why forecasters are often incorrect).

ANSWER: d richard@qwconsultancy.com

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72. The Conference Board has derived the following indicator series in order to monitor business cycles: a. M2, leading, and lagging b. leading, coincident, and consumer expectations c. leading, coincident, and lagging d. leading, coincident, and M e. consumer expectations, leading, and lagging ANSWER: c 73. An examination of the relationship between stock prices and the economy has shown that the relationship is a. weak and that stock prices turn after the economy does. b. nonexistent. c. strong and that stock prices turn after the economy does. d. strong and that stock prices turn before the economy does. e. weak and that stock prices turn before the economy does.

ANSWER: d 74. Which of the following economic series are included in the Conference Board coincident indicator group? a. employees on nonagricultural payrolls b. change in consumer price index for services c. index of consumer expectations d. spread of 10-year Treasury yield less fed funds e. index of stock prices ANSWER: a 75. Which of the following economic series are included in the Conference Board lagging indicator series? a. vendor performance b. index of industrial production c. manufacturing and trade sales data in 1992 dollars d. manufacturers' new orders, non-defense capital goods e. average duration of unemployment in weeks ANSWER: e 76. The initial effect of a change in monetary policy appears in ____ and only later in ____. a. the aggregate economy, financial markets b. financial markets, the aggregate economy c. bond markets, stock markets d. stock markets, bond markets e. stock markets, the aggregate economy ANSWER: b

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77. If interest rates increase due to inflation, but expected cash flows to a firm do not change, then you would expect stock prices to a. rise. b. rise and then decline. c. remain unchanged. d. decline. e. decline and then rise.

ANSWER: d 78. If interest rates rise due to inflation, and expected cash flows to a firm rise, then you would expect stock prices to a. rise. b. rise and then decline. c. rise and then decline. d. decline. e. decline and then rise.

ANSWER: c 79. Which of the following economic series is NOT included in the Conference Board leading indicator group? a. average weekly initial claims for unemployment b. index of 500 consumer stock prices c. real money supply, M2 d. index of industrial production e. All of these are correct (that is, all are included in the lagging indicator group).

ANSWER: d 80. Which of the following economic series is NOT included in the Conference Board lagging indicator group? a. average duration of unemployment b. ratio of manufacturing and trade inventories to sales c. number of employees on nonagricultural payrolls d. percentage change in the labor cost per unit of output in manufacturing e. All of these are correct (that is, all are included in the lagging indicator group).

ANSWER: c 81. Which of the following economic series is NOT included in the Conference Board coincident economic indicator group? a. total value of commercial loans b. employees on nonagricultural payrolls c. personal income less transfer payments d. industrial production e. manufacturing and trade sales ANSWER: a

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82. There are several techniques available to help an investor make a market decision. Which of the following is NOT such an analysis technique? a. macro techniques that are based on the strong relationship between the economy and security markets b. micro techniques that estimate future market values by applying one of several basic valuation models to equity markets c. technical analysis in which an investor analyzes past and recent market movements for indications of future performance d. fundamental analysis that considers the effect of market on the entire portfolio e. None of these are correct (that is, all are techniques available to make market decisions).

ANSWER: d 83. Which of the following is NOTa factor under the Free Cash Flow to Equity (FCFE) Model? a. depreciation expense b. capital expenditure c. change in working capital d. principal debt repayment e. earnings multiplier ANSWER: d 84. Expected earnings per share estimates requires all of the following EXCEPT a. a sales per share estimate. b. a GDP estimate. c. an aggregate operating profit margin estimate d. an estimate of the real risk-free rate. e. a tax rate estimate.

ANSWER: d 85. The dividend payout ratio, the required rate of return on common equity, and the expected growth rate of stock dividends are the major variables that affect a. the profit margin for the S&P Industrials Index. b. the earnings multiplier for common stock. c. aggregate tax revenues. d. capital gains tax revenues. e. aggregate GDP. ANSWER: b 86. Aggregate return on equity increases as a. profit margins increase. b. total asset turnover increases. c. financial leverage increases. d. equity turnover decreases. e. All of these are correct.

ANSWER: d

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87. All of the following factors affect the required rate of return EXCEPT a. the economy's risk-free rate. b. corporate business risk. c. return on equity. d. country risk. e. expected rate of inflation.

ANSWER: c 88. The growth rate (g) of dividends is affected by all of the following EXCEPT a. required return. b. retention rate. c. total asset turnover. d. financial leverage. e. net profit margin.

ANSWER: a 89. Unit labor costs, the rate of inflation, the level of foreign competition, and the capacity utilization rate were variables tested by Finkel and Tuttle as determinants of the a. balance of payments. b. the exchange rate. c. aggregate operating profit margin. d. aggregate profit margin. e. aggregate cost margin.

ANSWER: d 90. Which of the following is NOT a determinant of the aggregate gross profit margin? a. unit labor costs of production b. rate of inflation c. unemployment rate d. level of foreign competition e. growth rate of M2 money supply ANSWER: e 91. Which of the following is NOT a major variable that affects the aggregate stock market earnings multiplier in a country? a. required rate of return on common stock in the country b. expected growth rate of dividends for the stocks in the country c. composite dividend-payout ratio for common stocks in country d. composite debt to equity ratio for firms in the country e. All of these are correct (that is, all are major variables for a country's aggregate stock market earnings multiplier).

ANSWER: d 92. The growth rate will most likely increase if the a. retention ratio decreases. richard@qwconsultancy.com

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b. payout ratio decreases. c. return on equity decreases. d. net income increases. e. gross income decreases.

ANSWER: b 93. When applying the earnings multiplier model, all of the following will cause the required rate of return, k, to change EXCEPT a. changes in the real risk-free rate. b. changes in the retention rate. c. changes in the rate of inflation. d. changes in the risk premium for common stock. e. All of these are correct (that is, all of these changes will cause a change in the required rate of return).

ANSWER: b 94. If, for the S&P Industrials Index, the profit margin was 0.35 and the equity turnover ratio was 10, the ROE would be a. 0.035 percent. b. 2.857 percent. c. 3.500 percent. d. 28.57 percent. e. 35.00 percent.

ANSWER: c 95. If, for the S&P Industrials Index, the profit margin was 0.30 and the equity turnover ratio was 11, the ROE would be a. 0.033 percent. b. 3.300 percent. c. 33.00 percent. d. 36.70 percent. e. 333.00 percent.

ANSWER: b 96. If, for the S&P Industrials Index, the profit margin was .25 and the equity turnover ratio was 12, the ROE would be a. 0.83 percent. b. 0.48 percent. c. 3.00 percent. d. 30.00 percent. e. 48.00 percent.

ANSWER: c 97. If, for the S&P Industrials Index, the profit margin was 0.20 and the equity turnover ratio was 13, the ROE would be richard@qwconsultancy.com

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a. 0.026 percent. b. 2.600 percent. c. 6.500 percent. d. 26.00 percent. e. 65.00 percent.

ANSWER: b 98. The dividend payout ratio for the aggregate market is 55 percent, the required rate of return is 15 percent, and the expected growth rate for dividends is 7 percent. Compute the current earnings multiple. a. 3.93 b. 78.6 c. 6.88 d. 39.3 e. 7.89 ANSWER: c 99. The dividend payout ratio for the aggregate market is 65 percent, the required rate of return is 13 percent, and the expected growth rate for dividends is 8 percent. Compute the current earnings multiple. a. 7 b. 13 c. 4.61 d. 14.61 e. 15 ANSWER: b 100. The dividend payout ratio for the aggregate market is 65 percent, the required rate of return is 12 percent, and the expected growth rate for dividends is 6 percent. Compute the current earnings multiple. a. 5.41 b. 16.25 c. 6.25 d. 10.83 e. 11.58 ANSWER: d 101. The dividend payout ratio for the aggregate market is 50 percent, the required rate of return is 16 percent, and the expected growth rate for dividends is 6 percent. Compute the current earnings multiple. a. 5 b. 2.81 c. 7.5 d. 4 e. 3 ANSWER: a richard@qwconsultancy.com

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Exhibit 9.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that the dividend payout ratio will be 65 percent when the rate on long-term government bonds falls to 8 percent. Because investors are becoming more risk averse, the equity risk premium will rise to 7 percent and investors will require a 15 percent return. The return on equity will be 12 percent.

102. Refer to Exhibit 9.1. What is the expected sustainable growth rate? a. 2.80 percent b. 4.20 percent c. 5.25 percent d. 7.80 percent e. 9.75 percent ANSWER: b 103. Refer to Exhibit 9.1. What is your expectation of the market P/E ratio? a. 8.33 b. 5.33 c. 9.03 d. 6.02 e. 3.24 ANSWER: d 104. Refer to Exhibit 9.1. To what price will the market rise if the earnings expectation is $22.00 per share? a. $183.26 b. $132.41 c. $198.66 d. $71.28 e. $14.30 ANSWER: b Exhibit 9.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that the dividend payout ratio will be 75 percent when the rate on long-term government bonds falls to 8 percent. Because investors are becoming more risk averse, the equity risk premium will rise to 7 percent and investors will require a 15 percent return. The return on equity will be 12 percent.

105. Refer to Exhibit 9.2. What is the expected sustainable growth rate? a. 9.0 percent b. 7.2 percent richard@qwconsultancy.com

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c. 6.0 percent d. 3.0 percent e. 3.6 percent ANSWER: d 106. Refer to Exhibit 9.2. What is your expectation of the market P/E ratio? a. 3.92 b. 6.25 c. 6.67 d. 8.33 e. 12.00 ANSWER: b 107. Refer to Exhibit 9.2. To what price will the market rise if the earnings expectation is $32.00? a. $384.00 b. $266.56 c. $213.44 d. $200.00 e. $125.44 ANSWER: d Exhibit 9.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that the dividend payout ratio will be 55 percent when the rate on long-term government bonds falls to 9 percent. Because investors are becoming more risk averse, the equity risk premium will rise to 8 percent and investors will require a 7 percent return. The return on equity will be 13 percent.

108. Refer to Exhibit 9.3. What is the expected sustainable growth rate? a. 5.85 b. 7.15 c. 4.05 d. 6.75 e. 8.25 ANSWER: a 109. Refer to Exhibit 9.3. What is your expectation of the market P/E ratio? a. 37.69 b. 24.92 c. 58.15 d. 55.02 e. 47.82 ANSWER: e richard@qwconsultancy.com

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110. Refer to Exhibit 9.3. To what price will the market rise if the earnings expectation is $1.5? a. $138.42 b. $90.36 c. $71.74 d. $105.30 e. $85.14 ANSWER: c Exhibit 9.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that the dividend payout ratio will be 45 percent when the rate on long-term government bonds falls to 9 percent. Because investors are becoming more risk averse, the equity risk premium will rise to 7 percent and investors will require a 16 percent return. The return on equity will be 14 percent.

111. Refer to Exhibit 9.4. What is the expected sustainable growth rate? a. 4.95 b. 7.2 c. 8.8 d. 6.3 e. 7.7 ANSWER: e 112. Refer to Exhibit 9.4. What is your expectation of the market P/E ratio? a. 5.42 b. 7.14 c. 6.63 d. 6.25 e. 5.11 ANSWER: a 113. Refer to Exhibit 9.4. To what price will the market rise if the earnings expectation is $10.00? a. $71.40 b. $66.30 c. $54.20 d. $77.00 e. $51.10 ANSWER: c Exhibit 9.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

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An analyst wishes to estimate the share price for Ashley Corporation. The following information is made available: Estimated profit margin = 15% Total asset turnover = 2 Financial leverage = 1.2 Estimated dividend payout ratio = 75% Required rate of return = 14% Estimated EPS = $2.50

114. Refer to Exhibit 9.5. Calculate the firm's ROE. a. 36% b. 25% c. 15% d. 10% e. 8% ANSWER: a 115. Refer to Exhibit 9.5. The firm's sustainable growth rate is a. 15%. b. 10%. c. 9%. d. 8%. e. 7%.

ANSWER: c 116. Refer to Exhibit 9.5. Calculate the P/E multiple. a. 35 b. 30 c. 25 d. 20 e. 15 ANSWER: e 117. Refer to Exhibit 9.5. Calculate the firm's estimated share price. a. 57.5 b. 37.5 c. 45 d. 32.75 e. 75 ANSWER: b Exhibit 9.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

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Consider the following information that you propose to use to obtain an estimate of year 2004 EPS for the MacLog Company.

GDP GDP growth Sales per share Operating profit margin Depreciation/Fixed Assets Fixed asset turnover Interest rate Total asset turnover Debt/Total assets Tax rate

Year 2019 11,000 Billion

Estimated Year 2020 3.5%

$800 12% 14% 2 3.5% 0.7 45% 36%

In addition, a regression analysis indicates the following relationship between growth in sales per share for MacLog, and GDP growth is % Sales per share = 0.015 + 0.75(% GDP)

118. Refer to Exhibit 9.6. Calculate GDP for the year 2020. a. $10,500 billion b. $11,000 billion c. $11,385 billion d. $10,550 billion e. $11,025 billion ANSWER: c 119. Refer to Exhibit 9.6. Estimate the firm's growth rate in sales per share. a. 1.5% b. 2% c. 2.16% d. 4.13% e. 3.73% ANSWER: d 120. Refer to Exhibit 9.6. Estimate the firm's sales per share for the year 2020. a. $833.04 b. $900.08 c. $885.03 d. $925.56 e. $850.75 ANSWER: a 121. Refer to Exhibit 9.6. Calculate the firm's year 2020 EBITDA per share. a. $95.05 richard@qwconsultancy.com

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b. $87.15 c. $112.56 d. $104.73 e. $99.96 ANSWER: e 122. Refer to Exhibit 9.6. Obtain an estimate of the per share depreciation charge for the year 2020. a. $58.31 b. $102.35 c. $53.68 d. $75.93 e. $65.78 ANSWER: a 123. Refer to Exhibit 9.6. Calculate the per share EBIT for the year 2020. a. $35.53 b. $41.65 c. $55.89 d. $65.14 e. $75.10 ANSWER: b 124. Refer to Exhibit 9.6. Calculate the firm's level of Total Assets per share for the year 2020. a. $1050.65 b. $1065.67 c. $1113.58 d. $1190.06 e. $1385.77 ANSWER: d 125. Refer to Exhibit 9.6. Calculate the firm's level of debt for the year 2020. a. $535.53 b. $600.75 c. $637.67 d. $485.98 e. $393.72 ANSWER: a 126. Refer to Exhibit 9.6. Calculate the per share interest rate charge for the year 2020. a. $18.74 b. $14.72 c. $30.07 d. $13.76 e. $28.59 richard@qwconsultancy.com

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ANSWER: a 127. Refer to Exhibit 9.6. Calculate the firm's EBT per share for the year 2020. a. $13.29 b. $27.89 c. $18.75 d. $19.63 e. $22.91 ANSWER: e 128. Refer to Exhibit 9.6. Calculate the firm's EPS for the year 2020. a. $15.25 b. $14.66 c. $17.25 d. $12.56 e. $18.57 ANSWER: b Exhibit 9.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You are using the free cash flow to equity (FCFE) technique to analyze the U.S. equity market. The beginning FCFE is $90, and the required rate of return is 10 percent. Free cash flows are expected to grow at a 10 percent rate for the next two years and then grow at a constant rate of 7 percent forever.

129. Refer to Exhibit 9.7. What will FCFE be three years from now? a. 108.90 b. 116.52 c. 117.00 d. 119.79 e. 120.21 ANSWER: b 130. Refer to Exhibit 9.7. What is the estimated value of the U.S. market today using the FCFE approach? a. 2,852 b. 2,918 c. 3,210 d. 3,390 e. 3,884 ANSWER: d 131. Refer to Exhibit 9.7. What would the estimated value of the U.S. market be today using the FCFE approach, if the growth rate was expected to be a constant 8 percent indefinitely, instead of the 10 percent and 7 percent estimates? richard@qwconsultancy.com

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a. 4,500 b. 4,728 c. 4,860 d. 4,923 e. 5,042 ANSWER: c 132. Compute the current earnings multiple if the dividend payout ratio for the aggregate market is 60 percent, the required rate of return is 11 percent, and the dividend growth rate is 8 percent. a. 15 b. 20 c. 25 d. 30 e. 35 ANSWER: b Exhibit 9.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) As an economist for a research firm, you are forecasting the market P/E ratio using the dividend discount model. Because the economy has been slow for 5 years, you expect the dividend-payout ratio to be 55 percent. Long-term government bond rates are at 6 percent, and the equity risk premium is estimated to be 3 percent. Return on equity (ROE) is estimated to be 11 percent.

133. Refer to Exhibit 9.8. What is the expected growth rate? a. 3.00 percent b. 3.92 percent c. 4.95 percent d. 5.27 percent e. 6.05 percent ANSWER: c 134. Refer to Exhibit 9.8. What is your expectation of the market P/E ratio? a. 9.17 b. 11.11 c. 13.58 d. 18.33 e. 21.42 ANSWER: c Exhibit 9.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The aggregate market currently has a retention ratio of 60 percent, a required rate of return of 12 percent, and an expected growth rate for dividends of 4 percent. richard@qwconsultancy.com

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135. Refer to Exhibit 9.9. What is the current earnings multiplier? a. 2.5 b. 5.0 c. 7.5 d. 10.0 e. 12.5 ANSWER: b Exhibit 9.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The aggregate market currently has a retention ratio of 60 percent, a required rate of return of 12 percent, and an expected growth rate for dividends of 4 percent.

136. Refer to Exhibit 9.9. If the payout ratio changes to 50 percent, but there are no other changes, what will be the new P/E? a. 3.25 b. 4.16 c. 5.75 d. 6.25 e. 7.67 ANSWER: d 137. Refer to Exhibit 9.9. Starting with the initial conditions, you expect the retention ratio to be constant, the rate of inflation to decline by 2 percent, and the growth rate to decline by 1 percent.

What is the expected P/E? a. 8.57 b. 8.00 c. 6.67 d. 5.71 e. 5.00 ANSWER: d 138. Refer to Exhibit 9.9. Starting with the initial conditions, you expect the retention ratio to be constant, the rate of inflation to increase by 2 percent, and the growth rate to increase by 1 percent.

What is the expected P/E? a. 4.44 b. 5.00 c. 5.71 d. 6.67 e. 8.00 ANSWER: a

richard@qwconsultancy.com

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139. Toward the end of a recession, which stocks often recover first as their earnings rise? a. financial stocks b. consumer durable goods c. capital goods d. cyclical companies e. consumer staples ANSWER: a 140. _____ do well as the economy recovers. a. Financial stocks b. Consumer durable goods c. Capital goods d. Cyclical companies e. Consumer staples ANSWER: b 141. _____ tend to do well as the economy moves past recovery and into expansion. a. Financial stocks b. Consumer durable goods c. Capital goods d. Cyclical companies e. Consumer staples ANSWER: c 142. _____ tend to move in anticipation of the business cycle, turning up in anticipation of recovery and turning down at signs of economic weakness. a. Financial stocks b. Consumer durable goods c. Capital goods d. Cyclical companies e. Consumer staples ANSWER: d 143. _____ tend to outperform during an economic slowdown. a. Financial stocks b. Consumer durable goods c. Capital goods d. Cyclical companies e. Consumer staples ANSWER: d 144. Porter contends that ____ and ____ are two important competitive strategies. a. low cost leadership, barrier to entry b. new entrant deterrent, differentiation c. low cost leadership, differentiation richard@qwconsultancy.com

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d. differentiation, monopolistic e. monopolistic simulation, differentiation ANSWER: c 145. Which of the following factors does NOT indicate market liquidity? a. number of shareholders b. high price volatility c. number of shares outstanding d. number of shares traded e. institutional interest ANSWER: b 146. Which of the following statements concerning global company analysis is FALSE? a. Analysis of companies within industries should be extended to include foreign companies. b. There is a problem in obtaining data that is required for a thorough company analysis of foreign companies. c. Foreign companies' financial risk should be evaluated over time. d. Differences in relative measures can be explained by the variations in accounting procedures among countries and investors attitudes within each country. e. None of these are correct.

ANSWER: e 147. A speculative stock possesses a ____ probability of ____ return and is currently ____. a. high, negative, underpriced. b. high, negative, overpriced. c. high, positive, overpriced. d. low, negative, overpriced. e. low, positive, underpriced.

ANSWER: b 148. A ____ stock possesses a high probability of low or negative rates of return and a low probability of normal or high rates of return. a. growth b. defensive c. cyclical d. speculative e. value ANSWER: d 149. A growth company is one that has the ability to a. acquire capital at a low cost and is able to invest in projects that yield an average return. b. acquire capital at a low cost and is able to invest in projects that yield a below average return. c. acquire capital at an average cost and is able to invest in projects that yield an above average return. richard@qwconsultancy.com

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d. acquire capital at an average cost and is able to invest in projects that yield an average return. e. acquire capital at an above average cost and is able to invest in projects that yield an average return.

ANSWER: c 150. Cyclical companies are firms in which a. sales, earnings, and cash flows are extremely uncertain and not necessarily related to the economy. b. sales, earnings, and cash flows are likely to withstand changes caused by the economic environment. c. sales, earnings, and cash flows are heavily influenced by aggregate business activity. d. sales, earnings, and cash flows are growing exponentially. e. None of these are correct.

ANSWER: c 151. Defensive companies are firms in which a. sales, earnings, and cash flows are extremely uncertain and not necessarily related to the economy. b. sales, earnings, and cash flows are likely to withstand changes caused by the economic environment. c. sales, earnings, and cash flows are heavily influenced by aggregate business activity. d. sales, earnings, and cash flows are growing exponentially. e. None of these are correct.

ANSWER: b 152. Speculative companies are firms in which a. sales, earnings, and cash flows are extremely uncertain and not necessarily related to the economy. b. sales, earnings, and cash flows are likely to withstand changes caused by the economic environment. c. sales, earnings, and cash flows are heavily influenced by aggregate business activity. d. sales, earnings, and cash flows are growing exponentially. e. None of these are correct.

ANSWER: a 153. When a firm seeks to identify itself as unique in its industry in an area that is important to buyers, it is known as a a. defensive strategy. b. differentiation strategy. c. low-cost strategy. d. focused strategy. e. value strategy.

ANSWER: b 154. What variables impact the Price/Sales ratio? richard@qwconsultancy.com

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a. sales growth rate, volatility of sales growth, profit margin b. earnings growth rate, volatility of sales growth, profit margin c. earnings growth rate, volatility of sales growth, operating margin d. sales growth rate, volatility of sales growth, operating margin e. sales growth rate, volatility of profit margin, profit margin ANSWER: a 155. A growth company may exist for all of the following reasons EXCEPT a. the company holds patents. b. the company possesses unique distribution or marketing strategies. c. the company is in a competitive environment. d. significant barriers to entry exist. e. All of these are correct (that is, all of these are reasons a growth company may exist).

ANSWER: c 156. In a(n) ____ strategy, a firm seeks to identify itself as unique within its industry. a. defensive b. offensive c. low-cost d. differentiation e. leadership ANSWER: d 157. In SWOT analysis, one examines all of the following factors, EXCEPT a. strengths. b. weaknesses. c. opportunities. d. threats. e. turnarounds.

ANSWER: e 158. Which of the following statements concerning SWOT analysis is FALSE? a. Strengths are the factors that give the firm a comparative advantage in the marketplace. b. Weaknesses result when the company has potentially exploitable advantages over other firms. c. Opportunities are environmental factors that favor the firm. d. Threats are environmental factors that can hinder the firm in achieving its goals. e. None of these are correct (that is, all statements are true).

ANSWER: b 159. Which of the following is NOT a technique for valuing a firm's common stock? a. present value of free cash flow to equity b. present value of dividends c. price-earnings ratio richard@qwconsultancy.com

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d. price-book value ratios e. price-cost of goods sold ratio ANSWER: e 160. Which of the following is NOT considered when looking at free cash flow to equity technique? a. depreciation expense b. change in working capital c. principal debt repayments d. change in competitive environment e. net income ANSWER: d 161. Under the present value of operating free cash flow technique, the firm's operating free cash flow to the firm is discounted at the firm's a. weighted average cost of capital. b. cost of debt. c. internal rate of return. d. external cost of new equity. e. net present value.

ANSWER: a 162. Which of the following is NOT considered a relative valuation technique? a. price-earnings ratio b. price/cash flow ratio c. price/book value ratio d. price/cost of goods sold ratio e. price/sales ratio ANSWER: d 163. Which of the following is NOT considered in the price-earnings ratio technique? a. firm's required rate of return on equity (k) b. firm's dividend payout ratio (D/E) c. firm's expected growth rate of dividends (g) d. All of these are correct (that is, all are components of the P/E ratio). e. None of these are correct (that is, none are components of the P/E ratio).

ANSWER: d 164. Evidence that a firm has high business risk would be provided by its volatile ____. a. fixed costs. b. profit after taxes. c. operating profit. d. sales. e. employee turnover.

ANSWER: c richard@qwconsultancy.com

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165. A growth company can invest in projects that generate a return greater than the firm's a. return on equity. b. cost of debt. c. cost of equity. d. cost of capital. e. return on assets.

ANSWER: d Exhibit 9.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) (1) (2) (3) (4) (5) (6)

The firm's expected rate of growth of earning per share The amount of capital invested in growth investments The rate of return earned on the funds relative to the required rate of return The required rate of return on the security based on its systematic risk The firm's dividend payout ratio The time horizon when these growth investments will be available

166. Refer to Exhibit 9.10. In the listing above, which three factors influence the capital gain component of a growth company? a. 1, 3, and 5 b. 2, 3, and 4 c. 2, 3, and 6 d. 3, 4, and 5 e. 3, 4, and 6 ANSWER: c 167. Refer to Exhibit 9.10. In the listing above, which three factors influence the earnings multiple for a stock? a. 1, 4, and 5 b. 1, 4, and 6 c. 2, 4, and 6 d. 2, 5, and 6 e. 4, 5, and 6 ANSWER: a 168. An inconsistency between a stock's P/E ratio and growth rate can be attributed to all of the following, EXCEPT a. a major difference in the risk involved. b. inaccurate growth estimates. c. an undervaluation of the stock. d. an overvaluation of the stock. e. competition.

ANSWER: e

richard@qwconsultancy.com

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169. What is the implied growth duration of Bowe Industries given the following:

P/E Ratios Average Growth (%) Dividend Yield

S&P Industrials 15 5.0 .06

Bowe Industries 25 15.0 .02

a. 3.2 years b. 6.6 years c. 8.6 years d. 9.7 years e. 10.6 years ANSWER: d 170. What is the implied growth duration of Casey Industries given the following:

P/E Ratios Average Growth (%) Dividend Yield

S&P Industrials 15 5.0 .04

Casey Industries 20 15.0 .06

a. 3.2 years b. 2.8 years c. 4.8 years d. 9.6 years e. 13.2 years ANSWER: b 171. What is the implied growth duration of Jones Industries given the following:

P/E Ratios Average Growth (%) Dividend Yield

S&P Industrials 12 6.0 .05

Jones Industries 15 10.0 .03

a. 7.2 years b. 10.9 years c. 12.5 years d. 13.9 years e. 15.2 years ANSWER: c 172. What is the implied growth duration of Freed Industries given the following?

P/E Ratios Average Growth (%) Dividend Yield richard@qwconsultancy.com

S&P Industrials 19 11.0 .033

Freed Industries 22 16.0 .08 200 | P a g e

a. 1.8 years b. 1.3 years c. 5.0 years d. 4.5 years e. 3.5 years ANSWER: a 173. What is the implied growth duration of Howard Industries given the following?

P/E Ratios Average Growth (%) Dividend Yield

S&P Industrials 14 6.0 .07

Howard Industries 24 12.0 .04

a. 11.5 years b. 16.8 years c. 22.6 years d. 18.4 years e. 20.6 years ANSWER: e Exhibit 9.11 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Modular Industries currently has a 16 percent annual growth rate, while the market average is 6 percent. The market multiple is 10.

174. Refer to Exhibit 9.11. Determine the justified P/E ratio for Modular Industries assuming Modular can maintain its superior growth rate for the next five years. a. 6.4 b. 13.1 c. 16.5 d. 23.8 e. 15.7 ANSWER: e 175. Refer to Exhibit 9.11. Determine the P/E ratio for Modular Industries assuming Modular can maintain its superior growth rate for the next eight years. a. 6.4 b. 20.5 c. 16.5 d. 23.8 e. 29.5 ANSWER: b richard@qwconsultancy.com

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Exhibit 9.12 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Harcourt Industries currently has an 18 percent annual growth rate, while the market average is 8 percent. The market multiple is 12.

176. Refer to Exhibit 9.12. Determine the justified P/E ratio for Harcourt Industries assuming Harcourt can maintain its superior growth rate for the next nine years. a. 5.98 b. 13.13 c. 21.20 d. 58.68 e. 26.65 ANSWER: e 177. Refer to Exhibit 9.12. Determine the P/E ratio for Harcourt Industries assuming Harcourt can maintain its superior growth rate for the next three years. a. 4.25 b. 12.50 c. 15.67 d. 30.10 e. 42.80 ANSWER: c Exhibit 9.13 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The Valentine Company currently has a 14 percent annual growth rate, while the market average is 4 percent. The market multiple is 15.

178. Refer to Exhibit 9.13. Determine the justified P/E ratio for the Valentine Company assuming Valentine can maintain its superior growth rate for the next 10 years. a. 3.0 b. 9.2 c. 16.6 d. 28.6 e. 37.6 ANSWER: e 179. Refer to Exhibit 9.13. Determine the P/E ratio for the Valentine Company assuming Valentine can maintain its superior growth rate for the next five years. a. 23.7 b. 16.4 c. 15.3 d. 8.3 richard@qwconsultancy.com

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e. 3.8 ANSWER: a 180. Given Gitech's beta of 1.55 and a risk-free rate of 8 percent, what is the expected rate of return assuming a 14 percent market return? a. 12.4 percent b. 14.3 percent c. 17.3 percent d. 20.4 percent e. 29.7 percent ANSWER: c 181. The expected rate of return on Research Industries is twice the 12 percent expected rate of return from the market. What is Research's beta if the risk-free rate is 6 percent? a. 2 b. 3 c. 4 d. 5 e. 6 ANSWER: b 182. Given Birdchip's beta of 1.25 and a risk-free rate of 6 percent, what is the expected rate of return assuming a 12 percent market return? a. 1 percent b. 10 percent c. 11 percent d. 12 percent e. 31 percent ANSWER: c 183. The expected rate of return on Rewind Industries is 2.5 times the 12 percent expected rate of return from the market. What is Rewind's beta if the risk-free rate is 6 percent? a. 2 b. 3 c. 4 d. 5 e. 6 ANSWER: c 184. Given Gilbert's beta of 1.10 and a risk-free rate of 5 percent, what is the expected rate of return assuming a 10 percent market return? a. 21.5 percent b. 10.5 percent c. 5.5 percent d. 15.5 percent richard@qwconsultancy.com

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e. 16.5 percent ANSWER: b 185. The expected rate of return on Rooter Industries is 1.5 times the 16 percent expected rate of return from the market. What is Research's beta if the risk-free rate is 8 percent? a. 2 b. 3 c. 4 d. 5 e. 6 ANSWER: a 186. ABC Co. has paid annual dividends in the past five years of $.20, $.25, $.28, $.33, and $.36.

Calculate the average growth rate of its dividends. a. 1.16 percent b. 1.80 percent c. 12.47 percent d. 15.83 percent e. 17.25 percent ANSWER: d Exhibit 9.14 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

DPS Total Asset Turnover Net Profit Margin EPS Total Assets/Equity

Wal-Blue 1.00 3.20 3.50% 4.00 3.00

Industry 1.50 2.50 3.00% 3.00 4.00

187. Refer to Exhibit 9.14. What are the ROE's for Wal-Blue and its industry? a. 24.3% and 27.0% b. 29.7% and 27.0% c. 29.7% and 30.0% d. 33.6% and 30.0% e. 34.5% and 31.5% ANSWER: d 188. Refer to Exhibit 9.14. What are the expected sustainable growth rates for Wal-Blue and its industry? a. 25.2% and 15.0% b. 30.0% and 17.5% c. 25.2% and 17.5% d. 27.5% and 12.5% richard@qwconsultancy.com

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e. 30.0% and 15.0% ANSWER: a 189. A firm has a current price of $40 a share, an expected growth rate of 11 percent and expected dividend per share (D1) of $2. Given its risk, you have a required rate of return for it of 12 percent.

Your expected rate of return and investment decision is as follows: a. 10 percent − do not buy b. 12 percent − do not buy c. 14 percent − buy d. 16 percent − buy e. 18 percent − buy ANSWER: d 190. A firm has a current price of $40 a share, an expected growth rate of 11 percent and expected dividend per share (D1) of $2. Given its risk, you have a required rate of return for it of 12 percent.

Assuming that you expect the stock price to increase to $42 during the investment period, your expected rate of return and decision would be a. 10 percent − do not buy b. 12 percent − do not buy c. 14 percent − buy d. 16 percent − buy e. 18 percent − buy ANSWER: a 191. Based on the information provided, calculate the intrinsic value in 2010 of a share of INV Corp. using the FCFF (free cash flow to the firm) model. For 2010 the FCFF was $30,000, total debt was $20,000, and there were 12000 shares outstanding. The required rate of return is 9 percent, and the estimated growth rate in FCFF is 6.5 percent. a. $104.83 b. $153.25 c. $112.50 d. $94.92 e. $80.45 ANSWER: a 192. Based on the information provided, calculate the intrinsic value in 2010 of a share of INV Corp. using the Present Value of Earnings Model (infinite holding period). For 2010 net income was $250,000, total debt was $50,000, and there were 206,263 shares outstanding. The required rate of return is 12 percent, and the estimated growth rate in earnings is 5.5 percent. a. $19.43 b. $23.98 c. $28.52 d. $22.73 e. $15.50 ANSWER: a

richard@qwconsultancy.com

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193. You are provided with the following information about Javier Corporation. Sales for the year 2010 were $500,000, and the Net Profit Margin (NPM) was 15 percent. Analysts project sales to grow by 12 percent next year (that is 2011). However, because of more competition, the NPM is expected to decline by 10 percent for the year 2010. The expected P/E multiple for the year 2011 is 22. The total number of shares outstanding is 20,000. Use the earnings multiplier model to calculate the expected price for Javier Corporation in the year 2011. a. $74.25 b. $61.6 c. $82.5 d. $83.16 e. $101.64 ANSWER: d Exhibit 9.15 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You are provided with the following information on Kayray Corporation. Your ultimate objective is to calculate the EVA for the firm.

LIFO reserve Net plant, property, and equipment Other assets Goodwill Accumulated Goodwill amortized PV of Operating leases Tax benefit from interest on expenses Tax benefit from interest on leases Taxes on non-operating income Implied interest on op. lease Increase in LIFO reserve Goodwill amortization Operating profit Income tax expense Net working capital WACC

60 1325 30 325 65 140 10 5 2 9.5 12 15 550 215 440 0.12

194. Refer to Exhibit 9.15. Calculate the adjusted operating profits before taxes. a. $586.5 b. $225.64 c. $825.23 d. $831.56 e. $692.5 ANSWER: a 195. Refer to Exhibit 9.15. Calculate the cash operating expenses for the firm. a. 225 b. 228 c. 232 richard@qwconsultancy.com

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d. 242 e. 252 ANSWER: b 196. Refer to Exhibit 9.15. Calculate the capital for the firm. a. 1725 b. 1953 c. 2524 d. 2385 e. 1987 ANSWER: d 197. Refer to Exhibit 9.15. Calculate the dollar cost of capital. a. 286.2 b. 207 c. 234.36 d. 238.44 e. 302.9 ANSWER: a 198. The Peterson Company has an FCFF of $1000. The FCFF is expected to grow by 12 percent next year. The cost of capital is 12 percent, and the level of debt is $5000. The number of shares outstanding is 500. Calculate the firm's share price. a. $44 b. $55 c. $34.19 d. $47.23 e. $50 ANSWER: a 199. The Pekay Company has an FCFE of $800. The FCFE is expected to grow by 7 percent next year. The cost of capital is 7 percent, and the level of debt is $4000. The number of shares outstanding is 700. Calculate the firm's share price. a. $44.25 b. $65.12 c. $38.19 d. $40.76 e. $50.56 ANSWER: d Exhibit 9.16 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The Rollerball Corporation's industry averages are as follows: Net Profit Margin = 7.5%; Total Asset Turnover = 2.2; Total Assets/Equity = 2.0

richard@qwconsultancy.com

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Rollerball Corporation has the following financial statements for year ending 12/31/2008. (000's omitted) Sales Cost of Goods Sold Gross Profit Depreciation Operating Expenses Administration Exp. Operating Profit 795 Interest Expense Profit Before Taxes Taxes Net Income Dividends Assets Cash Accounts Receivable Inventory Total Current Assets Net Fixed Assets Total Assets

5,450 3,250 2,200 820 470 115 88 707 247 460 250

100 1,250 1,125 2,475 1,450 3,925

Liabilities Notes Payable Accounts Payable Total Current Liab.

Long Term Debt Common Stock Retained Earnings Total Liab. & Earnings

850 1,550 2,400 425 400 700 3,925

200. Refer to Exhibit 9.16. Calculate Rollerball Corporation's Net Profit Margin. a. 3.9% b. 8.4% c. 14.6% d. 40.4% e. 41.8% ANSWER: b 201. Refer to Exhibit 9.16. Calculate Rollerball Corporation's Total Asset Turnover. a. 0.72 b. 0.85 c. 1.39 d. 1.65 e. 2.31 ANSWER: c 202. Refer to Exhibit 9.16. Calculate Rollerball Corporation's Total Assets/Equity ratio. a. 3.57 b. 4.28 c. 5.61 d. 7.35 e. 9.81 ANSWER: a richard@qwconsultancy.com

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203. Refer to Exhibit 9.16. Calculate the return on equity (ROE) for Rollerball Corporation and the Industry.

Rollerball Industry Average a. 115.0% 67.5% b. 65.7% 33.0% c. 41.8% 33.0% d. 19.1% 15.7% e. 8.7% 15.7% ANSWER: c 204. Refer to Exhibit 9.16. Calculate the sustainable growth rate for Rollerball Corporation. a. 19.1% b. 22.7% c. 27.5% d. 52.5% e. 62.5% ANSWER: a 205. Johnson Company just paid an annual dividend of $1.75. The next dividend will be paid one year from today. Johnson Company expects a constant growth of 5 percent in dividends forever. The required rate of return for this company's common stock is 13 percent. What is the value of one share of common stock? a. $1.55 b. $13.46 c. $14.13 d. $21.88 e. $22.97 ANSWER: e Exhibit 9.17 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

DPS Total Asset Turnover Net Profit Margin EPS Total Assets/Equity

Left-Aid Corporation $2.45 3.80 6.50% $3.50 1.60

206. Refer to Exhibit 9.17. What is the Left-Aid Corporation's return on equity (ROE)? a. 25.5% b. 27.4% c. 29.7% d. 35.6% richard@qwconsultancy.com

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e. 39.5% ANSWER: e 207. Refer to Exhibit 9.17. What is Left-Aid Corporation's expected sustainable growth rate? a. 11.9% b. 18.7% c. 22.1% d. 27.7% e. 30.0% ANSWER: a Exhibit 9.18 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Investment Stock X Stock Y Market Portfolio Risk-free rate

Beta 2.3 1.2 1.0

Analyst's Estimated Return 15.5% 13.6% 11.5% 4.0%

208. Refer to Exhibit 9.18. What is the required rate of return for Stock X based on the capital asset pricing model (CAPM)? a. 15.5% b. 17.3% c. 21.3% d. 26.5% e. 30.5% ANSWER: c 209. Refer to Exhibit 9.18. What is the required rate of return for Stock Y based on the capital asset pricing model (CAPM)? a. 11.5% b. 13.0% c. 13.6% d. 14.8% e. 15.5% ANSWER: b 210. Refer to Exhibit 9.18. Based on the analyst's estimated return and the stocks' betas the analyst should a. sell both Stock X and Stock Y. b. sell Stock X and Buy Stock Y. c. buy Stock X and Sell Stock Y. d. buy both Stock X and Stock Y. e. None of these are correct. richard@qwconsultancy.com

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ANSWER: b 211. In Berkshire Hathaway annual reports, Warren Buffet highlights financial tenets that he believes are important. Which of the following is NOT a financial tenet of Warren Buffet? a. focus on return on equity (ROE) not earnings per share (EPS) b. calculate owner earnings similar to free cash flow after capital expenditures c. high profit margins relative to the industry d. Company should create at least one dollar of market value for every dollar retained. e. All of these are correct.

ANSWER: e 212. Which of the following is NOT considered a favorable attribute of firms by Peter Lynch? a. Firm's product is not faddish. b. Firm has a sustainable comparative competitive advantage over its rivals. c. Firm's industry or product has market stability. d. Firm can benefit from cost reductions. e. All of these are correct (that is, all of these are considered favorable attributes by Peter Lynch).

ANSWER: e 213. Which of the following is a business tenet of Warren Buffett? a. long-term prospects b. resistance to institutional imperative c. creation of one dollar of market value for every dollar retained d. purchase at discount to intrinsic value e. Product is not faddish.

ANSWER: a 214. Which of the following is a management tenet of Warren Buffett? a. long-term prospects b. resistance to institutional imperative c. creation of one dollar of market value for every dollar retained d. purchase at discount to intrinsic value e. Product is not faddish.

ANSWER: b 215. Which of the following is a financial tenet of Warren Buffett? a. long-term prospects b. resistance to institutional imperative c. creation of one dollar of market value for every dollar retained d. purchase at discount to intrinsic value e. Product is not faddish.

ANSWER: c 216. Which of the following is a market tenet of Warren Buffett? richard@qwconsultancy.com

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a. long-term prospects b. resistance to institutional imperative c. creation of one dollar of market value for every dollar retained d. purchase at discount to intrinsic value e. Product is not faddish.

ANSWER: d

Chapter 10 - The Practice of Fundamental Investing True / False 1. A company goes public for many reasons, including that the original investors and the management team would like liquidity. a. True b. False ANSWER: True 2. Being a public company also has some advantages, among which management must answer to outside shareholders. a. True b. False ANSWER: False 3. The least significant part of the registration statement is known as the prospectus. a. True b. False ANSWER: False 4. When a firm decides to go public, it hires an investment bank to lead the company through the process. a. True b. False ANSWER: True 5. A successful offering is undersubscribed. a. True b. False ANSWER: False 6. The sell-side refers to firms that facilitate securities transactions. a. True b. False ANSWER: True

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7. Buy-side analysts typically cover the stocks within a particular industry and produce reports that are intended to help the sell-side reach investment decisions. a. True b. False ANSWER: False 8. Sell-side analysts provide information and recommendations to their firm’s portfolio manager(s). a. True b. False ANSWER: False 9. Capital allocation is the description of how management uses resources to create value on behalf of shareholders. a. True b. False ANSWER: True 10. When a company acquires another public company, it typically pays a significant premium above the previous market price. a. True b. False ANSWER: True 11. Some investors believe that dividends increase the agency conflict. a. True b. False ANSWER: False 12. The declaration date is the date that a dividend is announced by the board of directors. a. True b. False ANSWER: True 13. The ex-dividend date is the date on which the transfer agent “closes the book” and looks at who is the shareholder. a. True b. False ANSWER: False 14. Share repurchases do not always create value. a. True b. False ANSWER: True

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15. Corporate governance refers to the rules, policies, and procedures that are used to direct and control a company. a. True b. False ANSWER: True 16. A growing percentage of institutional investors are integrating environmental, social, and governance (ESG) factors into their investment decisions. a. True b. False ANSWER: True 17. Corporations can use many tools in order to prevent takeovers, including poison pills, which require a supermajority of shareholder votes to approve selling the firm, selling the most profitable part of the company, and staggered boards. a. True b. False ANSWER: True 18. Investors want directors who will voice their opinion, who are not beholden to the CEO or board chair, and who have enough experience that their opinion carries weight on the board. a. True b. False ANSWER: True 19. CEO compensation is often used to try to remedy the principal–agent conflict. a. True b. False ANSWER: True 20. The three goals of executive compensation are to align management’s interest with the shareholders, to keep management from leaving in bad times, and to refrain from giving too much of shareholder profits to management. a. True b. False ANSWER: True 21. Kaplan (2013) argues that the market for top executives is competitive, and compensation of other professionals is growing even faster. a. True b. False ANSWER: True 22. Compensation for the top executives at public companies is set by a compensation committee, which is a subset of the board of directors. a. True richard@qwconsultancy.com

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b. False ANSWER: True 23. The level of compensation of the top five earners within each public company can be found in the company’s proxy statement. a. True b. False ANSWER: True 24. The goal of the stock pitch is to convince an investor to buy a stock or to sell a stock short. a. True b. False ANSWER: True 25. A stock pitch is like a book report or a news report. a. True b. False ANSWER: False Multiple Choice 26. Advantages of a company going public include all of the following, EXCEPT that a. publicly traded stock provides valuable signaling information concerning the health of the company. b. the original investors and the management team would like liquidity. c. it is easier to use public stock as currency to acquire other companies. d. it might need more capital in order to finance growth. e. management must answer to outside shareholders.

ANSWER: e 27. Disadvantages of a company going public include all of the following, EXCEPT that a. there are direct costs associated with compliance. b. management may have to disclose more of its strategy. c. publicly traded stock provides valuable signaling information. d. management will spend significant time meeting with analysts. e. management must answer to outside shareholders.

ANSWER: c 28. An investment bank can do an IPO offering as a a. firm commitment. b. best efforts commitment. c. firm offering. d. bought offering. e. red herring.

ANSWER: a richard@qwconsultancy.com

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29. An investment bank can do an IPO offering as a a. discounted commitment. b. best efforts commitment. c. premium commitment. d. best efforts offering. e. red herring.

ANSWER: d 30. Which of the following is a document that helps potential investors understand the company? a. Indications of interest b. The pricing meeting c. The registration statement d. The road show e. The prospectus ANSWER: e 31. Which of the following describes the process of when the underwriter takes the issuing company’s management to meet with potential investors? a. Indications of interest b. The pricing meeting c. The registration statement d. The road show e. The prospectus ANSWER: d 32. Once the offering has been deemed effective, the investment bank and the issuing firm have a/an _____. a. indication of interest b. pricing meeting c. registration statement d. road show e. prospectus ANSWER: b 33. The preliminary prospectus is often referred to as a/an _____ a. SEC form S-1. b. red herring. c. registration statement. d. winner’s curse. e. green shoe.

ANSWER: b 34. A company is going public with an offering price of $15 per share. The gross spread is 7 percent.

How much will the bank receive? How much will the issuing firm receive? richard@qwconsultancy.com

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a. $1.05; $13.95 b. $1.50; $15.00 c. $1.50; $13.50 d. $1.05; $15.00 e. $7.00; $15.00 ANSWER: a 35. A company is going public with an offering price of $10 per share. The gross spread is 7 percent.

How much will the bank receive? How much will the issuing firm receive? a. $1.07; $17.00 b. $1.70; $7.00 c. $0.70; $9.30 d. $7.00; $10.00 e. $7.00; $3.00 ANSWER: c 36. A company is going public with an offering price of $27 per share. The gross spread is 7 percent.

How much will the bank receive? How much will the issuing firm receive? a. $2.70; $24.30 b. $1.89; $25.11 c. $0.70; $27.00 d. $7.00; $20.00 e. $7.00; $27.00 ANSWER: b 37. The fee paid to the underwriter is called the a. tactical spread. b. net spread. c. gross spread. d. listing fee. e. banking fee.

ANSWER: c 38. If there is a demand for more shares than are available at the offering price, the offering is said to be _____. a. undersubscribed b. oversubscribed c. overpriced d. underpriced e. popular ANSWER: b 39. A stock went public at $15 and closed at $17.70. What was the underpricing percentage? a. 15 percent b. 17 percent richard@qwconsultancy.com

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c. 18 percent d. 17.70 percent e. 15.25 percent ANSWER: c 40. A stock went public at $27 and closed at $45. What was the underpricing percentage? a. 18 percent b. 40 percent c. 27 percent d. 66.67 percent e. 45 percent ANSWER: d 41. The underpricing during the 1999–2000 technology bubble was above _____. a. 18 percent b. 30 percent c. 25 percent d. 66 percent e. 55 percent ANSWER: e 42. From 1980 to 2016, the average IPO in the United States closed _____higher than the IPO price. a. 18 percent b. 30 percent c. 25 percent d. 66 percent e. 55 percent ANSWER: a 43. The _____ gives the investment bank the right to buy 15 percent more shares within the next 30 days. a. underwriters fee b. red herring c. overallotment option d. winner’s curse e. red shoe option ANSWER: c 44. The overallotment option gives the investment bank the right to buy _____ more shares within the next _____. a. 5 percent; 10 days b. 30 percent; 10 days c. 10 percent; 30 days d. 30 percent; 15 days e. 15 percent; 30 days richard@qwconsultancy.com

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ANSWER: e 45. A company is going public by selling 50 million shares. As a result of the overallotment option, the investment bank has the right to buy an additional _____ shares. a. 2.5 million b. 5.25 million c. 7.5 million d. 9.5 million e. 11.25 million ANSWER: c 46. A company is going public by selling 75 million shares. As a result of the overallotment option, the investment bank has the right to buy an additional _____ shares. a. 2.5 million b. 5.25 million c. 7.5 million d. 9.5 million e. 11.25 million ANSWER: e 47. The investment bank helps stabilize the price of new issues in the secondary market by a. purchasing shares in the open market. b. selling shares in the open market. c. risking its capital. d. market manipulation. e. underallotment of shares.

ANSWER: a 48. The _____ is the idea that anyone who wins an auction must have bid too much. a. blue herring b. red herring c. loser’s curse d. winner’s curse e. red shoe ANSWER: d 49. In a _____, the issuing company could agree to sell the shares at a price below the clearing price. a. bookbuilt offering b. discount offering c. dirty auction d. clean auction e. green shoe ANSWER: c 50. The _____ refers to firms that facilitate securities transactions. richard@qwconsultancy.com

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a. buy-side b. sell-side c. SEC d. issuing firm e. pension fund ANSWER: b 51. The _____ refers to firms that actually invest in securities. a. buy-side b. sell-side c. SEC d. issuing firm e. investment bank ANSWER: a 52. _____ is the description of how management uses resources to create value on behalf of shareholders. a. Corporate governance b. Capital allocation c. Executive compensation d. Going public e. A stock pitch ANSWER: b 53. All of the following are primary ways to allocate capital, EXCEPT a. engaging in mergers and acquisitions. b. paying dividends. c. repurchasing shares. d. decreasing the working capital of the business. e. returning cash to debtholders.

ANSWER: d 54. _____ refers to the rules, policies, and procedures that are used to direct and control a company. a. Corporate governance b. Capital allocation c. Executive compensation d. Going public e. A stock pitch ANSWER: a 55. The key issues that investors seem to care about with respect to a board include all of the following, EXCEPT a. the size of the board. b. stratthe independence of the board. c. how the board responds to shareholder proposals. richard@qwconsultancy.com

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d. separation of the CEO and board chair positions. e. how management is compensated.

ANSWER: e 56. Corporations can use many tools in order to prevent takeovers, including a. poison pills. b. non-staggered boards. c. retaining the most profitable part of the company. d. requiring a minority of shareholder votes to approve selling the firm. e. staging a walk out.

ANSWER: a 57. According to a study (Callahan and Mauboussin), when does compensation conflict tend to occur? a. When it provides strong incentives to create shareholder value b. When it helps retain key talent c. When it limits compensation cost to levels that maximize the wealth of shareholders d. When management has most of their wealth in this one company, so they may take too little risk e. When it makes management focus on long-term value maximization rather than earnings per share ANSWER: d 58. Which of the following facts about executive compensation is TRUE? a. The level of compensation of the top five earners within each public company is not disclosed. b. Officers are permitted to hedge their stock and option awards. c. CEO compensation has increased much faster than the wages of the other corporate employees. d. Aligning compensation to share price will align management to shareholders. e. The majority of the compensation committee must be dependent directors.

ANSWER: c 59. A stock pitch includes all of the following EXCEPT a. that stock returns are mean reverting. b. merits of a stock. c. models and multiples. d. risks. e. background information about the company.

ANSWER: a 60. The goal of _____ is to convince an investor to buy a stock or to sell a stock short. a. corporate governance b. capital allocation c. executive compensation d. going public richard@qwconsultancy.com

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e. the stock pitch ANSWER: e

Chapter 11 - Equity Portfolio Management Strategies True / False 1. A way to distinguish between these strategies is to decompose the total actual return that the portfolio manager attempts to produce. a. True b. False ANSWER: True 2. Active portfolio managers just try to capture the expected return consistent with the risk level of their portfolios. a. True b. False ANSWER: False 3. Passive portfolio managers attempt to “beat the market” by forming portfolios capable of producing actual returns that exceed risk-adjusted expected returns. a. True b. False ANSWER: False 4. The difference between the actual and expected return is often called the portfolio’s alpha, a. True b. False ANSWER: True 5. An attempt on the manager’s part to generate alpha is generally referred to as indexing. a. True b. False ANSWER: True 6. The goal of a passive portfolio is to track the index as closely as possible. a. True b. False ANSWER: True 7. Active equity portfolio management is a long-term buy-and-hold strategy. a. True b. False ANSWER: False richard@qwconsultancy.com

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8. A benchmark portfolio is defined as a passive portfolio whose average characteristics match the client's risk-return objectives. a. True b. False ANSWER: True 9. The three basic techniques for constructing a passive index are: full replication, sampling, and linear programming. a. True b. False ANSWER: False 10. An advantage of sampling is that portfolio returns will not track the index as closely as with full replication. a. True b. False ANSWER: False 11. An advantage of quadratic programming is that it relies on historical correlations. a. True b. False ANSWER: False 12. Tracking error is defined as the degree to which the portfolio's returns deviate from those of the actual index. a. True b. False ANSWER: True 13. There is a direct relationship between a passive portfolio's tracking error relative to its index and the time and expense necessary to create and maintain the portfolio. a. True b. False ANSWER: False 14. Completeness funds are portfolios designed to complement active portfolios that do not cover the entire market. a. True b. False ANSWER: True 15. 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 richard@qwconsultancy.com

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ANSWER: True 16. Following an earnings momentum strategy, an investor acquires stocks that have enjoyed abovemarket stock price increases. a. True b. False ANSWER: False 17. The goal of active equity management is to earn a return that exceeds the return of a passive benchmark portfolio, net of transaction costs, on a risk-adjusted basis. a. True b. False ANSWER: True 18. Growth stocks consistently outperform value stocks. a. True b. False ANSWER: False 19. A growth investor focuses on the current and future economic “story” of a company, with less regard for share valuation. a. True b. False ANSWER: True 20. The value investor focuses on share price in anticipation of a market correction and, possibly, improving company fundamentals. a. True b. False ANSWER: True 21. Growth oriented investors focus on the price component of the Price/Earnings ratio. a. True b. False ANSWER: False 22. Style investing involves constructing portfolios in such a way as to capture one or more of the characteristics of equity securities. a. True b. False ANSWER: True 23. It does not make economic sense for portfolio managers to try to "time" between different investment styles. a. True richard@qwconsultancy.com

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b. False ANSWER: False 24. Style identification allows an investor to select investment managers that allow his overall portfolio to be properly diversified. a. True b. False ANSWER: True 25. Style investing allows control of the total portfolio to be shared between investment managers and pension fund managers. a. True b. False ANSWER: True 26. Insured asset allocation is a strategy to limit investment losses by shifting funds between an existing equity portfolio and a risk-free security. a. True b. False ANSWER: True 27. A portfolio manager who uses tactical asset allocation is attempting to create alpha. a. True b. False ANSWER: True 28. The integrated asset allocation strategy separately examines capital market conditions and the investor’s objectives and constraints. a. True b. False ANSWER: True 29. Tactical asset allocation is used to determine the long-term policy asset weights in a portfolio. a. True b. False ANSWER: False 30. Strategic asset allocation frequently adjusts the asset class mix in the portfolio to take advantage of changing market conditions. a. True b. False ANSWER: False Multiple Choice

richard@qwconsultancy.com

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31. The difference between the actual and expected return is often called a. alpha. b. beta. c. risk premium. d. the risk-free rate. e. the benchmark.

ANSWER: a 32. Which of the following statements concerning active equity portfolio management strategies is true? a. The goal of active equity portfolio management is to earn a portfolio return that exceeds the return of a passive benchmark portfolio (net of transaction costs) on a risk-adjusted basis. b. An actively managed equity portfolio has lower total transaction costs. c. An actively managed equity portfolio has lower risk than the passive benchmark. d. A key to success for an actively managed equity portfolio is to maximize trading activity. e. An actively managed equity portfolio has lower turnover.

ANSWER: a 33. Which of the following is considered a passive management strategy? a. sector rotation b. use of factor models c. quantitative screens d. sampling e. linear programming ANSWER: d 34. Which of the following is NOT a technique for constructing a passive index portfolio? a. full replication b. sampling c. quadratic programming d. linear programming e. indexing ANSWER: d 35. The goal of the passive portfolio manager is to minimize a. alpha. b. beta. c. standard error. d. tracking error. e. portfolio risk.

ANSWER: d 36. All of the following are advantages of ETFs over mutual funds EXCEPT a. The ability for continuous trading while markets are open. richard@qwconsultancy.com

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b. the ability to time capital gain tax realizations. c. a smaller management fee. d. ETFs can be bought and sold like common stock. e. smaller brokerage commission.

ANSWER: e 37. In equity portfolio management, tracking error occurs when a. the managed portfolio outperforms the benchmark portfolio. b. the managed portfolio under performs the benchmark portfolio. c. the return volatility of the managed portfolio is positively correlated with the return volatility of the benchmark portfolio. d. the return volatility of the managed portfolio is negatively correlated with the return volatility of the benchmark portfolio. e. the return volatility of the managed portfolio is not correlated with the return volatility of the benchmark portfolio.

ANSWER: e 38. The table below provides returns on a portfolio along with returns for the corresponding benchmark index for the past eight quarters. The table also provides the difference between portfolio returns and the benchmark index, the average of these differences over the past eight quarters, and the standard deviation of these differences.

Period 1 2 3 4 5 6 7 8

Portfolio 0.05 −0.036 0.022 0.012 −0.003 −0.023 0.089 −0.008

Index 0.027 −0.046 0.019 0.022 −0.001 −0.03 0.081 0.006

Average SD

Difference 0.023 0.010 0.003 −0.010 −0.002 0.007 0.008 −0.014 0.003 0.011789

The annualized tracking error for this period is a. 2.36 percent. b. 4.08 percent c. 2.89 percent. d. 3.33 percent. e. 1.18 percent.

ANSWER: a 39. In ____ strategy, certain economic sectors or industries are overweighted relative to the benchmark in anticipation of the next phase of the business cycle. a. sector rotation b. price momentum c. earnings momentum richard@qwconsultancy.com

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d. return rotation e. passive momentum ANSWER: a 40. Which of the following is NOT considered an active management strategy? a. sector rotation b. use of factor models c. quantitative screens d. full replication e. linear programming ANSWER: d 41. Which of the following is considered a strategy for timing the market and adding value to actively managed portfolios? a. timing the markets by shifting between different types of securities based on market forecasts and estimated risk premiums. b. shifting funds between the various equity sectors, industries, investment styles, etc., in order to take advantage of the "hot" concept before the remainder of the market does. c. individual stock picking in order to buy low and sell high. d. using tactical asset allocation strategies. e. All of these are correct.

ANSWER: e 42. A portfolio management strategy that overweights a particular industry, relative to the benchmark portfolio, based on the next expected phase of the business cycle is called a. tactical asset allocation. b. indexing. c. sector rotation. d. contrarian investing. e. Bottom-up investing.

ANSWER: c 43. ____ is a strategy used because the market seems to reward companies that have steady, above average earnings growth, or whose prices are rising because of market optimism. a. Relative strength b. Asset momentum c. Rotational attribution d. Sector rotation e. Earnings momentum ANSWER: e 44. The following is an example of a fundamental active equity portfolio management strategy. a. contrarian investing b. earnings momentum investing c. low P/E and low P/BV investing richard@qwconsultancy.com

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d. bottom up investing e. investing on the basis of calendar effects ANSWER: d 45. Which of the following statements regarding 130/30 strategies is FALSE? a. Analysts can make full use of their knowledge of undervalued and overvalued stocks. b. Long positions up to 130 percent of the value of the portfolio can be made. c. Short positions up to 30 percent of the value of the portfolio can be made. d. 130/30 strategies are not very popular due to the increased risk of hedging. e. The use of short positions creates leverage.

ANSWER: d 46. If you have a portfolio with a market value of $100 million and a beta (measured against the S&P 500) of 1.5, then if the market rises by 10 percent, what value would you expect your portfolio to have? a. $100 million b. $110 million c. $150 million d. $165 million e. $1.65 billion ANSWER: d 47. Which of the following statements regarding momentum strategies is TRUE? a. Price momentum is a fundamental strategy. b. Earnings momentum is a technical strategy. c. Price momentum and earnings momentum strategies will often result in identical portfolio strategies and holdings. d. The earnings momentum investor will most likely acquire stocks for companies that have positive earnings surprises. e. All of these are correct.

ANSWER: d 48. An active portfolio manager sold $90 million of stocks in a year. If the portfolio had an average value of $110 million in assets under management what is the portfolio turnover ratio? a. 22.2 percent b. 81.8 percent c. 90.0 percent d. 110.0 percent e. 122.2 percent ANSWER: b 49. If the annual geometric mean for the equity risk premium is 8.4 percent, what percentage of the equity risk premium is consumed by trading costs of 1.2 percent? a. 7.20 percent b. 9.60 percent richard@qwconsultancy.com

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c. 9.70 percent d. 10.08 percent e. 14.29 percent ANSWER: e 50. Fund XYZ had a pretax return of 10.2 percent and a tax-adjusted return of 9.5 percent. Calculate Fund XYZ's tax cost ratio. a. 0.006 b. 0.106 c. 0.116 d. 0.342 e. 0.635 ANSWER: e 51. A fundamental tenet of the contrarian investment strategy is the notion that a. all stock returns are mean reverting. b. certain stocks outperform others during different stages of the business cycle. c. value stock investing is superior to growth stock investing. d. growth stock investing is superior to value stock investing. e. None of these are correct.

ANSWER: a 52. Value stocks would have the following characteristics: a. low price/book and high price/earnings. b. low price/book and low price/earnings. c. high EPS growth and high profitability. d. low EPS growth and high profitability. e. None of these are correct.

ANSWER: b 53. Growth stocks would have the following characteristics: a. low price/book and high price/earnings. b. low price/book and low price/earnings. c. high EPS growth and high profitability. d. low EPS growth and high profitability. e. None of these are correct.

ANSWER: c 54. An investor focusing on a growth strategy does all of the following EXCEPT a. focus on the earnings per share (EPS) component on the P/E ratio. b. seek out investments with higher expected growth in earnings. c. implicitly assume that the P/E ratio will grow over the near term. d. focus on the current and future economic "story" of a company. e. All of these are correct. richard@qwconsultancy.com

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ANSWER: c 55. Which of the following statements about investment style is FALSE? a. Growth stocks generally have smaller capitalizations than value stocks. b. Value stocks have P/E and P/B ratios significantly lower than those of growth stocks. c. Value stocks dividend yields are much higher than those of growth stocks. d. Growth and levels of earnings is higher in growth stocks. e. Value stocks have a higher risk premium.

ANSWER: a 56. Which of the following is NOT considered an investment style? a. value b. growth c. market-oriented d. benchmark e. small-cap ANSWER: d 57. Which of the following statements is FALSE? a. A manager's choice to align with an investment style communicates information to clients about the investor's focus, area of expertise, and stock evaluation methods. b. An investment manager's style cannot be used as a basis for measuring the manager's performance relative to a benchmark. c. Style identification allows an investor to select investment managers that allow his overall portfolio to be properly diversified. d. Style investing allows control of the total portfolio to be shared between the investment managers and a knowledgeable sponsor. e. An investor needs to be cautious about a manager whose portfolio exhibits unintentional style drift.

ANSWER: b 58. In returns-based style analysis, a coefficient of determination of 95 percent would suggest that a. the portfolio manager outperformed 95 percent of his peers. b. the portfolio manager was outperformed by 95 percent of his peers. c. 95 percent of the portfolio return variability could be attributed to portfolio style. d. 95 percent of the portfolio return variability could be attributed to stock selection skills. e. 5 percent of the portfolio return variability could be attributed to portfolio style.

ANSWER: c 59. Which of the following is NOT considered an asset allocation strategy? a. integrated asset allocation b. strategic asset allocation c. tactical asset allocation d. insured asset allocation e. full replication richard@qwconsultancy.com

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ANSWER: e 60. In ____ asset allocation, the investor's risk tolerance and constraints are assumed to be constant over time. However, changes in capital market conditions result in changes in the portfolio's stockbond mix. a. integrated b. strategic c. tactical d. insured e. replication ANSWER: c 61. The strategy that is used to determine the long-term policy asset weights in a portfolio is called a. integrated asset allocation. b. tactical asset allocation. c. sector rotation. d. strategic asset allocation. e. insured asset allocation.

ANSWER: d 62. The strategy that separately examines capital market conditions and the investor's objectives and constraints is called a. integrated asset allocation. b. tactical asset allocation. c. sector rotation. d. strategic asset allocation. e. insured asset allocation.

ANSWER: a 63. The strategy that frequently adjusts the asset class mix in the portfolio to take advantage of changing market conditions while assuming that the investor’s risk tolerance and investment constraints to be constant over time is called a. integrated asset allocation. b. tactical asset allocation. c. sector rotation. d. strategic asset allocation. e. insured asset allocation.

ANSWER: b 64. A contrarian investment strategy is based on the belief that a. stock returns are mean reverting. b. the best time to buy is when other investors are bullish. c. rising stocks will continue to rise. d. passive management is preferred to active management. e. a long/short portfolio will outperform a long only portfolio. richard@qwconsultancy.com

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ANSWER: a 65. A portfolio manager who is trying to generate alpha could use a. hedge funds. b. mutual funds. c. insured asset allocation. d. ETFs. e. indexing.

ANSWER: a

Chapter 12 - Bond Fundamentals and Valuation 1. Public bonds differ from other debt because they are sold to the public rather than to a single investor. a. True b. False ANSWER: True 2. The market for short-term issues with maturities of one year or less is commonly known as the money market. a. True b. False ANSWER: True 3. Instruments for intermediate-term issues with maturities in excess of one year but less than 10 years are known as notes. a. True b. False ANSWER: True 4. The coupon of a bond indicates the income that the bond investor will receive over the life of the bond. a. True b. False ANSWER: True 5. A bond's maturity is affected by call features, non-refunding provisions, and sinking fund provisions. a. True b. False ANSWER: True 6. A nonrefunding provision prohibits a call and premature retirement of an issue from the proceeds of a lower-coupon refunding bond. a. True richard@qwconsultancy.com

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b. False ANSWER: True 7. In the case of a bond, the only contractual factor is the amount of interest payments, as beginning and ending bond prices are determined by market forces. a. True b. False ANSWER: True 8. Bonds can have different types of collateral and can be secured, unsecured, or registered bonds. a. True b. False ANSWER: False 9. In most countries, sovereign bond issues are the smallest bond market segment. a. True b. False ANSWER: False 10. High-yield bonds are considered "investment" grade. a. True b. False ANSWER: False 11. Bonds rated BB or above are considered to be investment-grade bonds. a. True b. False ANSWER: False 12. Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds in which the bond principal and interest payments are indexed to the consumer price index. a. True b. False ANSWER: True 13. Treasury Inflation Protected Securities (TIPS) ensures that investors will receive the promised yield in real terms by indexing bond principal and interest payments to the stock market. a. True b. False ANSWER: False 14. Most U.S. municipal bonds are serial issues that are subject to state and local taxes when they are issued in the investor's home state. a. True b. False richard@qwconsultancy.com

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ANSWER: False 15. Revenue bonds are essentially backed by the full faith and credit of the issuer and its entire taxing power. a. True b. False ANSWER: False 16. General obligation bonds (GOs) are serviced by the income generated from specific revenueproducing projects of the municipality. a. True b. False ANSWER: False 17. Samurai bonds are yen-denominated bonds sold in markets outside Japan by international syndicates. a. True b. False ANSWER: False 18. The major problem facing a bond analyst is the ability to forecast the basic interest rate level because yield spreads are generally inconsequential. a. True b. False ANSWER: False 19. Yield to maturity and current yield are equal when the bond is selling for exactly par value. a. True b. False ANSWER: True 20. The three major theories explaining the term structure of interest rates are the expectations hypothesis, the liquidity differential hypothesis, and the segmented quality hypothesis. a. True b. False ANSWER: False 21. The expectations hypothesis is also known as both the institutional theory and the hedging pressure theory. a. True b. False ANSWER: False 22. According to the expectations hypothesis, a rising yield curve indicates that investors' demand for long maturity bonds is expected to rise. a. True richard@qwconsultancy.com

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b. False ANSWER: False 23. The fundamental determinants of interest rates are the real risk-free rate, inflation, and the risk premium. a. True b. False ANSWER: True 24. 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 ANSWER: True 25. The term structure of interest rates is a dynamic function that relates the term to maturity to the yield to maturity of bonds. a. True b. False ANSWER: False 26. There is a direct relationship between coupon and price. a. True b. False ANSWER: True 27. A bond's price is determined by the issue's coupon rate, length to maturity, and the prevailing yield in the market. a. True b. False ANSWER: True 28. The yield to maturity is normally equal to the coupon rate. a. True b. False ANSWER: False 29. For a bond, the present value model incorporates both the coupon receipts and the capital gain or loss. a. True b. False ANSWER: True 30. The internal rate of return is that discount rate that sets the present value of cash flows from an investment equal to its par value. richard@qwconsultancy.com

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a. True b. False ANSWER: False 31. If an investor buys a high coupon bond, and rates then fall, the investor has "locked up" that high yield as a realized yield. a. True b. False ANSWER: False 32. The realized yield measures the expected rate of return of a bond that you expect to sell prior to its maturity. a. True b. False ANSWER: True 33. The annual interest paid on a bond relative to its prevailing market price is called its ____. a. promised yield b. yield to maturity c. coupon rate d. effective yield e. current yield ANSWER: e 34. Of the following provisions that may be found in a bond indenture, which would tend to reduce the coupon interest rate? a. a call provision b. no restrictive covenants c. a sinking fund provision d. change in bond rating from Aaa to Aa e. an indenture provision ANSWER: c 35. The refunding provision of an indenture allows bonds to be retired EXCEPT if a. they are replaced with a lower coupon bond issue. b. the remaining time to maturity is less than five years. c. the remaining time to maturity is greater than five years. d. the stated time period in the indenture has not passed. e. the stated time period in the indenture has passed.

ANSWER: a 36. When a bond issue is secured by a legal claim on equipment it is known as a(n) a. junior bond. b. income bond. c. bearer bond. richard@qwconsultancy.com

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d. trust certificate. e. perpetuity.

ANSWER: d 37. The legal document setting forth the obligations of a bond's issuer is called a a. debenture. b. warrant. c. indenture. d. rights certificate. e. trustee deed.

ANSWER: c 38. Issues that provide funds to retire another issue early are known as a. bearer bonds. b. secured debentures. c. unsecured debentures. d. revenue bonds. e. refunding bonds.

ANSWER: e 39. Which bond provision would be considered the riskiest for an investor who is concerned that market interest rates will drop dramatically over the life of the bond? a. sinking fund b. deferred call c. freely callable d. non-callable e. None of these are correct.

ANSWER: c 40. Which of the following statements is not true regarding bond ratings? a. The ratings assigned are meant to indicate the probability of default for the bond issuer. b. The bonds assigned one of the top four rating classes are considered investment grade bonds. c. Once a rating is assigned to an issue it cannot be changed for the first two years after which it is reviewed on a regular basis. d. Bonds rated BB and below are referred to as high yield or "junk" bonds. e. The rating agencies modify the ratings with + and − signs or numbers after the letters.

ANSWER: c 41. Junk bonds are high yield bond bonds rated below a. BBB. b. BB. c. B. d. CCC. e. CC. richard@qwconsultancy.com

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ANSWER: a 42. The institutions that invest most heavily in corporate bond issues are a. life insurance companies and commercial banks. b. life insurance companies and property and liability insurance companies. c. life insurance companies and pension funds. d. commercial banks and property and liability insurance companies. e. commercial banks and pension funds.

ANSWER: c 43. Which of the following is NOT a major rating agency for bonds? a. Moody's b. Standard & Poor's c. Fitch Investor Services d. Value Line e. Duff and Phelps ANSWER: d 44. Institutional investors typically account for about a. 90 to 95 percent of bond market trading. b. 40 to 50 percent of bond market trading. c. 10 to 15 percent of bond market trading. d. less than 5 percent of bond market trading. e. less than 1 percent of bond market trading.

ANSWER: a 45. Bond ratings are positively related to a. leverage. b. size. c. type of business. d. bond maturity. e. coupon rate.

ANSWER: b 46. Bond ratings are negatively related to a. profitability. b. cash flow coverage. c. earnings instability. d. bond maturity. e. coupon rate.

ANSWER: c 47. Which factors indicate that in-depth credit analysis of high-yield bonds is important? a. the large number of high-yield issues richard@qwconsultancy.com

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b. the overall decline in quality of these bonds c. the wide range of quality among these bonds d. the growing complexity of these bonds e. All of these are correct.

ANSWER: e 48. Which type of bond is backed by the full faith and credit of the issuer and its entire taxing power? a. Fannie Mae b. Freddie Mac c. GSEs d. general obligation bonds e. revenue bonds ANSWER: d 49. The bonds issued by the Bank of England are known as a. gilts. b. bunds. c. limies. d. treasuries. e. benchmarks.

ANSWER: a 50. When a fixed income security is being traded at the price above its face value it is trading a. at a discount. b. at par. c. at a premium. d. flat. e. no accrual.

ANSWER: c 51. Which type of bond market is the largest sector in both Japan and the United States? a. corporate b. high yield/emerging market c. securitized/collateralized d. sovereign e. quasi & foreign governments ANSWER: d 52. A security that has a coupon that is periodically adjusted is a(n) a. variable note. b. variation note. c. adjustable coupon note. d. money market certificate. e. deep discount bond. richard@qwconsultancy.com

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ANSWER: a 53. TIPS are U.S Treasury securities where the coupon rate is a. zero. b. indexed to the rate of inflation. c. indexed to the discount rate. d. indexed to the prime rate. e. indexed to the stock market.

ANSWER: b 54. If the yield to maturity for a par value TIPS bond with eight years to maturity is 3 percent, and the yield to maturity of a U.S Treasury note with 8 years is 4.25 percent, this implies that a. the expected annual rate of inflation over the next eight years is −1.25 percent. b. the expected annual rate of inflation over the next eight years is 1.25 percent. c. the expected annual rate of inflation over the next eight years is −2.25 percent. d. the expected annual rate of inflation over the next eight years is 2.25 percent. e. the expected annual rate of inflation over the next eight years is 0 percent.

ANSWER: b 55. When homeowners pay off mortgages when they sell their homes, or when homeowners refinance home mortgages, they effectively a. make the maturities of GNMA securities longer. b. make the maturities of GNMA securities shorter. c. make the maturities of U.S. Treasury securities longer. d. make the maturities of U.S. Treasury securities shorter. e. default on their mortgages.

ANSWER: b 56. General obligation bonds are a. U.S. Treasury bonds backed by the full faith and credit of the issuer. b. U.S. Treasury bonds backed by income generated form specific projects. c. municipal bonds backed by the full faith and credit of the issuer. d. municipal bonds backed by income generated from specific projects. e. a type of U.S. agency security.

ANSWER: c 57. Revenue bonds are a. U.S. Treasury bonds backed by the full faith and credit of the issuer. b. U.S. Treasury bonds backed by income generated form specific projects. c. municipal bonds backed by the full faith and credit of the issuer. d. municipal bonds backed by income generated from specific projects. e. a type of U.S. agency security.

ANSWER: d 58. Collateralized Mortgage obligations are richard@qwconsultancy.com

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a. mortgage pass-through securities. b. mortgage pass-through securities with varying maturities. c. mortgage pass-through securities with no default risk. d. mortgage pass-through securities with variable coupon rates. e. mortgage pass-through securities with zero coupon rates.

ANSWER: b 59. A bond denominated in U.S. dollars and sold in Japan to Japanese investors is called a a. Samurai bond. b. Eurobond. c. Yankee bond. d. Euroyen bond e. foreign bond.

ANSWER: b 60. Collateralized mortgage obligations (CMOs) offset some of the problems associated with traditional mortgage pass-throughs because a. they are overcollateralized. b. they have variable rates. c. they are collateralized by auto-loans. d. they are deep discount instruments. e. they are collateralized by credit card debt.

ANSWER: a 61. A bond that only pays a principal payment at maturity date is known as a(n) a. blank bond. b. maturity bond. c. interest free bond. d. mini-coupon bond. e. zero coupon bond.

ANSWER: e 62. What was developed in the early 1980s to offset some of the problems with traditional mortgage pass-throughs? a. variable rate mortgages b. collateralized mortgage obligations (CMOs) c. leveraged buyouts (LBOs) d. deep discount bonds (DDBs) e. high yield bonds.

ANSWER: b 63. Which of the following statements regarding Collateralized Debt Obligations (CDOs) is FALSE? a. CDOs experienced rapid growth since the year 2000. b. The assets used to back the CDOs are substantially diverse. c. The credit quality within a CDO at the time of issue is diverse. richard@qwconsultancy.com

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d. CDOs have generated significant credit and liquidity problems. e. All of these are correct.

ANSWER: e 64. A U.S. dollar-denominated bond sold in the United States by a Japanese-firm is called a(n) a. Yankee bond. b. homeland bond. c. international bond. d. U.S. Domestic bond. e. Japanese U.S. Regional bond.

ANSWER: a 65. When a borrower pledges financial assets as collateral for a bond it is called a(n) a. mortgage bond. b. equipment trust certificate. c. mortgage pass-through security. d. collateral trust bond. e. collateralized mortgage obligation (CMO).

ANSWER: d 66. The term structure of interest rates is a static function that relates the a. term to call and the yield to maturity. b. term to maturity and the yield to maturity. c. term to call and the yield to call. d. term to maturity and the coupon rate. e. term to maturity and the current yield.

ANSWER: b 67. Which set of conditions will result in a bond with the greatest volatility? a. a high coupon and a short maturity b. a high coupon and a long maturity c. a low coupon and a short maturity d. a low coupon and a long maturity e. a deferred call feature and a sinking fund ANSWER: d 68. According to the liquidity preference hypothesis, yield curves generally slope upward because a. investors prefer short maturity obligations to long maturity obligations. b. investors prefer long maturity obligations to short maturity obligations. c. investors prefer less volatile long maturity obligations. d. investors prefer more volatile short maturity obligations. e. None of these are correct.

ANSWER: a

richard@qwconsultancy.com

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69. According to the segmented-market hypothesis, a downward sloping yield curve indicates that a. demand for long term bonds has fallen and demand for short term bonds has fallen. b. demand for long term bonds has risen and demand for short term bonds has fallen. c. demand for long term bonds has fallen and demand for short term bonds has risen. d. demand for long term bonds has risen and demand for short term bonds has risen. e. None of these are correct.

ANSWER: b 70. According to the segmented-market hypothesis, a rising yield curve indicates that a. demand for long term bonds has fallen and demand for short term bonds has fallen. b. demand for long term bonds has risen and demand for short term bonds has fallen. c. demand for long term bonds has fallen and demand for short term bonds has risen. d. demand for long term bonds has risen and demand for short term bonds has risen. e. None of these are correct.

ANSWER: c 71. 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 these are correct.

ANSWER: b 72. Which term-structure hypothesis suggests that any long-term interest rate simply represents the geometric mean of current and future on-year interest rates expected to prevail over the maturity of the issue? a. expectations hypothesis b. liquidity preference hypothesis c. segmented market hypothesis d. preferred habitat hypothesis e. hedging pressure hypothesis ANSWER: a 73. Which of the four major yield spreads defines the difference in yields between pure government agency bonds and corporate bonds? a. segments b. sectors c. coupons d. seasoning e. maturity ANSWER: a 74. The annual interest paid on a bond relative to its prevailing market price is called its a. promised yield. richard@qwconsultancy.com

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b. yield to maturity. c. coupon rate. d. effective yield. e. current yield.

ANSWER: e 75. The yield to call is a more conservative yield measure whenever the price of a callable bond is quoted at a value a. equal to or greater than par plus one year's interest. b. equal to par. c. equal to par less one year's interest. d. less than par. e. 5 percent over par.

ANSWER: a 76. Which of the following is NOT a major risk premium component for bond investors? a. quality differentials b. term to maturity c. indenture provisions d. yield to maturity e. exchange rate risk differences ANSWER: d 77. There are four major factors accounting for the existence of yield differentials. Which of the following is NOT a factor? a. segments b. sectors c. indentures d. coupons e. maturities ANSWER: c 78. A 4.75 percent coupon bond issued by the State of Washington 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 28 percent marginal tax bracket? a. 1.1 percent b. 5.8 percent c. 6.6 percent d. 7.3 percent e. 9.7 percent ANSWER: c 79. 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? richard@qwconsultancy.com

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a. 1.69 percent b. 11.25 percent c. 8.78 percent d. 14.63 percent e. 25 percent ANSWER: c 80. An 8.5 percent coupon bond issued by the State of Ohio 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 25 percent marginal tax bracket? a. 2.13 percent b. 12.25 percent c. 11.33 percent d. 13.53 percent e. 34.71 percent ANSWER: c 81. A 7.0 percent coupon bond issued by the State of Tennessee 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 29 percent marginal tax bracket? a. 7.59 percent b. 12.25 percent c. 9.86 percent d. 14.63 percent e. 30.71 percent ANSWER: c 82. At what point would an investor be indifferent between a Drifton corporate bond yielding 12.5 percent and a tax-free municipal bond of equal financial strength if the investor's marginal tax rate is 25 percent? a. 6.05 percent b. 7.10 percent c. 8.15 percent d. 9.38 percent e. 16.27 percent ANSWER: d 83. At what point would an investor be indifferent between a Compco corporate bond yielding 8.5 percent and a tax-free municipal bond of equal financial strength if the investor's marginal tax rate is 25 percent? a. 6.05 percent b. 7.10 percent c. 8.15 percent d. 6.38 percent e. 2.34 percent ANSWER: d richard@qwconsultancy.com

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84. At what point would an investor be indifferent between a Bridgford corporate bond yielding 8.0 percent and a tax-free municipal bond of equal financial strength if the investor's marginal tax rate is 25 percent? a. 5.00 percent b. 7.10 percent c. 8.00 percent d. 9.15 percent e. 6.00 percent ANSWER: e 85. 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 percent b. 8.16 percent c. 8.22 percent d. 8.32 percent e. 8.47 percent ANSWER: b 86. You purchase a 9 3/4s February $10,000 par Treasury note at 101:11 and hold it for exactly one year at which time you sell it. What is your rate of return if your selling price is 101:17? a. 8.14 percent b. 8.75 percent c. 9.75 percent d. 9.81 percent e. 10.47 percent ANSWER: d 87. You purchase an 8 1/2s February $10,000 par Treasury note at 105:16 and hold it for exactly one year at which time you sell it. What is your rate of return if your selling price is 105:16? a. 8.00 percent b. 8.06 percent c. 8.22 percent d. 8.50 percent e. 8.47 percent ANSWER: b 88. You purchase an 11 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 100:13? a. 10.14 percent b. 11.75 percent c. 8.22 percent d. 8.32 percent e. 8.16 percent richard@qwconsultancy.com

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ANSWER: e 89. You purchase a 10 1/4s February $10,000 par Treasury note at 102:15 and hold it for exactly one year at which time you sell it. What is your rate of return if your selling price is 104:14? a. 11.92 percent b. 8.16 percent c. 8.55 percent d. 8.61 percent e. 10.25 percent ANSWER: a Exhibit 12.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Company Gen Elec

Ticker GE

Coupon 4.75

Maturity 9/15/2019

Last Price 99.544

Last Yield 4.808

EST Spread 62

UST 10

Est $ Vol (000's) 158736

90. Refer to Exhibit 12.1. What annual dollar coupon amount will investors receive? a. $4.75 b. $47.50 c. $4.808 d. $48.08 e. $62 ANSWER: b 91. Refer to Exhibit 12.1. What price would you pay in dollars to purchase this bond? a. $62 b. $9.954 c. $48.08 d. $99.544 e. $995.44 ANSWER: e 92. Refer to Exhibit 12.1. What is the estimated yield on Treasury securities? a. 4.188 percent b. 5.428 percent c. 5.371 percent d. 4.132 percent e. 4.753 percent ANSWER: a 93. Refer to Exhibit 12.1. What is the current yield for this bond? a. 4.18 percent richard@qwconsultancy.com

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b. 5.88 percent c. 4.77 percent d. 8.125 percent e. 4.063 percent ANSWER: c 94. Refer to Exhibit 12.1. What is the capital gains/loss yield on this bond? a. −0.038 percent b. 0.456 percent c. 0.038 percent d. −0.456 percent e. 0 percent ANSWER: c 95. How much would you expect to pay for a $10,000 Treasury note quoted at 96:27? a. $9,627.00 b. $10,000.00 c. $968.44 d. $9,684.38 e. $962.70 ANSWER: d 96. How much would you expect to pay for a $10,000 stripped Treasury bond quoted at 101:16? a. $10,150.00 b. $10,000.00 c. $101.16 d. $10,160.00 e. $1,011.60 ANSWER: a 97. For bonds A and B below find the values of X and Y assuming each is a zero-coupon bond with a $1,000 face value (semiannual compounding).

Bond A B

Maturity (Years) X 9

Yield (Percent) 10 Y

Price ($$) 458.10 212.00

a. eight years and 4 percent b. 10 years and 8 percent c. 12 years and 10 percent d. 14 years and 12 percent e. eight years and 18 percent ANSWER: e

richard@qwconsultancy.com

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98. Calculate the yield to maturity of a zero-coupon bond with a face value of $1000, maturing in 10 years and selling for a price of $529.30. a. 6.57 percent b. 8.45 percent c. 4.16 percent d. 10.23 percent e. 12.17 percent ANSWER: a 99. Calculate the yield to maturity of a zero-coupon bond with a face value of $1000, maturing in 15 years and selling for a price of $525.75. a. 5.62 percent b. 4.38 percent c. 8.74 percent d. 15.26 percent e. 16.27 percent ANSWER: b 100. Calculate the price of a zero-coupon bond with yield to maturity of 8.75 percent, a face value of $1000, and maturing in five years. a. $1000 b. $756.43 c. $675.44 d. $435.12 e. $875.14 ANSWER: c 101. What is the value of a zero-coupon bond with a yield to maturity of 9 percent, a par value of $1,000, and 10 years to maturity? (Assume semi-annual compounding) a. $208.29 b. $414.64 c. $422.41 d. $643.93 e. $910.00 ANSWER: b Exhibit 12.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) XLR Corporation just issued a $1,000 par value bond with a 7 percent yield to maturity, twenty years to maturity, with an 8 percent semi-annual coupon rate.

102. Refer to Exhibit 12.2. What is the price of the XLR Corporate bond? a. $901.04 b. $932.04 richard@qwconsultancy.com

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c. $1,102.62 d. $1,105.94 e. $1,106.78 ANSWER: e 103. Refer to Exhibit 12.2. If market interest rates are constant, what will the price of the XLR Corporate bond be in three years? a. $904.29 b. $1,097.63 c. $1,098.50 d. $1,102.85 e. $1,105.62 ANSWER: c 104. Refer to Exhibit 12.2. If market interest rates rise to 10 percent, what will the price of the XLR Corporate bond be in three years? a. $832.89 b. $838.07 c. $1097.63 d. $1,102.85 e. $1,191.43 ANSWER: b 105. A 9.0 percent coupon bond issued by the State of Iowa 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 30 percent marginal tax bracket? a. 6.30 percent b. 6.92 percent c. 11.70 percent d. 12.86 percent e. 15.25 percent ANSWER: d 106. At what point would an investor be indifferent between a GM corporate bond yielding 9.5 percent and a tax-free municipal bond of equal financial strength if the investor's marginal tax rate is 25 percent? a. 7.13 percent b. 7.60 percent c. 11.87 percent d. 12.67 percent e. 14.27 percent ANSWER: a 107. Calculate the yield to maturity of a zero-coupon bond with a face value of $1000, maturing in 10 years, and selling for a price of $628.72. a. 4.18 percent richard@qwconsultancy.com

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b. 4.75 percent c. 6.29 percent d. 8.23 percent e. 9.54 percent ANSWER: b 108. If the holding period is equal to the term to maturity for a corporate bond, then the rate of discount represents the a. coupon yield. b. effective yield. c. yield to call. d. yield to maturity. e. reinvestment rate.

ANSWER: d 109. 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.

ANSWER: d 110. If the coupon payments are NOT reinvested during the life of the issue, then the a. promised yield is greater than the realized yield. b. promised yield is less than the realized yield. c. nominal yield declines. d. nominal yield is greater than the promised yield. e. current yield equals the yield to maturity.

ANSWER: a 111. The importance of the reinvestment assumption increases with a ____ coupon and a ____ term to maturity. a. low, short b. low, long c. high, short d. high, long e. zero, very long ANSWER: d 112. The best way for an investor to "lock in" to high interest rates would be to purchase a bond that has a ____ coupon and a ____ term to maturity. a. low, short b. low, long c. high, short richard@qwconsultancy.com

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d. high, long e. zero, very long ANSWER: e 113. The promised yield to maturity calculation assumes that a. all coupon interest payments are reinvested at the current market interest rate for the bond. b. all coupon interest payments are reinvested at the coupon interest rate for the bond. c. all coupon interest payments are reinvested at short-term money market interest rates. d. all coupon interest payments are not reinvested. e. None of these are correct.

ANSWER: a 114. If the coupon payments are not reinvested during the life of the issue then the a. promised yield is greater than realized yield. b. promised yield is less than realized yield. c. nominal yield declines. d. nominal yield is greater than promised yield. e. current yield equals the yield to maturity.

ANSWER: a 115. Consider a bond portfolio manager who expects interest rates to decline and must choose between the following two bonds.

Bond A: 10 years to maturity, 5 percent coupon, 5 percent yield to maturity Bond B: 10 years to maturity, 3 percent coupon, 4 percent yield to maturity a. Bond A because it has a higher coupon rate b. Bond A because it has a higher yield to maturity c. Bond B because it has a lower coupon rate d. Bond A or Bond B because the maturities are the same e. None of these are correct.

ANSWER: c 116. ____ measures the expected rate of return of a bond assuming that you sell it prior to its maturity. a. Yield to maturity b. Current yield c. Realized yield d. Coupon rate e. None of these are correct.

ANSWER: c 117. The yield to call is a more conservative yield measure whenever the price of a callable bond is quoted at a value a. equal to or greater than par plus one year's interest. b. equal to par. richard@qwconsultancy.com

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c. equal to par less one year's interest. d. less than par. e. 5 percent over par.

ANSWER: a 118. Consider a 12 percent, 15-year bond that pays interest semiannually, and its current price is $675. What is the promised yield to maturity? a. 10.23 percent b. 18.45 percent c. 17.77 percent d. 2.31 percent e. 9.26 percent ANSWER: b 119. Consider a 15 percent, 20-year bond that pays interest annually, and its current price is $850.

What is the promised yield to maturity? a. 10.23 percent b. 18.45 percent c. 2.31 percent d. 17.77 percent e. 9.26 percent ANSWER: d 120. Consider a 10 percent, 15-year bond that pays interest annually quarterly, and its current price is $1060. What is the promised yield to maturity? a. 10.23 percent b. 18.45 percent c. 2.31 percent d. 17.77 percent e. 9.26 percent ANSWER: e 121. Consider a zero-coupon bond that has a current price of $436.19 and matures in 10 years. What is its yield to maturity? a. 0.86 percent b. 8.65 percent c. 8.00 percent d. 58.80 percent e. 6.564 percent ANSWER: b 122. What is the current price of a zero-coupon bond with a 6 percent yield to maturity that matures in 15 years? a. $4.17 b. $41.27 richard@qwconsultancy.com

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c. $417.27 d. $4,172.00 e. $41,720.00 ANSWER: c 123. What is the current price of a zero-coupon bond with a 7 percent yield to maturity that matures in 20 years? a. $1,000 b. $2,582 c. $25.82 d. $258.42 e. $100.00 ANSWER: d 124. Consider a bond with a 9 percent coupon and a current yield of 8 1/2 percent. What is this bond's price? a. $1058.82 b. $1009.00 c. $1085.00 d. $1062.44 e. $1077.96 ANSWER: a 125. Consider a bond with a current yield of 8 percent and a price of $1,250. What is this bond's coupon? a. 8.0 percent b. 10.0 percent c. 11.0 percent d. 8.5 percent e. 9.6 percent ANSWER: b 126. Consider a bond with a price of $944.44 and a coupon of 8 1/2 percent. What is the current yield? a. 9.4 percent b. 6.8 percent c. 8.6 percent d. 9.0 percent e. 11.0 percent ANSWER: d 127. Suppose you have a 12 percent, 20-year bond traded at $850. If it is callable in 5 years at $1,100, what is the bond's yield to call? Interest is paid semiannually. a. 8 percent b. 9.0 percent richard@qwconsultancy.com

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c. 18.0 percent d. 9.4 percent e. 16.5 percent ANSWER: c 128. Suppose you have a 15 percent, 25-year bond traded at $975. If it is callable in 5 years at $1050, what is the bond's yield to call? Interest is paid annually. a. 15 percent b. 16.5 percent c. 7.65 percent d. 8.52 percent e. 9.64 percent ANSWER: b 129. Suppose you have a 10 percent, 20-year bond traded at $1,120. If it is callable in 5 years at $1,150, what is the bond's approximate yield to call? Interest is paid quarterly. a. 7.78 percent b. 8.00 percent c. 9.40 percent d. 9.36 percent e. 9.72 percent ANSWER: c 130. If the price before yields changed was $950, what is the resulting price? a. $922.64 b. $918.66 c. $1000.00 d. $968.50 e. $1012.45 ANSWER: a 131. If the price before yields changed was $925, what is the resulting price? a. $865.22 b. $918.66 c. $889.11 d. $1000.00 e. $1012.45 ANSWER: c 132. If the price before yields changed was $975, what is the resulting price? a. $937.46 b. $918.66 c. $965.55 d. $898.62 e. $1012.45 richard@qwconsultancy.com

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ANSWER: a 133. Assume that you purchase a three-year, $1,000 par value bond, with an 8 percent coupon and a yield of 10 percent. After you purchase the bond, one-year interest rates are as follows: year 1 = 10 percent, year 2 = 8 percent, year 3 = 6 percent (these are the reinvestment rates). Calculate the realized horizon yield if you hold the bond to maturity. Interest is paid annually. a. 8.37 percent b. 7.28 percent c. 9.76 percent d. 10.67 percent e. 14.0 percent ANSWER: c 134. Assume that you purchase a 10-year, $1,000 par value bond, with a 12 percent coupon and a yield of 9 percent. Immediately after you purchase the bond, yields fall to 8 percent and remain at that level to maturity. Calculate the realized horizon yield, if you hold the bond for five years and then sell. Interest is paid annually. a. 16.25 percent b. 12.15 percent c. 7.75 percent d. 10.05 percent e. 9.34 percent ANSWER: e 135. Estimate the percentage price change for a five-year, $1,000 par value bond, with a 6 percent coupon, if the yield rises from 8 percent to 8.5 percent. Interest is paid semiannually. a. 2.1 percent b. −2.1 percent c. 4.4 percent d. −4.4 percent e. 0 percent ANSWER: b 136. A 15-year bond has a $1,000 par value bond, a 4 percent coupon, and a yield to maturity of 3.3 percent. Interest is paid annually. The bond's current yield is a. 3.7 percent. b. 4.0 percent. c. 3.3 percent. d. 7.3 percent. e. 8.3 percent.

ANSWER: a 137. A five-year bond has a $1,000 par value bond, a 12 percent coupon, and a yield to maturity of 8 percent. Interest is paid semiannually. The bond's price is a. $864.65. b. $1081.78. richard@qwconsultancy.com

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c. $852.80. d. $1162.22. e. $1785.35.

ANSWER: d 138. A 15-year bond, purchased five years ago, has a $1,000 par value bond, a 10 percent coupon, and a yield to maturity of 12 percent. Interest is paid annually. The bond's price is a. $864. b. $887. c. $1152. d. $1123. e. $1253.

ANSWER: b

Chapter 13 - Bond Analysis and Portfolio Management Strategies 1. The breakeven yield is the same as the implied forward rate. a. True b. False ANSWER: True 2. Bond price volatility varies directly with the term to maturity and directly with the coupon. a. True b. False ANSWER: False 3. The longer the time to maturity, the greater the percentage change in a bond's price. a. True b. False ANSWER: True 4. There is an inverse relationship between duration and coupon. a. True b. False ANSWER: True 5. The lower a bond's yield to maturity, the greater its duration. a. True b. False ANSWER: True 6. For a given change in yield bond price, volatility is inversely related to term to maturity. a. True b. False richard@qwconsultancy.com

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ANSWER: False 7. For a given change in yield bond price, volatility is inversely related to coupon. a. True b. False ANSWER: True 8. For a given change in yield bond price, volatility is directly related to duration. a. True b. False ANSWER: True 9. Modified duration is determined by making small adjustments to the Macaulay duration. a. True b. False ANSWER: True 10. Convexity is a measure of how much a bond's price-yield curve deviates from the linear approximation of that curve. a. True b. False ANSWER: True 11. The price-yield curve is a concave curve representing the relationship of bond prices and yields. a. True b. False ANSWER: False 12. Because you expect market interest rates to decline during the next four months, if you were offered two bonds with equal duration, you would select the one with the higher measure of convexity. a. True b. False ANSWER: True 13. The investment style of a bond portfolio can be summarized by its two most important characteristics: credit quality and interest rate sensitivity. a. True b. False ANSWER: True 14. In a buy-and-hold strategy, bonds are purchased in light of the investor's objectives and constraints and then held until maturity. a. True b. False richard@qwconsultancy.com

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ANSWER: True 15. In a ladder strategy, funds are invested equally among a wide range of maturities. a. True b. False ANSWER: True 16. Indexing is an active portfolio management strategy that seeks to copy the composition and performance of a selected market index. a. True b. False ANSWER: False 17. Interest rate anticipation is the most conservative management strategy. a. True b. False ANSWER: False 18. In valuation analysis, undervalued bonds are bonds in which the expected YTMs are lower than the prevailing YTM. a. True b. False ANSWER: True 19. A bond swap involves liquidating a current bond position and later investing in a similar issue under more favorable conditions. a. True b. False ANSWER: False 20. A pure yield pickup swap involves a switch from a low-coupon bond to a higher-coupon bond of similar quality and maturity. a. True b. False ANSWER: True 21. A swap relies heavily on interest rate expectations. a. True b. False ANSWER: True 22. When applying active management techniques to a global portfolio, the additional concern is an expectation regarding exchange rates between countries. a. True b. False richard@qwconsultancy.com

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ANSWER: True 23. A manager following an interest rate anticipation strategy would shorten portfolio duration if interest rates were expected to increase. a. True b. False ANSWER: True 24. When applying active management techniques to a global portfolio, the additional concern is an expectation regarding exchange rates between countries. a. True b. False ANSWER: True 25. Interest rate anticipation is one of the matched funding techniques that matches anticipated interest rates with the required rates on a portfolio. a. True b. False ANSWER: False 26. Altman-Nammacher (1987) created a modified Z-score model using a multiple regression analysis technique. a. True b. False ANSWER: False 27. An investor in a pure yield pickup swap is most concerned about changes in interest rates. a. True b. False ANSWER: False 28. Credit analysis and core-plus management are examples of active bond portfolio management. a. True b. False ANSWER: True 29. A bond portfolio is immunized from interest rate risk if the modified duration of the portfolio is always equal to the desired investment horizon. a. True b. False ANSWER: True 30. The bond management strategy intended to eliminate interest rate risk is immunization. a. True b. False richard@qwconsultancy.com

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ANSWER: True 31. A portfolio of bonds is immunized from interest rate risk if the duration of the portfolio is always equal to the desired investment horizon. a. True b. False ANSWER: True 32. With a matched funding technique, portfolio managers try to match specific liability obligations due at specific times to a portfolio of bonds that minimize the portfolio's interest rate risk. a. True b. False ANSWER: True 33. Investment horizon is the future time when an investor must begin an investment program to generate the required funds for a future liability. a. True b. False ANSWER: False 34. The components of interest rate risk are price risk and maturity risk. a. True b. False ANSWER: False 35. Contingent procedures for managing bond portfolios are a form of what has come to be called structured active management. a. True b. False ANSWER: True 36. Contingent immunization is a strategy that allows the bond manager flexibility to actively manage the portfolio subject to an overriding constraint that the portfolio remains immunized at some predetermined yield level. a. True b. False ANSWER: True 37. Estimating forward rates from the spot rate curve is based on the assumption that the ____ hypothesis accurately describes the shape of the yield curve. a. expectations b. liquidity preference c. liquidity preference d. efficient market e. None of these are correct.

ANSWER: a richard@qwconsultancy.com

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38. If you expected interest rates to fall, you would prefer to own bonds with a. long durations and high convexity. b. long durations and low convexity. c. short durations and high convexity. d. short durations and high convexity. e. None of these are correct.

ANSWER: a 39. If you expected interest rates to fall, you would prefer to own bonds with a. short maturities and low coupons. b. long maturities and high coupons. c. long maturities and low coupons. d. short maturities and high coupons. e. None of these are correct.

ANSWER: c 40. If you expected interest rates to rise, you would prefer to own bonds with a. short maturities and low coupons. b. long maturities and high coupons. c. long maturities and low coupons. d. short maturities and high coupons. e. None of these are correct.

ANSWER: d 41. Convexity is a desirable feature of bonds because as interest rates decline, the price of a low convexity bond a. decreases at a decreasing rate. b. decreases at an increasing rate. c. increases at a decreasing rate. d. increases at an increasing rate. e. decreases at a decreasing rate.

ANSWER: d 42. The position of a bondholder that is long a callable bond is equal to being a. long a noncallable bond + long a call option on the bond. b. long a noncallable bond + short a call option on the bond. c. short a noncallable bond + long a call option on the bond. d. short a noncallable bond + short a call option on the bond. e. None of these are correct.

ANSWER: b 43. Option adjusted duration can be calculated as a. duration of noncallable bond − duration of call option on the bond. richard@qwconsultancy.com

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b. duration of noncallable bond + duration of call option on the bond. c. duration of callable bond − duration of call option on the bond. d. duration of callable bond + duration of call option on the bond. e. None of these are correct.

ANSWER: a 44. The option adjusted duration will approach the duration to maturity, when a. interest rates are significantly above the coupon rate because the option has very little chance of being called, and the call option will have very little value. b. interest rates are significantly below the coupon rate because the option has very little chance of being called, and the call option will have very little value. c. interest rates are significantly above the coupon rate because the option has a high chance of being called, and the call option will have significant value. d. interest rates are significantly below the coupon rate because the option has a high chance of being called, and the call option will have significant value. e. None of these are correct.

ANSWER: a 45. All of the following are one of Malkiel's stated relationships between yield changes and bond prices EXCEPT a. bond prices move inversely to bond yields. b. longer-maturity bonds experience larger price changes than shorter-maturity bonds. c. bond price volatility increases at a diminishing rate as term to maturity increases. d. bond price movements resulting from equal absolute increases or decreases in yield are symmetrical. e. bond price volatility is inversely related to the coupon rate.

ANSWER: d 46. Which duration is computed by discounting flows using the yield to maturity of the bond? a. effective duration b. Macaulay duration c. modified duration d. present value duration e. cash flow duration ANSWER: b 47. A graph of a bond's Price-Yield curve reveals all of the following EXCEPT a. price moves inverse to yield. b. the bond sells at a premium when the yield is below the coupon rate. c. the bond sells at a discount when the yield is above the coupon rate. d. the Price-Yield curve is concave. e. All of these are correct.

ANSWER: d 48. When there are no embedded options, ____ duration can be used to provide an approximation of the interest rate sensitivity of the bond. richard@qwconsultancy.com

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a. Macaulay b. modified c. effective d. empirical e. None of these are correct.

ANSWER: b 49. Calculate the duration of a 6 percent, $1,000 par bond maturing in three years if the yield to maturity is 10 percent and interest is paid semiannually. a. 1.35 years b. 1.78 years c. 2.50 years d. 2.78 years e. 2.95 years ANSWER: d 50. Calculate the modified duration for a 10-year, 12 percent bond with a yield to maturity of 10 percent and a Macaulay duration of 7.2 years. a. 6.43 years b. 6.55 years c. 6.79 years d. 6.86 years e. 7.01 years ANSWER: d 51. A 12-year, 8 percent bond with a YTM of 12 percent has a Macaulay duration of 9.5 years. If interest rates decline by 50 basis points, what will be the percent change in price for this bond? a. +4.48 percent b. +4.61 percent c. +8.48 percent d. +8.96 percent e. +17.92 percent ANSWER: a 52. Consider a bond with a duration of 6 years having a yield to maturity of 8 percent, and interest rates are expected to rise by 50 basis points. What is the percentage change in the price of the bond? a. 2.88 percent b. 3.45 percent c. −3.89 percent d. −3.45 percent e. −2.88 percent ANSWER: e 53. Consider a bond with a duration of 7 years having a yield to maturity of 7 percent, and interest rates are expected to rise by 50 basis points. What is the percentage change in the price of the bond? richard@qwconsultancy.com

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a. 3.62 percent b. 3.45 percent c. −3.38 percent d. 3.38 percent e. −3.62 percent ANSWER: c 54. Consider a bond with a duration of 8 years having a yield to maturity of 8 percent, and interest rates are expected to rise by 50 basis points. What is the percentage change in the price of the bond? a. 3.85 percent b. 3.45 percent c. −4.02 percent d. −3.45 percent e. −3.85 percent ANSWER: e 55. Suppose the current six-year spot rate is 8 percent and the current five-year spot rate is 7 percent.

What is the one year forward rate in five years? a. 12.62 percent b. 11.58 percent c. 13.14 percent d. 14.65 percent e. 15.14 percent ANSWER: c 56. Suppose the current six-year rate is 9 percent and the current five-year rate is 7 percent. What is the one year forward rate for five years? a. 19.57 percent b. 18.62 percent c. 15.80 percent d. 14.65 percent e. 12.67 percent ANSWER: a 57. Suppose the current seven-year rate is 8 percent and the current six-year rate is 6 percent. What is the one year forward rate for six years? a. 16.33 percent b. 18.22 percent c. 20.82 percent d. 14.65 percent e. 15.14 percent ANSWER: c 58. Calculate the Macaulay duration for a five-year, $1,000 par value bond, with a 6 percent coupon and a yield to maturity of 8 percent. Interest is paid annually. richard@qwconsultancy.com

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a. 6.44 years b. 5.25 years c. 4.44 years d. 2.50 years e. 1.25 years ANSWER: c Exhibit 13.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A $1000 par value bond with five years to maturity and a 6 percent coupon has a yield to maturity of 8 percent. Interest is paid semiannually.

59. Refer to Exhibit 13.1. Calculate the current price of the bond. a. $1579.46 b. $918.89 c. $789.29 d. $1000 e. $743.29 ANSWER: b 60. Refer to Exhibit 13.1. Calculate the Macaulay duration for the bond. a. 4.19 years b. 4.36 years c. 8.72 years d. 8.38 years e. 9.52 years ANSWER: b 61. Refer to Exhibit 13.1. Calculate the modified duration for the bond. a. 4.19 years b. 4.36 years c. 8.72 years d. 8.38 years e. 9.52 years ANSWER: a 62. Refer to Exhibit 13.1. Estimate the percentage price change for this five-year, $1,000 par value bond, with a 6 percent coupon, if the yield rises from 8 percent to 8.5 percent. Interest is paid semiannually. a. 2.1 percent b. −2.1 percent c. 4.4 percent d. −4.4 percent richard@qwconsultancy.com

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e. 0 percent ANSWER: a Exhibit 13.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Talmart Corporation bonds have a $1,000 face value and will mature in four years. The bonds have a 7 percent coupon rate. Interest is paid annually, and the required rate of return is 6 percent for these bonds.

63. Refer to Exhibit 13.2. What is the price of the Talmart corporate bonds? a. $965.63 b. $966.13 c. $1,034.65 d. $1,135.10 e. $1,051.97 ANSWER: c 64. Refer to Exhibit 13.2. What is the Macaulay duration of the Talmart corporate bonds? a. 3.43 b. 3.64 c. 3.76 d. 3.85 e. 4.11 ANSWER: b 65. Refer to Exhibit 13.2. What is the Modified duration of the Talmart corporate bonds? a. 3.43 b. 3.64 c. 3.76 d. 3.85 e. 4.11 ANSWER: a 66. Refer to Exhibit 13.2. If interest rates increase 50 basis points, what will be the approximate price change for the Talmart bond? a. −17.0 percent b. −1.7 percent c. 1.7 percent d. 1.8 percent e. 17.0 percent ANSWER: b

richard@qwconsultancy.com

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67. Calculate the modified duration of a bond that has a Macaulay duration of 7.6 and the bond pays interest semi-annually with a coupon rate of 6 percent and a required rate of return of 8 percent. a. 7.04 b. 7.17 c. 7.31 d. 7.38 e. 8.12 ANSWER: d 68. Zappo Corporation just issued $1,000 face value bonds that will mature in 20 years and have a 7 percent coupon rate. Interest is paid semi-annually, and the required rate of return is 9 percent for these bonds. The bonds have a five-year call provision that will pay a call premium of $1,050 if they are called in. What is the price of the Zappo Corporation bond? a. $815.98 b. $817.43 c. $826.35 d. $920.87 e. $953.07 ANSWER: e Exhibit 13.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A $1000 par value bond with four years to maturity and a 5 percent coupon has a yield to maturity of 6 percent. Interest is paid annually.

69. Refer to Exhibit 13.3. Calculate the current price of the bond. a. $964.90 b. $965.35 c. $981.41 d. $1035.45 e. $1035.85 ANSWER: b 70. Refer to Exhibit 13.3. Calculate the Macaulay duration for the bond. a. 3.19 years b. 3.36 years c. 3.57 years d. 3.72 years e. 3.84 years ANSWER: d 71. Refer to Exhibit 13.3. Calculate the modified duration for the bond. a. 3.51 years b. 3.61 years richard@qwconsultancy.com

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c. 3.72 years d. 4.38 years e. 7.44 years ANSWER: a 72. Refer to Exhibit 13.3. Estimate the percentage price change for this four-year, $1,000 par value bond, with an annual 5 percent coupon, if the yield falls from 6 percent to 5.5 percent. a. −3.50 percent b. −1.75 percent c. 1.75 percent d. 3.50 percent e. 0 percent ANSWER: c 73. Assuming no change in interest rates, the duration of a coupon bond a. stays constant. b. declines more slowly than the term to maturity. c. declines more quickly than the term to maturity d. increases at a slower rate than the term to maturity. e. changes in line with the term to maturity.

ANSWER: b 74. Investment style for a bond portfolio is best characterized by a. beta and credit quality. b. credit quality and duration. c. interest rate risk and yield to maturity. d. yield to maturity and beta. e. beta and duration.

ANSWER: b 75. Two common methods for constructing a bond index are a. full replication and stratified sampling. b. partial replication and overall market approach. c. ETFs and High Yield sampling. d. multiple discriminant analysis and bond swaps. e. High Yield sampling and partial replication.

ANSWER: a 76. For a bond investor selecting a buy-and-hold strategy, which of the following would be the least important consideration? a. term to maturity b. indenture provisions c. coupon levels d. liquidity e. quality richard@qwconsultancy.com

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ANSWER: d 77. Reinvestment risk is greatest for bonds that have a. short maturities and low coupon rates. b. long maturities and high coupon rates. c. short maturities and high coupon rates. d. long maturities and low coupon rates. e. None of these are correct.

ANSWER: b 78. Which of the following would NOT normally be a reason for a bond swap? a. increasing current yield b. improving the quality of the portfolio c. taking advantage of interest rate shifts d. tax savings e. realigning the portfolio's duration ANSWER: e 79. A pure yield pickup swap involves swapping out of a a. bond to realize capital losses into a comparable bond. b. low coupon bond into a comparable high coupon bond. c. high coupon bond into a comparable low coupon bond. d. bond that is underpriced into a comparable bond that is overpriced. e. bond that is overpriced into a comparable bond that is underpriced.

ANSWER: b 80. An example of an active strategy for bond management would be a. buy and hold. b. credit analysis. c. indexing. d. classical immunization. e. horizon matching.

ANSWER: b 81. A portfolio manager that attempts to select bonds based on their intrinsic value would be carrying out a. credit analysis. b. valuation analysis. c. yield-spread analysis. d. horizon-matching analysis. e. interest-rate analysis.

ANSWER: b 82. The active strategies for bond management include all of the following EXCEPT richard@qwconsultancy.com

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a. interest rate anticipation. b. credit analysis. c. spread analysis. d. classical immunization. e. bond swaps.

ANSWER: d 83. Studies by Reilly and Wright (1994, 2001) and Fabozzi (2005) suggest analysis of high-yield bonds should be expanded to include all of the following EXCEPT a. the firm's competitive position with respect to cost and pricing. b. the firm's cash flow relative to interest expense, research expenses, and growth needs. c. the firm's market share and growth in sales. d. the quality of the total management team. e. the firm's size.

ANSWER: c Exhibit 13.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The following information is given concerning a pure yield pick-up swap: You currently hold a 10year, 7 percent coupon bond priced to yield 8 percent. As a swap candidate, you are considering a 10year, 8 percent coupon bond priced to yield 9 percent. Assume a reinvestment at 9 percent, semiannual compounding, and a one-year workout period.

Dollar Investment Coupon i on One Coupon Principal Value at Year End Total Accrued Realized Compound Yield

Current Bond $932.05 $70.00 $1.575 $936.70 $1008.28 8.018%

Candidate Bond $934.96 $80.00 ? ? ? ?

84. Refer to Exhibit 13.4. The interest on one coupon for the candidate bond is a. $2.97. b. $2.03. c. $1.80. d. $1.37. e. $3.49.

ANSWER: c 85. Refer to Exhibit 13.4. The realized compound yield on the candidate bond is a. 7.0%. b. 11.0%. c. 10.0%. d. 9.0%. e. 12.0%. richard@qwconsultancy.com

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ANSWER: d 86. Refer to Exhibit 13.4. The value of the swap is ____ basis points in one year. a. 32.3 b. 48.7 c. 75.8 d. 98.2 e. 104.3 ANSWER: d Exhibit 13.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The following information is given concerning a substitution swap. You currently hold a 15-year, 7 percent coupon bond priced to yield 8 percent. As a swap candidate you are considering a 15-year, 7 percent coupon bond priced to yield 8.5 percent. Assume a reinvestment rate of 8.5 percent, semiannual compounding, and a one-year workout period.

Dollar Investment Coupon i on One Coupon Principal Value at Year End Total Accrued Total Gain Gain per Invested Dollar Realized Compound Yield

Current Bond $913.54 70.00 1.487 916.68 988.17 74.63 ? ?

Candidate Bond ?

70.00 1.487 878.55 950.04 ? ? ?

87. Refer to Exhibit 13.5. The dollar investment in the candidate bond is a. $812.57. b. $803.22. c. $874.16. d. $746.83. e. $700.01.

ANSWER: c 88. Refer to Exhibit 13.5. The realized compound yield on the current bond is a. 15.50%. b. 11.03%. c. 10.30%. d. 8.01%. e. 9.00%.

ANSWER: d 89. Refer to Exhibit 13.5. The value of the swap is ____ basis points in one year. a. 18.4 richard@qwconsultancy.com

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b. 23.3 c. 49.1 d. 46.5 e. 46.8 ANSWER: c Exhibit 13.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The following information is given concerning a pure yield pick-up swap: You currently hold a 20year, Aa 8 percent coupon bond priced to yield 10 percent. As a swap candidate you are considering a 20-year, Aa 10 percent coupon bond priced to yield 10.75 percent. Assume a reinvestment rate of 12.00 percent, semiannual compounding, and a one-year workout period.

Dollar Investment Coupon i on One Coupon Principal Value at Year End Total Accrued Realized Compound Yield

Current Bond $828.41 80.00 2.4 831.32 913.72 10.5547

Candidate Bond $938.83 100.00 ? ? ? ?

90. Refer to Exhibit 13.6. The interest on one coupon for the candidate bond is a. $2.40. b. $2.75. c. $9.60. d. $11.00. e. $50.00.

ANSWER: b 91. Refer to Exhibit 13.6. The value of the swap is ____ basis points in one year. a. 40.4 b. 60.6 c. 80.8 d. 20.5 e. 100.1 ANSWER: d Exhibit 13.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The following information is given concerning a substitution swap. You currently hold a 25-year, Aa 8 percent coupon bond priced to yield 10 percent. As a swap candidate you are considering a 25-year, Aa 8 percent coupon bond priced to yield 10.50 percent. Assume a reinvestment rate of 10 percent, semiannual compounding, and a one-year workout period.

Current Bond richard@qwconsultancy.com

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Dollar Investment Coupon i on One Coupon Principal Value at Year End Total Accrued Total Gain Gain per Invested Dollar Realized Compound Yield

$817.44 80.00 2.00 819.23 901.23 83.79 ? ?

?

80.00 2.20 782.33 864.53 ? ? ?

92. Refer to Exhibit 13.7. The dollar investment in the candidate bond is a. $780.34. b. $1483.25. c. $1361.54. d. $1413.95. e. $1000.00.

ANSWER: a 93. Refer to Exhibit 13.7. The realized compound yield on the current bond is a. 6.00%. b. 7.00%. c. 8.00%. d. 10.00%. e. 12.00%.

ANSWER: d 94. Refer to Exhibit 13.7. 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 ANSWER: e Exhibit 13.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The following information is given concerning a pure yield pick-up swap: You currently hold a 20year, Aa 2 percent coupon bond priced to yield 9.5 percent. As a swap candidate, you are considering a 20-year, Aa 14 percent coupon bond priced to yield 10.00. Assume a reinvestment rate of 11 percent, semiannual compounding, and a one-year workout period.

Dollar Investment Coupon i on One Coupon Principal Value at Year End Total Accrued richard@qwconsultancy.com

Current Bond $1222.04 110.00 3.3 1218.04 1341.34

Candidate Bond $1343.18 140.00 ? ? ?

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Realized Compound Yield 9.5351%

?

95. Refer to Exhibit 13.8. The interest on one coupon for the candidate bond is a. $70.00. b. $3.58. c. $3.85. d. $8.35. e. $5.38.

ANSWER: c 96. Refer to Exhibit 13.8. The value of the swap is ____ basis points in one year. a. 0.004921 b. 0.4921 c. 4.921 d. 49.21 e. 492.1 ANSWER: d Exhibit 13.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The following information is given concerning a substitution swap. You currently hold a 25-year, Aa 10-percent coupon bond priced to yield 12 percent. As a swap candidate, you are considering a 25year, Aa 10 percent coupon bond priced to yield 13 percent. Assume a reinvestment rate of 12 percent, semiannual compounding, and a one-year workout period.

Dollar Investment Coupon i on One Coupon Principal Value at Year End Total Accrued Total Gain Gain per Invested Dollar Realized Compound Yield

Current Bond $842.38 100.00 3.0 843.50 946.50 104.12 ? ?

Candidate Bond ?

100.00 2.75 780.46 883.21 ? ? ?

97. Refer to Exhibit 13.9. The dollar investment in the candidate bond is a. $1515.36. b. $853.50. c. $780.46. d. $779.13. e. $877.53.

ANSWER: d 98. Refer to Exhibit 13.9. The realized compound yield on the current bond is richard@qwconsultancy.com

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a. 10.00%. b. 11.9985%. c. 12.9397%. d. 13.9399%. e. 12.3585%.

ANSWER: b 99. Refer to Exhibit 13.9. The value of the swap is ____ basis points in one year. a. 94.14 b. 0.9414 c. 9.414 d. 941.4 e. 0.09414 ANSWER: a Exhibit 13.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider two bonds, both pay semiannual interest. Bond A has a coupon of 8 percent per year, maturity of 30 years, yield to maturity of 9 percent per year, and a face value of $1000. Bond B has a coupon of 8 percent per year, maturity of 30 years, yield to maturity of 9.5 percent per year, and a face value of $1000.

100. Refer to Exhibit 13.10. Calculate the percentage gain per invested dollar for Bond A assuming a one-year horizon, and a reinvestment rate of 9 percent per year. a. 9.73% b. 9.93 percent c. 9.20 percent d. 8.20 percent e. 9.50 percent ANSWER: c 101. Refer to Exhibit 13.10. Calculate the percentage gain per invested dollar for Bond B assuming a one-year horizon and a reinvestment rate of 9.5 percent per year. a. 9.73 percent b. 9.93 percent c. 9.20 percent d. 8.20 percent e. 9.50 percent ANSWER: a 102. Refer to Exhibit 13.10. Calculate the value of swap out of Bond A into Bond B. a. 0.41 percent b. 1.73 percent c. 0.23 percent richard@qwconsultancy.com

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d. 0.00 percent e. 0.51 percent ANSWER: e Exhibit 13.11 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider two bonds: both pay semiannual interest. Bond X has a coupon of 7 percent per year, maturity of 20 years, yield to maturity of 8 percent per year, and a face value of $1000. Bond Y has a coupon of 7 percent per year, maturity of 20 years, yield to maturity of 8.5 percent per year, and a face value of $1000.

103. Refer to Exhibit 13.11. Calculate the percentage gain per invested dollar for Bond X assuming a one-year horizon and a reinvestment rate of 8 percent per year. a. 2.35 percent b. 4.08 percent c. 7.92 percent d. 8.16 percent e. 8.32 percent ANSWER: d 104. Refer to Exhibit 13.11. Calculate the percentage gain per invested dollar for Bond Y assuming a one-year horizon and a reinvestment rate of 8.5 percent per year. a. 7.84 percent b. 7.97 percent c. 8.18 percent d. 8.34 percent e. 8.56 percent ANSWER: e 105. Refer to Exhibit 13.11. Calculate the value of swap out of Bond X into Bond Y. a. 0.38 percent b. 0.81 percent c. 1.94 percent d. 3.76 percent e. 4.12 percent ANSWER: a 106. In core-plus bond management, a. 75 percent of the portfolio is allocated to an equity index and the balance is allocated to a bond index. b. 75 percent of the portfolio is allocated to a bond index, and the balance is allocated to an equity index. c. 75 percent of the portfolio is allocated to a bond index, and the balance is allocated to actively managed bond sectors. richard@qwconsultancy.com

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d. 75 percent of the portfolio is allocated to actively managed bond sectors, and the balance is allocated to a bond index. e. 75 percent of the portfolio is allocated to actively managed bond sectors, and the balance is allocated to a foreign bond index.

ANSWER: c 107. The term dedication, used to describe portfolio management techniques, is referring to servicing a prescribed set of a. interest payments. b. assets. c. liabilities. d. pensioners. e. sinking fund payments.

ANSWER: c 108. Coupon reinvestment risk arises because the yield to maturity computation implicitly assumes that all coupon flows will be reinvested at the a. coupon rate. b. effective rate of interest. c. realized yield to maturity. d. promised yield to maturity. e. existing yield as the coupons are paid.

ANSWER: d 109. In a ladder strategy, a. one-half of funds are invested in short duration bonds, and the rest are invested in long duration bonds. b. 75 percent of funds are invested in short duration bonds, and the rest are invested in long duration bonds. c. 25 percent of funds are invested in short duration bonds, and the rest are invested in long duration bonds. d. an equal amount of funds is invested in a wide range of maturities. e. all the funds are invested in long duration bonds.

ANSWER: d 110. Horizon matching is a combination of a. cash-matching dedication and interest rates swaps. b. cash-matching dedication and immunization. c. interest rate swaps and immunization. d. enhanced indexing and immunization. e. enhanced indexing and interest rate swaps.

ANSWER: b Exhibit 13.12 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

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Consider two bonds: both pay annual interest. Bond C has a coupon of 6 percent per year, maturity of five years, yield to maturity of 6 percent per year, and a face value of $1000. Bond D has a coupon of 8 percent per year, maturity of 15 years, yield to maturity of 6 percent per year, and a face value of $1000.

111. Refer to Exhibit 13.12. Calculate the modified duration for Bond C. a. 4.47 b. 4.22 c. 4.34 d. 5 e. 5.34 ANSWER: b 112. Refer to Exhibit 13.12. Calculate the modified duration for Bond D. a. 9.5 b. 9.8 c. 9.2 d. 15 e. 17 ANSWER: c 113. Refer to Exhibit 13.12. Assume that your investment horizon is 6 years and your portfolio consists only of Bond C and Bond D. Indicate the proportions invested in each bond so that the portfolio is immunized. a. 50 percent in Bond C and 50 percent in Bond D b. 64 percent in Bond C and 36 percent in Bond D c. 36 percent in Bond C and 64 percent in Bond D d. 100 percent in Bond D e. 100 percent in Bond C ANSWER: b Exhibit 13.13 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider two bonds: both pay annual interest. Bond Y has a coupon of 6 percent per year, maturity of five years, yield to maturity of 6 percent per year, and a face value of $1000. Bond X has a coupon of 7 percent per year, maturity of 10 years, yield to maturity of 4 percent per year, and a face value of $1000.

114. Refer to Exhibit 13.13. Calculate the modified duration for Bond Y. a. 7.8 b. 4.22 c. 4.34 d. 7.5 richard@qwconsultancy.com

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e. 9.8 ANSWER: b 115. Refer to Exhibit 13.13. Calculate the modified duration for Bond X. a. 4.22 b. 7.8 c. 7.5 d. 9.2 e. 4.34 ANSWER: c 116. Refer to Exhibit 13.13. Assume that your investment horizon is five years and your portfolio consists only of Bond Y and Bond X. Indicate the proportions invested in each bond, so that the portfolio is immunized. a. 50 percent in Bond Y and 50 percent in Bond X b. 76 percent in Bond Y and 24 percent in Bond X c. 36 percent in Bond Y and 64 percent in Bond X d. 100 percent in Bond X e. 100 percent in Bond Y ANSWER: b Exhibit 13.14 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You are creating a portfolio that consists of the following two bonds. Bond A pays an annual 7 percent coupon, matures in two years, has a yield to maturity of 8 percent, and a face value of $1,000.

Bond B pays an annual 8 percent coupon, matures in three years, has a yield to maturity of 9 percent, and a face value of $1,000.

117. Refer to Exhibit 13.14. Calculate the price of Bond A. a. $975.62 b. $982.17 c. $990.57 d. $1,009.50 e. $1,018.08 ANSWER: b 118. Refer to Exhibit 13.14. Calculate the price of Bond B. a. $974.69 b. $990.64 c. $995.22 d. $1,013.88 e. $1,025.77 ANSWER: a

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119. Refer to Exhibit 13.14. Calculate the Macaulay Duration for Bond A. a. 0.98 b. 1.79 c. 1.90 d. 1.93 e. 2.31 ANSWER: d 120. Refer to Exhibit 13.14. Calculate the Macaulay Duration for Bond B. a. 1.44 b. 2.47 c. 2.55 d. 2.70 e. 2.78 ANSWER: e 121. Refer to Exhibit 13.14. Calculate the Modified Duration for Bond A. a. 0.98 b. 1.79 c. 1.90 d. 1.93 e. 2.31 ANSWER: b 122. Refer to Exhibit 13.14. Calculate the Modified Duration for Bond B. a. 1.44 b. 2.47 c. 2.55 d. 2.70 e. 2.78 ANSWER: c 123. Refer to Exhibit 13.14. Assume that your investment horizon is two years and your portfolio consists only of bonds A and B. What proportion should be invested in each bond to immunize the portfolio? a. Invest 72.4 percent in bond A and 27.6 percent in bond B. b. Invest 68.3 percent in bond A and 31.7 percent in bond B. c. Invest 58.5 percent in bond A and 41.5 percent in bond B. d. Invest 31.7 percent in bond A and 68.3 percent in bond B. e. Invest 27.6 percent in bond A and 72.4 percent in bond B. ANSWER: a 124. Which of the following is a strategy that allows the bond manager flexibility to actively manage the portfolio subject to an overriding constraint that the portfolio remains immunized at some predetermined yield level? richard@qwconsultancy.com

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a. classical immunization b. contingent immunization c. bond swaps d. valuation analysis e. interest rate anticipation ANSWER: b 125. Assume that you purchase a five-year, $1,000 par value bond, with a 6 percent coupon and a yield of 7 percent. Immediately after you purchase the bond, yields rise to 8 percent and remain at that level to maturity. Calculate the realized horizon yield if you hold the bond to maturity. Interest is paid annually. a. 6.0 percent b. 7.11 percent c. 8.0 percent d. 15.25 percent e. 8.18 percent ANSWER: b

Chapter 14 - An Introduction to Derivative Markets and Securities True / False 1. A cash or spot contract is an agreement for the immediate delivery of an asset, such as the purchase of stock on the NYSE. a. True b. False ANSWER: True 2. Forward and future contracts, as well as options, are types of derivative securities. a. True b. False ANSWER: True 3. All features of a forward contract are standardized, except for price and number of contracts. a. True b. False ANSWER: False 4. Forward contracts are traded over-the-counter and are generally not standardized. a. True b. False ANSWER: True 5. The forward market has low liquidity relative to the futures market. richard@qwconsultancy.com

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a. True b. False ANSWER: True 6. A futures contract is an agreement between a trader and the clearinghouse of the exchange for delivery of an asset in the future. a. True b. False ANSWER: False 7. A primary function of futures markets is to allow investors to transfer risk. a. True b. False ANSWER: True 8. The futures market is a dealer market in which all the details of the transactions are negotiated. a. True b. False ANSWER: False 9. Futures contracts are slower to absorb new information than forward contracts. a. True b. False ANSWER: False 10. The initial value of a future contract is the price agreed upon in the contract. a. True b. False ANSWER: False 11. A futures contract eliminates uncertainty about the future spot price that an individual can expect to pay for an asset at the time of delivery. a. True b. False ANSWER: True 12. Investment costs are generally higher in the derivative markets than in the corresponding cash markets. a. True b. False ANSWER: False 13. An option buyer must exercise the option on or before the expiration date. a. True b. False richard@qwconsultancy.com

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ANSWER: False 14. The minimum value of an option is zero. a. True b. False ANSWER: True 15. An option to sell an asset is referred to as a call, whereas an option to buy an asset is called a put. a. True b. False ANSWER: False 16. If an investor wants to acquire the right to buy or sell an asset, but not the obligation to do it, the best instrument is an option rather than a futures contract. a. True b. False ANSWER: True 17. Investors buy call options because they expect the price of the underlying stock to increase before the expiration of the option. a. True b. False ANSWER: True 18. A call option is in the money if the current market price is above the strike price. a. True b. False ANSWER: True 19. A put option is in the money if the current market price is above the strike price. a. True b. False ANSWER: False 20. The price at which the stock can be acquired or sold is the exercise price. a. True b. False ANSWER: True 21. The minimum amount that must be maintained in an account is called the maintenance margin. a. True b. False ANSWER: True

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22. A forward contract gives its holder the option to conduct a transaction involving another security or commodity. a. True b. False ANSWER: False 23. In the forward market, both parties are required to post collateral or margin. a. True b. False ANSWER: False 24. The option premium is the price the call buyer will pay to the option seller if the option is exercised a. True b. False ANSWER: False 25. The payoffs to both the long and short position in the forward contact are symmetric around the contract price. a. True b. False ANSWER: True 26. The payoffs diagrams to both long and short positions in a forward contract are asymmetrical around the contract price. a. True b. False ANSWER: False 27. Forward contracts are much easier to unwind than futures contracts due to the standardization of the contracts. a. True b. False ANSWER: False 28. Forward contracts do not require an upfront premium. a. True b. False ANSWER: True Multiple Choice 29. Which of the following statements is FALSE? a. Derivatives help shift risk from risk-adverse investors to risk-takers. b. Derivatives assist in forming cash prices. richard@qwconsultancy.com

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c. Derivatives provide additional information to the market. d. In many cases, the investment in derivatives (both commissions and required investment) is more than in the cash market. e. Some derivatives trade hypothetical underlying assets.

ANSWER: a 30. Derivative instruments exist because a. they help shift risk from risk-averse investors to risk-takers. b. they help in forming prices. c. they have lower investment costs. d. allow investors to hedge portfolio risk. e. All of these are correct.

ANSWER: e 31. There are a number of differences between forward and futures contracts. Which of the following statements is FALSE? a. Futures have less liquidity risk than forward contracts. b. Futures have less credit risk than forward contracts. c. Futures have more default risk than forward contracts. d. In futures, the exchange becomes the counterparty to all transactions. e. Futures have standardized terms of agreement.

ANSWER: c 32. Futures differ from forward contracts because a. futures have more liquidity risk. b. futures have more credit risk. c. futures have more maturity risk. d. futures do not require collateral. e. None of these are correct.

ANSWER: e 33. 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.

ANSWER: d 34. Which of the following statements is TRUE? a. The buyer of a futures contract is said to be long futures. b. The buyer of a futures contract is said to be long futures. c. The seller of a futures contract is said to be long futures. d. The buyer of a futures contract is said to be short futures. e. The buyer of a futures contract is unwinding a long position. richard@qwconsultancy.com

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ANSWER: a 35. The CBOE brought numerous innovations to the option market. Which of the following is NOT such an innovation? a. creation of a central marketplace b. creation of a non-liquid secondary option market c. introduction of a Clearing Corporation d. standardization of all expiration dates e. standardization of all exercise prices ANSWER: b 36. Which of the following factors is NOTconsidered in the valuation of call and put options? a. current stock price b. exercise price c. market interest rate d. volatility of underlying stock price e. the option trading market ANSWER: e 37. Which of the following statements is a true definition of an in-the-money option? a. a call option in which the stock price exceeds the exercise price b. a call option in which the exercise price exceeds the stock price c. a put option in which the stock price exceeds the exercise price d. an index option in which the exercise price exceeds the stock price e. a call option in which the call premium exceeds the stock price ANSWER: a 38. The value of a call option just prior to expiration is (where V is the underlying asset's market price and X is the option's exercise price) a. max [0, V − X]. b. max [0, X − V]. c. min [0, V − X]. d. min [0, X − V]. e. max [0, V > X].

ANSWER: a 39. Which of the following is NOT a factor needed to calculate the value of an American call option? a. price of the underlying stock b. exercise price c. price of an equivalent put option d. volatility of the underlying stock e. interest rate ANSWER: c

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40. You own a stock that has risen from $10 per share to $32 per share. You wish to delay taking the profit, but you are troubled about the short-run behavior of the stock market. An effective action on your part would be to a. buy a put option on the stock. b. write a call option on the stock. c. purchase an index option. d. purchase an interest rate option. e. write a put option on the stock.

ANSWER: a 41. Intrinsic value represents the value a. the seller could extract from the option if they exercised it immediately. b. the buyer could extract from the option if they exercised it immediately. c. seller pays for the time premium. d. buyer pays for time premium. e. below zero.

ANSWER: b 42. The value of a put option at expiration is a. max [0, S(T) − X]. b. max [0, X − S(T)]. c. min [0, X − S(T)]. d. X ANSWER: b 43. Which of the following does NOT influence the option price? a. past stock price b. up and down factors u and d c. risk free rate d. exercise price e. current stock price ANSWER: a 44. A call option in which the stock price is higher than the exercise price is said to be a. at-the-money. b. in-the-money. c. before-the-money. d. out-of-the-money. e. above-the-money.

ANSWER: b 45. The price paid for the option contract is referred to as the a. forward price. b. exercise price. c. striking price. richard@qwconsultancy.com

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d. option premium. e. call price.

ANSWER: d 46. A stock currently sells for $75 per share. A call option on the stock with an exercise price of $70 currently sells for $5.50. The call option is a. at-the-money. b. in-the-money. c. out-of-the-money. d. at breakeven. e. above-the-money.

ANSWER: b 47. A stock currently sells for $150 per share. A call option on the stock with an exercise price of $155 currently sells for $2.50. The call option is a. at-the-money. b. in-the-money. c. out-of-the-money. d. at breakeven. e. above-the-money.

ANSWER: c 48. A stock currently sells for $75 per share. A put option on the stock with an exercise price of $70 currently sells for $0.50. The put option is a. at-the-money. b. in-the-money. c. out-of-the-money. d. at breakeven. e. above-the-money.

ANSWER: c 49. A stock currently sells for $15 per share. A put option on the stock with an exercise price of $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. above-the-money.

ANSWER: a 50. A stock currently sells for $15 per share. A put option on the stock with an exercise price of $20 currently sells for $6.50. The put option is a. at-the-money. b. in-the-money. c. out-of-the-money. richard@qwconsultancy.com

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d. at breakeven. e. above-the-money.

ANSWER: b 51. A call option differs from a put option in that a. a call option obliges the investor to purchase a given number of shares in a specific common stock at a set price; a put obliges the investor to sell a certain number of shares in a common stock at a set price. b. both give the investor the opportunity to participate in stock market dealings without the risk of actual stock ownership. c. a call option gives the investor the right to purchase a given number of shares of a specified stock at a set price; a put option gives the investor the right to sell a given number of shares of a stock at a set price. d. a put option has risk because leverage is not as great as with a call. e. All of these are correct.

ANSWER: c 52. A buyer of the call option is NOT speculating on the a. direction of the price movement of the underlying investment. b. timing of the price movement of the underlying investment. c. leverage that a call option creates with respect to the underlying investment. d. volatility of the price movement of the underlying investment. e. liquidity of the underlying investment.

ANSWER: e 53. Which of the following statements is a true definition of an out-of-the-money option? a. a call option in which the stock price exceeds the exercise price b. a call option in which the exercise price exceeds the stock price c. a call option in which the exercise price exceeds the stock price d. a put option in which the exercise price exceeds the stock price e. a call option in which the call premium exceeds the stock price ANSWER: b 54. Futures contracts are similar to forward contracts in that they both a. have volatile price movements and strong interest from buyers and sellers. b. give the holder the option to make a transaction in the future. c. have similar liquidity. d. have similar credit risk. e. trade on the same exchange.

ANSWER: a 55. Which of the following statements are TRUE? a. Futures contracts have less liquidity risk and credit risk than forward contracts. b. Futures contract prices are strongly linked to the prevailing level of the underlying spot index. richard@qwconsultancy.com

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c. Futures contract decrease in price the further forward in time the delivery date is set. d. Futures contracts have more liquidity risk and credit risk than forward contracts. e. Futures contract prices are weakly linked to the prevailing level of the underlying spot index.

ANSWER: b 56. An advantage of a forward contract over a futures contract is that a. the terms of the contract are flexible. b. it is more liquid. c. it trades through a centralized market exchange. d. it is easier to unwind due to contract homogeneity. e. the counterparty is anonymous.

ANSWER: a 57. 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. trade on exchanges.

ANSWER: a 58. An expiration date payoff and profit diagram for forward positions illustrates a. gains and losses are usually small. b. the payoffs to both long and short positions in the forward contract are asymmetrical around the contract price. c. forward contracts are zero-sum games. d. long positions benefit from falling prices. e. short positions benefit from rising prices.

ANSWER: c Exhibit 14.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) On the last day of October, Bruce Springsteen is considering the purchase of 100 shares of Olivia Corporation common stock selling at $37 1/2 per share and is considering an Olivia option.

Calls Price 35 40

December 3 3/4 2 1/2

Puts March 5 3 1/2

December 1 1/4 4 1/2

March 2 4 3/4

59. Refer to Exhibit 14.1. If Bruce decides to buy a March call option with an exercise price of 35, what is his dollar gain (loss) if he closes his position when the stock is selling at 43 1/2? a. $225.00 loss richard@qwconsultancy.com

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b. $350.00 loss c. $225.00 gain d. $350.00 gain e. $850.00 gain ANSWER: d 60. Refer to Exhibit 14.1. If Bruce buys a March put option with an exercise price of 40, what is his dollar gain (loss) if he closes his position when the stock is selling at 43 1/2? a. $825.00 loss b. $475.00 loss c. $350.00 loss d. $25.00 loss e. $50.00 gain ANSWER: b Exhibit 14.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Rick Thompson is considering the following alternatives for investing in Davis Industries, which is now selling for $44 per share: (1) (2)

Buy 500 shares Buy six-month call options with an exercise price of 45 for $3.25 premium.

61. Refer to Exhibit 14.2. Assuming no commissions or taxes, what is the annualized percentage gain if the stock reaches $50 in four months and a call was purchased? a. 161.54 percent gain b. 53.85 percent gain c. 161.54 percent loss d. 11.11 percent gain e. 53.85 percent loss ANSWER: a 62. Refer to Exhibit 14.2. Assuming no commissions or taxes, what is the annualized percentage gain if the stock is at $30 in four months and the stock was purchased? a. 9.54 percent loss b. 95.45 percent loss c. 0.9545 percent gain d. 95.45 percent gain e. 9.54 percent gain ANSWER: b 63. Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and a three-month Johnson Walker put option with an exercise price of $105.00 for $20.00. What is his dollar gain if the stock is selling for $80.00 per share at expiration? richard@qwconsultancy.com

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a. $200 loss b. $700 loss c. $200 gain d. $700 gain e. $900 gain ANSWER: a 64. Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and a three-month Johnson Walker put option with an exercise price of $105.00 for $20.00. What is Tom's dollar gain/loss if at expiration the stock is selling for $105.00 per share? a. $1000 gain b. $200 loss c. $1000 loss d. $200 gain e. $500 gain ANSWER: b Exhibit 14.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Sarah Kling bought a six-month Peppy Cola put option with an exercise price of $55 for a premium of $8.25 when Peppy was selling for $48.00 per share.

65. Refer to Exhibit 14.3. If at expiration Peppy is selling for $42.00, what is Sarah's dollar gain or loss? a. $420 gain b. $420 loss c. $475 loss d. $475 gain e. $525 gain ANSWER: d 66. Refer to Exhibit 14.3. What is Sarah's annualized gain/loss? a. 11.51 percent gain b. 115.15 percent gain c. 11.51 percent loss d. 115.15 percent loss e. 0 percent ANSWER: b 67. Refer to Exhibit 14.3. If at expiration Peppy is selling for $47.00, what is Sarah's dollar gain or loss? a. $25 loss b. $250 loss c. $25 gain richard@qwconsultancy.com

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d. $250 gain e. $0 ANSWER: a 68. Refer to Exhibit 14.3. What is Sarah's annualized gain/loss? a. 60.60 percent gain b. 6.06 percent loss c. 60.60 percent loss d. 6.06 percent gain e. 0 percent ANSWER: b 69. A stock currently trades for $25. January call options with a strike price of $30 sell for $6. The appropriate risk-free bond has a price of $30. Calculate the price of the January put option. a. $11 b. $24 c. $19 d. $30 e. $25 ANSWER: a 70. Assume that you have purchased a call option with a strike price $60 for $5. At the same time, you purchase a put option on the same stock with a strike price of $60 for $4. If the stock is currently selling for $75 per share, calculate the dollar return on this option strategy. a. $10 b. −$4 c. $5 d. $6 e. $15 ANSWER: d 71. Assume that you purchased shares of a stock at a price of $35 per share. At this time, you purchased a put option with a $35 strike price of $3. The stock currently trades at $40. Calculate the dollar return on this option strategy. a. $3 b. −$2 c. $2 d. −$3 e. $0 ANSWER: c 72. Assume that you purchased shares of a stock at a price of $35 per share. At this time, you wrote a call option with a $35 strike and received a call price of $2. The stock currently trades at $70.

Calculate the dollar return on this option strategy. a. $25 richard@qwconsultancy.com

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b. −$2 c. $2 d. −$25 e. $0 ANSWER: c 73. A stock currently trades at $110. June call options on the stock with a strike price of $105 are priced at $4. Calculate the arbitrage profit that you can earn. a. $0 b. $1 c. $5 d. $4 e. $9 ANSWER: b 74. Datacorp stock currently trades at $50. August call options on the stock with a strike price of $55 are priced at $5.75. October call options with a strike price of $55 are priced at $6.25. Calculate the value of the time premium between the August and October options. a. −$0.50 b. $0 c. $0.50 d. $5 e. −$5 ANSWER: c 75. A stock currently trades at $110. June put options on the stock with a strike price of $100 are priced at $5.25. Calculate the dollar return on one put contract. a. −$525 b. $1000 c. $0 d. −$1000 e. $525 ANSWER: a 76. A stock currently trades at $110. June call options on the stock with a strike price of $120 are priced at $5.75. Calculate the dollar return on one call contract. a. −$1000 b. $1000 c. $575 d. −$575 e. $0 ANSWER: d 77. Consider a stock that is currently trading at $65. Calculate the intrinsic value for a put option that has an exercise price of $55. richard@qwconsultancy.com

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a. $10 b. $50 c. $55 d. −$10 e. $0 ANSWER: e 78. Consider a stock that is currently trading at $20. Calculate the intrinsic value for a put option that has an exercise price of $35. a. $15 b. $55 c. $35 d. −$15 e. $0 ANSWER: a 79. Consider a stock that is currently trading at $45. Calculate the intrinsic value for a call option that has an exercise price of $35. a. $25 b. $35 c. $0 d. −$10 e. $10 ANSWER: e 80. Consider a stock that is currently trading at $10. Calculate the intrinsic value for a call option that has an exercise price of $15. a. $25 b. −$5 c. $0 d. $20 e. $5 ANSWER: c Exhibit 14.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The current stock price of ABC Corporation is $53.50. ABC Corporation has the following put and call option prices that expire six months from today. The risk-free rate of return is 5 percent, and the expected return on the market is 11 percent.

Exercise Price 50 55

Put Price $1.50 $3.25

richard@qwconsultancy.com

Call Price $5.75 ---

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81. Refer to Exhibit 14.4. What should the price be of a call option that expires six months from today with an exercise price of $55? a. $1.33 b. $3.08 c. $4.58 d. $6.07 e. $6.33 ANSWER: b 82. Refer to Exhibit 14.4. What is the value of a synthetic stock created with put and call options that expire in six months with an expiration price of $50? a. $53.04 b. $53.53 c. $54.54 d. $55.03 e. $56.23 ANSWER: a 83. You own a call option and put option that both have the same exercise price of $50, and their respective prices are $4 and $3. The stock is currently trading at $60. Calculate the dollar return on this strategy. a. $1.00 b. $2.00 c. $3.00 d. $4.00 e. $5.00 ANSWER: c Exhibit 14.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The current stock price of Zanco Corporation is $50. Zanco Corporation has the following put and call option prices with exercise prices at $45 and $50.

Exercise Price $45 $50

Put Price $1.50 $3.75

Call Price $6.75 $4.25

84. Refer to Exhibit 14.5. The time premium for the put option with a $45 exercise price is a. $0.00. b. $1.50. c. $2.75. d. $5.25. e. $6.50.

ANSWER: b richard@qwconsultancy.com

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85. Refer to Exhibit 14.5. The intrinsic value for the put option with a $50 exercise price is a. $0.00. b. $1.50. c. $2.25. d. $3.75. e. $8.75.

ANSWER: a 86. Refer to Exhibit 14.5. The intrinsic value for the call option with a $45 exercise price is a. $0.00. b. $1.50. c. $5.00. d. $5.25. e. $6.75.

ANSWER: c 87. Refer to Exhibit 14.5. The time premium for the call option with a $50 exercise price is a. $0.00. b. $1.50. c. $1.75. d. $4.25. e. $9.25.

ANSWER: d Exhibit 14.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The current stock price of ABC Corporation is $53.50. ABC Corporation has the following put and call option prices that expire six months from today. The risk-free rate of return is 5 percent, and the expected return on the market is 11 percent.

Exercise Price 50 55

Put Price $1.50 $3.25

Call Price $5.75 ---

88. Refer to Exhibit 14.6. How could an investor create arbitrage profits? a. sell the stock short, write a put, buy a call, and invest the proceeds at the risk-free rate b. buy the stock, write a put, buy a call, and invest the proceeds at the risk-free rate c. sell the stock short, buy a put, write a call, and invest the proceeds at the risk-free rate d. buy the stock, write a put, buy a call, and borrow the strike price at the risk-free rate e. sell the stock short, write a put, buy a call, and borrow the strike price at the risk-free rate.

ANSWER: a

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89. A stock currently trades for $63. Call options with a strike price of $62 sell for $4.00 and expire in six months. If the risk-free rate is 4 percent, what should the price of a put option with an exercise price of $62 be worth? a. $0.62 b. $0.98 c. $1.80 d. $3.00 e. $5.80 ANSWER: c 90. In the valuation of an option contract, the following statements apply EXCEPT: a. The value of an option increases with its maturity. b. There is a negative relationship between the market interest rate and the value of a call option. c. The value of a call option is negatively related to its exercise price. d. The value of a call option is positively related to the volatility of the underlying asset. e. The value of a call option is positively related to the price of the underlying stock.

ANSWER: b 91. Which of the following is consistent with put-call-spot parity? a. S + C = P + X/(1 + RFR) b. S + P = C + X/(1 + RFR) c. S − C = P + X/(1 + RFR) d. S − P = C + X/(1 + RFR) e. S = P − C + X/(1 + RFR) ANSWER: b 92. According to put/call parity: a. Stock price + Call Price = Put Price + Risk Free Bond Price b. Stock price + Put Price = Call Price + Risk Free Bond Price c. Put price + Call Price = Stock Price + Risk Free Bond Price d. Stock price − Put Price = Call Price + Risk Free Bond Price e. Stock price + Call Price = Put Price − Risk Free Bond Price ANSWER: b 93. A one-year call option has a strike price of 50, expires in 6 months, and has a price of $5.04. If the risk-free rate is 5 percent, and the current stock price is $50, what should the corresponding put be worth? a. $3.04 b. $4.64 c. $6.08 d. $3.83 e. $0 ANSWER: d

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94. A one-year call option has a strike price of 50, expires in 6 months, and has a price of $4.74. If the risk-free rate is 3 percent, and the current stock price is $45, what should the corresponding put be worth? a. $12.74 b. $10.48 c. $5.00 d. $9.00 e. $8.30 ANSWER: d 95. A one-year call option has a strike price of 60, expires in 6 months, and has a price of $2.5. If the risk-free rate is 7 percent, and the current stock price is $55, what should the corresponding put be worth? a. $5.00 b. $4.56 c. $5.50 d. $7.08 e. $7.54 ANSWER: c 96. A one-year call option has a strike price of 70, expires in three months, and has a price of $7.34. If the risk-free rate is 6 percent, and the current stock price is $62, what should the corresponding put be worth? a. $5.34 b. $8.00 c. $10.68 d. $14.33 e. $13.33 ANSWER: d 97. A stock currently trades for $115. January call options with a strike price of $100 sell for $16, and January put options a strike price of $100 sell for $5. Estimate the price of a risk-free bond. a. $120 b. $15 c. $105 d. $116 e. $104 ANSWER: e 98. Derivative securities can be used a. by investors in the same way as the underlying security. b. to modify the risk and expected return characteristics of existing investment portfolios. c. to duplicate cash flow patterns for arbitrage opportunities. d. to protect against potential price declines. e. All of these are correct.

ANSWER: e richard@qwconsultancy.com

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99. Holding a put option and the underlying security at the same time is an example of a. a collar. b. a straddle. c. income generation. d. portfolio insurance. e. a reverse collar.

ANSWER: d 100. An equity portfolio manager can neutralize the risk of falling stock prices by entering into a hedge position where the payoffs are a. not correlated with the existing exposure. b. positively correlated with the existing exposure. c. negatively correlated with the existing exposure. d. at breakeven with the existing exposure. e. imperfectly correlated with the existing exposure.

ANSWER: c 101. The derivative based strategy known as portfolio insurance involves a. the sale of a put option on the underlying security position. b. the purchase of a put on the underlying security position. c. the sale of a call on the underlying security position. d. the purchase of a call on the underlying security position. e. the simultaneous sale of an out-of-the-money put and purchase of an out-of-the-money call.

ANSWER: b 102. A hedge strategy known as a collar agreement involves the simultaneous a. purchase of an in-the-money put and purchase of an out-of-the-money call on the same underlying asset with same expiration date and market price. b. sale of an out-of-the-money put and sale of an out-of-the-money call on the same underlying asset with same expiration date and market price. c. purchase of an in-the-money put and purchase of an in-the-money call on the same underlying asset with same expiration date and market price. d. purchase of an out-of-the-money put and sale of an out-of-the-money call on the same underlying asset with same expiration date and market price. e. sale of an in-the-money put and purchase of an in-the-money call on the same underlying asset with same expiration date and market price.

ANSWER: d

Chapter 15 - Forward, Futures, and Swap Contracts True / False

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1. Forward contracts are individually designed agreements and can be tailored to the specific needs of the ultimate end-user. a. True b. False ANSWER: True 2. Like future contracts, all forward contracts are processed by the exchange clearinghouse. a. True b. False ANSWER: False 3. Because futures contracts are "marked-to-market" daily, the gains and losses are settled daily. a. True b. False ANSWER: True 4. Some forward contracts, particularly in the foreign exchange market, are quite standard and liquid. a. True b. False ANSWER: True 5. Forward rate agreements usually require substantial collateral. a. True b. False ANSWER: False 6. The futures exchange requires each customer to post an initial margin account. a. True b. False ANSWER: True 7. Margin accounts are adjusted, or marked to market, at the end of each trading day. a. True b. False ANSWER: True 8. The settlement price is set by the futures exchange after trading ends to reflect the midpoint of the closing price range. a. True b. False ANSWER: True 9. The goal of a hedge transaction is to increase expected returns of a fundamental holding. a. True b. False richard@qwconsultancy.com

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ANSWER: False 10. The basis is the spot price minus the future price. a. True b. False ANSWER: True 11. An investor in a hedge position is no longer exposed to the absolute price movement of the underlying asset, but the investor is still exposed to basis risk. a. True b. False ANSWER: True 12. The number of future contracts needed to hedge a unit of the spot assets is solely a function of the variance of the spot prices. a. True b. False ANSWER: False 13. The basis (Bt,T) at time t between the spot price (St) and a futures contract expiring at time T (Ft,T) is St − Ft,T. a. True b. False ANSWER: True 14. In the absence of arbitrage opportunities, the forward price should be equal to the spot price plus the cost of carry. a. True b. False ANSWER: True 15. The cost-of-carry model is useful for pricing future contracts. a. True b. False ANSWER: True 16. According to the cost of carry model, the futures price is the present value of the spot price discounted at the risk-free rate. a. True b. False ANSWER: False 17. In the cost of carry model, the inclusion of storage costs will increase the futures price. a. True b. False richard@qwconsultancy.com

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ANSWER: True 18. In the absence of arbitrage opportunities, the forward contract price should be equal to the current spot price plus interest. a. True b. False ANSWER: False 19. The pure expectations hypothesis suggests futures prices serve as unbiased forecasts of future spot prices. a. True b. False ANSWER: True 20. Interest rate parity is a key concept in managing risk in the commodities market. a. True b. False ANSWER: False 21. If you have entered into a currency futures hedge for the Japanese yen in connection with buying Japanese equipment and if the yen goes from 110 yen/$1 to 100 yen/$1, you will lose in the spot market but have an offsetting gain in the futures market. a. True b. False ANSWER: True 22. Like hedging, arbitrage results in increased returns with a disproportional increase in risk. a. True b. False ANSWER: False 23. The inclusion of dividends in the cost of carry model will increase the futures price. a. True b. False ANSWER: False 24. A riskless stock index arbitrage profit is possible if the following condition holds: F0,T = S0(1 + rf − d)T, where spot price now is S0, value now of a futures contract expiring at time T is (F0,T), rf is the risk free rate, and d is the dividend. a. True b. False ANSWER: False 25. Stock index futures are useful in providing a hedge against movements in an underlying financial asset. richard@qwconsultancy.com

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a. True b. False ANSWER: True 26. If you were bearish on the near-term outlook for the stock market but did not want to sell your portfolio, you could hedge against the decline by selling stock index futures. a. True b. False ANSWER: True 27. The Chicago Board of Trade (CBT) uses conversion factors to correct for differences in deliverable bonds. a. True b. False ANSWER: True 28. The Eurodollar futures contract is a popular hedging vehicle because it is based on the threemonth LIBOR. a. True b. False ANSWER: True 29. The forward rate agreement is the most complicated of the OTC interest rate contracts. a. True b. False ANSWER: True 30. In an interest rate swap, the fixed rate payer profits if interest rates fall. a. True b. False ANSWER: False 31. While LIBOR is usually used with forward rate agreements, it is rarely used with other interest rate agreements. a. True b. False ANSWER: False 32. In a forward rate agreement (FRA), two parties agree today to a future exchange of cash flows based on two different interest rates. a. True b. False ANSWER: True

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33. On the settlement date for a forward rate agreement (FRA) contract, the difference between the two interest rates is multiplied by the FRA's par value and prorated by the length of the holding period. a. True b. False ANSWER: False 34. A plain vanilla swap agreement is used in similar situations as a forward rate agreement. a. True b. False ANSWER: True 35. Equity swaps are traded in the OTC markets. a. True b. False ANSWER: True 36. Equity swaps are equivalent to portfolios of forward contracts calling for the exchange of cash flows based on two different investment rates: (1) a variable debt rate and (2) the return to an equity index. a. True b. False ANSWER: True Multiple Choice 37. An investor who wants a long position in a ____ must first place the order with a broker, who then passes it on to the trading pit or electronic network. Details of the order are then passed on to the exchange clearinghouse. a. call option b. put option c. forward contract d. futures contract e. All of these are correct.

ANSWER: d 38. The process by which invest on margin accounts are credited or debited to reflect daily trading gains or losses is referred to as the ____ process. a. hedge rationing b. daily settlement c. marked-to-market d. book-to-market e. account realization ANSWER: c

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39. The major difference between valuing futures versus forward contracts stems from the fact that future contracts are a. traded on exchange. b. backed by a clearinghouse. c. marked-to-market daily. d. less risky. e. relatively inflexible.

ANSWER: c 40. As a contract approaches maturity, the spot price and forward price a. increase. b. diverge. c. maintain a fixed price differential. d. have a random relationship. e. converge.

ANSWER: e 41. The basis (Bt,T) at time t between the spot price (St) and a futures contract expiring at time T (Ft,T) is a. Bt,T = St + Ft,T. b. Bt,T = St − Ft,T. c. Bt,T = St  Ft,T. d. Bt,T = St/Ft,T. e. Bt,T = Ft,T/St. ANSWER: b 42. According to the cost of carry model, the relationship between the spot (S0) and futures price (F0,T) is a. S0 = F0,T/(1 + rf)T. b. S0 = F0,T(1 + rf)T. c. S0 + F0,T = (1 + rf)T. d. S0 = F0,T + (1 + rf)T. e. S0 − F0,T = (1 + rf)T. ANSWER: a 43. A backwardated futures market occurs when a. F0,T < S0. b. F0,T = S0. c. F0,T > S0. d. F0,T > E( ST). e. F0,T > ST. richard@qwconsultancy.com

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ANSWER: a 44. Which of the following is true when F0,T < E(ST)? a. occurs when long hedgers outnumber short hedgers b. occurs when short hedgers outnumber long hedgers c. The market is said to be in contango. d. The market is said to be in normal contango. e. The pure expectations hypothesis holds.

ANSWER: b 45. When F0,T > E(ST), it is known as a. backwardation. b. normal backwardation. c. normal contango. d. inverted spread. e. pure expectations equilibrium.

ANSWER: c 46. The inclusion of the following in the cost of carry model will increase the futures price. a. dividends b. storage costs c. interest rate d. taxes e. transaction costs ANSWER: b 47. The cost of carry includes all of the following EXCEPT a. storage costs. b. insurance. c. current price. d. financing costs. e. risk-free rate.

ANSWER: c 48. In the absence of arbitrage opportunities, the forward contract price should be equal to the current price plus a. contract price. b. the cost of carry. c. margin requirement. d. the price discovery rate. e. the convenience return.

ANSWER: b 49. Which of the following is NOT considered a "cost of carry"? richard@qwconsultancy.com

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a. commissions for physical storage b. an opportunity cost for the net amount of invested capital c. a premium for the convenience of consuming the asset now d. a risk premium for uncertainty e. the intrinsic price of the underlying ANSWER: d 50. Financial futures include all of the following underlying securities EXCEPT a. stock indexes. b. treasury bonds. c. bank deposits. d. foreign currencies. e. All of these are correct.

ANSWER: e 51. Financial futures have become an increasingly attractive investment alternative because the Chicago Board of Trade (CBOT) began trading them in 1977, and their hedging function partly accounts for the growth in trading. Which of the following statements concerning financial futures is true? a. Financial futures protect the investment portfolio against inflation in the economy. b. Investors seek protection against the increasing volatility of interest rates. c. Unlike commodity futures, factors that influence price shifts are not supply and demand of the commodity but buyer psychology. d. A reason for their popularity is that trading is restricted to government obligations, which reduces risks. e. A reason for their popularity is that trading is tax-free.

ANSWER: b 52. The most popular financial futures in terms of average daily volume are the a. OEX contracts. b. S&P 500 contracts. c. LIBOR contracts. d. t-bill contracts. e. t-bond contracts.

ANSWER: e 53. In your portfolio you have $1 million of 20-year, 8 5/8 percent bonds that are selling at 83.15 (or 83 15/32) against this position. Because you feel interest rates will rise, you sell 10 bond futures at 81.15 (or 81 15/32) against this position. Two months later, you decide to close your position. The bonds have fallen to 78, and the futures contracts are at 75.16 (75 16/32). Disregarding margin and transaction costs, what is your gain or loss? a. $5,000 loss b. $500 loss c. breakeven d. $500 gain e. $5,000 gain richard@qwconsultancy.com

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ANSWER: e Exhibit 15.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) In late January 2004, The Union Cosmos Company is considering the sale of $100 million in 10-year bonds that will probably be rated AAA like the firm's other bond issues. The firm is anxious to proceed at today's rate of 10.5 percent. As treasurer, you know that it will take until sometime in April to get the issue registered and sold. Therefore, you suggest that the firm hedge the pending issue using Treasury bond futures contracts each representing $100,000.

Current Value − January 2004 Bond Rate June 2004 Treasury Bonds Estimated Values − April 2004 Bond Rate June 2004 Treasury Bonds

Case 1

Case 2

10.5% 78.875

10.5% 78.875

11.0% 75.93

10.0% 81.84

54. Refer to Exhibit 15.1. Explain how you would go about hedging the bond issue? a. sell 1,000 contracts b. buy 1,000 contracts c. sell 100 contracts d. sell 10,000 contracts e. buy 10,000 contracts ANSWER: a 55. Refer to Exhibit 15.1. What is the dollar gain or loss assuming that future conditions described in Case 1 actually occur? (Ignore commissions and margin costs.) a. $2,945,000.00 gain b. $65,500.00 gain c. $2,945,000.00 loss d. $65,500.00 loss e. $10,500.00 loss ANSWER: d 56. Refer to Exhibit 15.1. What is the dollar gain or loss assuming that future conditions described in Case 2 actually occur? (Ignore commissions and margin costs). a. $2,965,000.00 gain b. $45,500.00 gain c. $2,965,000.00 loss d. $45,500.00 loss e. $0 ANSWER: b Exhibit 15.2 richard@qwconsultancy.com

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USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume you are the Treasurer for the Johnson Pharmaceutical Company and in late July 2004, the company is considering the sale of $500 million in 20-year bonds that will most likely be rated the same as the firm's other debt issues. The firm would like to proceed at the current rate of 8.5%, but you know that it will probably take until November to bring the issue to market. Therefore, you suggest that the firm hedge the pending issue using Treasury bond futures contracts, which each represent $100,000.

Current Value − July 2004 Bond Rate Dec. 2004 Treasury Bonds Estimated Values − Nov. 2004 Bond Rate Dec. 2004 Treasury Bonds

Case 1

Case 2

8.5% 87.75

8.5% 87.75

9.5% 85.60

7.5% 91.65

57. Refer to Exhibit 15.2. How you would go about hedging the bond issue? a. buy 5,000 contracts b. buy 50,000 contracts c. sell 5,000,000 contracts d. sell 5,000 contracts e. sell 500 contracts ANSWER: d 58. Refer to Exhibit 15.2. What is the dollar gain or loss assuming that future conditions described in Case 1 actually occur? (Ignore commissions and margin costs .) a. $47,316,683.00 gain b. $36,566,683.00 loss c. $10,750,000.00 gain d. $10,750,000.00 loss e. $0 ANSWER: b 59. Refer to Exhibit 15.2. What is the dollar gain or loss assuming that future conditions described in Case 2 actually occur? (Ignore commissions and margin costs .) a. $19,500,000.00 gain b. $27,816,683.04 gain c. $27,816,683.04 loss d. $19,500,000.00 loss e. $0 ANSWER: b Exhibit 15.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

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As a relationship officer for a money-center commercial bank, one of your corporate accounts has just approached you about a one-year loan for $3,000,000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each quarter. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market: 90-day LIBOR 180-day LIBOR 270-day LIBOR 360-day LIBOR

4.70% 4.85% 5.10% 5.40%

60. Refer to Exhibit 15.3. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the first quarter? a. $35,250.00 b. $36,375.00 c. $38,250.00 d. $40,500.00 e. $0 ANSWER: a 61. Refer to Exhibit 15.3. What is the implied 90-day forward rate at the beginning of the second quarter? a. 4.70% b. 4.85% c. 4.60% d. 4.94% e. 0% ANSWER: d 62. Refer to Exhibit 15.3. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the second quarter? a. $40,500.00 b. $38,250.00 c. $35,250.00 d. $37,064.25 e. $34,500.00 ANSWER: d 63. Refer to Exhibit 15.3. What is the implied 90-day forward rate at the beginning of the third quarter? a. 5.10% b. 5.47% c. 4.70% d. 4.85% e. 0% richard@qwconsultancy.com

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ANSWER: b 64. Refer to Exhibit 15.3. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the third quarter? a. $35,250.00 b. $36,375.00 c. $38,250.00 d. $41,005.50 e. $0 ANSWER: d 65. Refer to Exhibit 15.3. What is the implied 90-day forward rate at the beginning of the fourth quarter? a. 6.19% b. 5.10% c. 6.07% d. 5.68% e. 0% ANSWER: c 66. Refer to Exhibit 15.3. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the fourth quarter? a. $36,223.50 b. $40,500.00 c. $38,250.00 d. $36,375.00 e. $0 ANSWER: a 67. Refer to Exhibit 15.3. If the bank wanted to hedge its exposure to falling LIBOR on this loan commitment, describe the sequence of transactions in the futures markets it could undertake. a. buy three Eurodollar futures contracts that expire at the end of the first quarter b. buy three Eurodollar futures contracts that expire at the end of the first quarter, three that expire at the end of the second quarter, and three that expire at the end of the third quarter. c. sell three Eurodollar futures contracts that expire at the end of the year. d. sell one Eurodollar futures contract that expires at the end of the first quarter, one that expires at the end of the second quarter, and one that expires at the end of the third quarter. e. buy three Eurodollar futures contracts that expire at the end of the year.

ANSWER: b 68. Refer to Exhibit 15.3. Assuming the yields inferred from the Eurodollar futures contract prices for the next three settlement periods are equal to the implied forward rates, calculate the dollar value of the annuity that would leave the bank indifferent between making the floating-rate loan and hedging it in the futures market and making a one-year fixed-rate loan. a. $49,312.36 b. $35,120.62 richard@qwconsultancy.com

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c. $39,036.45 d. $44,452.36 e. $0 ANSWER: c 69. Refer to Exhibit 15.3. Assuming the yields inferred from the Eurodollar futures contract prices for the next three settlement periods are equal to the implied forward rates, calculate, in annual (360-day) percentage terms, the annuity that would leave the bank indifferent between making the floating-rate loan and hedging it in the futures market and making a one-year fixed-rate loan. a. 20.86% b. 5.10% c. 4.91% d. 5.20% e. 0% ANSWER: d 70. A bond portfolio manager expects a cash inflow of $12,000,000. The manager plans to hedge potential risk with a Treasury futures contract with a value of $105,215. The conversion factor between the CTD and the bond specified in the Treasury futures contract is 0.85. The duration of bond portfolio is eight years, and the duration of the CTD bond is 6.5 years. Indicate the number of contracts required and whether the position to be taken is short or long. a. 114 contracts short b. 114 contracts long c. 119 contracts short d. 119 contracts long e. 100 contracts long ANSWER: d 71. A bond portfolio manager expects a cash outflow of $35,000,000. The manager plans to hedge potential risk with a Treasury futures contract with a value of $105,215. The conversion factor between the CTD and the bond specified in the Treasury futures contract is 0.85. The duration of bond portfolio is eight years, and the duration of the CTD bond is 6.5 years. Indicate the number of contracts required and whether the position to be taken is short or long. a. 333 contracts short b. 333 contracts long c. 348 contracts short d. 348 contracts long e. 300 contracts long ANSWER: c Exhibit 15.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A three-month T-bond futures contract (maturity 20 years, coupon 6 percent, face $100,000) currently trades at $98,781.25 (implied yield 6.11 percent). A three-month T-note futures contract (maturity 10 years, coupon 6 percent, face $100,000) currently trades at $101,468.80 (implied yield 5.80%).

Assume semiannual compounding. richard@qwconsultancy.com

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72. Refer to Exhibit 15.4. If you expected the yield curve to steepen, the appropriate NOTE AGAINST BOND futures spread strategy would be a. go long the T-bond and short the T-note. b. go short the T-bond and long the T-note. c. go long the T-bond and long the T-note. d. go short the T-bond and short the T-note. e. None of these are correct.

ANSWER: b 73. Refer to Exhibit 15.4. If you expected the yield curve to flatten, the appropriate note against bond futures spread strategy would be a. go long the T-bond and short the T-note. b. go short the T-bond and long the T-note. c. go long the T-bond and long the T-note. d. go short the T-bond and short the T-note. e. None of these are correct.

ANSWER: a 74. Refer to Exhibit 15.4. Suppose the yield curve changed so the that the new yield on the T-bond contract rose to 6.5 percent, and the new yield on the T-note contract fell to 5.5 percent. Calculate the profit on the note against bond futures spread. (Assume coupons are paid semiannually) a. −$5850.92 b. −$6,671.42 c. $6,671.42 d. $5850.92 e. $4550.42 ANSWER: c Exhibit 15.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that you observe the following prices in the T-Bill and Eurodollar futures markets

September

T-Bill 93.25

Eurodollar 92.35

75. Refer to Exhibit 15.5. If you expected the TED spread to widen 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 these are correct.

ANSWER: c richard@qwconsultancy.com

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76. Refer to Exhibit 15.5. Assume that a month later the price of the September T-Bill future is 93 and the price of the Eurodollar future is 90.25. Calculate the profit on the T-Bill futures position. a. 25 basis points b. 110 basis points c. −25 basis points d. −110 basis points e. 50 basis points ANSWER: c 77. Refer to Exhibit 15.5. Assume that a month later the price of the September T-Bill future is 93 and the price of the Eurodollar future is 90.25. Calculate the profit on the Eurodollar futures position. a. 190 basis points b. 210 basis points c. −190 basis points d. −210 basis points e. 100 basis points ANSWER: b Exhibit 15.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that you observe the following prices in the T-Bill and Eurodollar futures markets

September

T-Bill 95.24

Eurodollar 94.6

78. Refer to Exhibit 15.6. If you expected the 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 these are correct.

ANSWER: d 79. Refer to Exhibit 15.6. Assume that a month later the price of the September T-Bill future is 96.25 and the price of the Eurodollar future is 95.9. Calculate the profit on the T-Bill futures position. a. 101 basis points b. 130 basis points c. −101 basis points d. −130 basis points e. 29 basis points ANSWER: c richard@qwconsultancy.com

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80. Refer to Exhibit 15.6. Assume that a month later the price of the September T-Bill future is 96.25 and the price of the Eurodollar future is 95.9. Calculate the profit on the Eurodollar futures position. a. 101 basis points b. 130 basis points c. −101 basis points d. −130 basis point. e. 29 basis points ANSWER: b Exhibit 15.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Suppose you are a loan officer for a commercial bank and one of your clients has just approached you about a one-year loan for $4,000,000. Interest on the new loan will be paid at the end of each quarter based on the prevailing level of LIBOR at the beginning of each quarter. The LIBOR yield curve in the cash market is as follows: 90-day LIBOR 180-day LIBOR 270-day LIBOR 360-day LIBOR

2.70% 2.85% 3.10% 3.40%

81. Refer to Exhibit 15.7. What will the dollar level of the bank's interest receipt be at the end of the first quarter? a. $26,500 b. $27,000 c. $28,500 d. $108,000 e. $17,000 ANSWER: b 82. Refer to Exhibit 15.7. What is the implied 90-day forward rate at the beginning of the second quarter? a. 2.70% b. 2.85% c. 2.98% d. 3.15% e. 3.32% ANSWER: c 83. Refer to Exhibit 15.7. What is the implied 90-day forward rate at the beginning of the third quarter? a. 2.97% b. 3.05% c. 3.34% d. 3.55% richard@qwconsultancy.com

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e. 3.76% ANSWER: d 84. Refer to Exhibit 15.7. A bond portfolio manager expects a cash inflow of $10,000,000. The manager plans to hedge potential risk with a Treasury futures contract with a value of $102,150. The conversion factor between the CTD and the bond specified in the Treasury futures contract is 0.88.

The duration of bond portfolio is six years, and the duration of the CTD bond is 4.5 years. Indicate the number of contracts required and whether the position to be taken is short or long. a. 114 contracts short b. 114 contracts long c. 60 contracts short d. 60 contracts long e. 55 contracts long ANSWER: b Exhibit 15.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A futures contract on Treasury bond futures with a December expiration date currently trade at 103:06. The face value of a Treasury bond futures contract is $100,000. Your broker requires an initial margin of 10 percent.

85. Refer to Exhibit 15.8. Calculate the current value of one contract. a. $100,000 b. $103,600.5 c. $103,187.5 d. $102,306.3 e. $104,293.5 ANSWER: c 86. Refer to Exhibit 15.8. Calculate the initial margin deposit. a. $10,000 b. $10,360.50 c. $10,318.75 d. $10,230.63 e. $10,429.35 ANSWER: c 87. Refer to Exhibit 15.8. If the futures contract is quoted at 105:08 at expiration, calculate the percentage return. a. 1.99 percent b. 19.99 percent c. 20.62 percent d. 25.37 percent e. −13.65 percent richard@qwconsultancy.com

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ANSWER: b 88. In late January 2011, Starlight Corporation is considering the sale of $50 million in 10-year bonds rated AAA. The issue will most likely be registered and sold some time in April. Therefore, Starlight Corporation desires to hedge the pending issue using Treasury bond futures contracts, which each represent $100,000. Explain how you would go about hedging the bond issue? a. sell 500 contracts b. buy 500 contracts c. sell 50 contracts d. buy 50 contracts e. buy 5000 contracts ANSWER: a 89. Assume that you manage a $50 million equity portfolio. The portfolio beta is 0.85. You anticipate a cash inflow of $5 million into the portfolio. Calculate the number of contracts you would need to hedge your position and indicate whether you would go short or long. Assume that the price of the S&P 500 futures contract is 1062 and the multiplier is 250. a. 25 contracts short b. 18 contracts short c. 16 contracts long d. 19 contracts short e. 15 contracts short ANSWER: c 90. Assume that you manage an equity portfolio. The portfolio beta is 1.15. You anticipate a decline in equity values and wish to hedge $500 million of the portfolio. Calculate the number of contracts you would need to hedge your position and indicate whether you would go short or long. Assume that the price of the S&P 500 futures contract is 1105 and the multiplier is 250. a. 2500 contracts short b. 1810 contracts short c. 1810 contracts long d. 2081 contracts short e. 2081 contracts long ANSWER: d 91. Assume that you manage an equity portfolio. The portfolio beta is 1.15. You anticipate a rise in equity values and wish to increase equity exposure on $500 million of the portfolio. Calculate the number of contracts you would need to hedge your position and indicate whether you would go short or long. Assume that the price of the S&P 500 futures contract is 1105 and the multiplier is 250. a. 2500 contracts short b. 1810 contracts short c. 1810 contracts long d. 2081 contracts short e. 2081 contracts long ANSWER: e Exhibit 15.9 richard@qwconsultancy.com

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USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The S&P 500 stock index is at 1100. The annualized interest rate is 3.5 percent, and the annualized dividend is 2 percent.

92. Refer to Exhibit 15.9. Calculate the price of the futures contract now. a. 1108.59 b. 1102.75 c. 1139.79 d. 1123.19 e. 1350.15 ANSWER: b 93. Refer to Exhibit 15.9. If the futures contract was currently available for 1250, indicate the appropriate strategy that would earn an arbitrage profit. a. long futures and short the index b. short futures and long the index c. long futures and long the index d. short futures and short the index e. None of these are correct.

ANSWER: b 94. Refer to Exhibit 15.9. If the futures contract was currently available for 1050, indicate the appropriate strategy that would earn an arbitrage profit. a. long futures and short the index b. short futures and long the index c. long futures and long the index d. short futures and short the index e. None of these are correct.

ANSWER: a 95. Refer to Exhibit 15.9. If the futures contract was currently available for 1250, calculate the arbitrage profit. a. $0 b. $133.41 c. −$133.41 d. $147.25 e. −$147.25 ANSWER: d Exhibit 15.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

richard@qwconsultancy.com

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Consider a portfolio manager with a $20,500,000 equity portfolio under management. The manager wishes to hedge against a decline in share values using stock index futures. Currently a stock index future is priced at 1250 and has a multiplier of 250. The portfolio beta is 1.25.

96. Refer to Exhibit 15.10. 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. 82 contracts short c. 82 contracts long d. 100 contracts short e. 50 contracts short ANSWER: b 97. Refer to Exhibit 15.10. Assume that a month later the equity portfolio has a market value of $20,000,000 and the stock index future is priced at 1150 with a multiplier of 250. Calculate the profit on the equity position. a. $100,000 b. −$200,000 c. $600,000 d. −$500,000 e. $400,000 ANSWER: d 98. Refer to Exhibit 15.10. Assume that a month later the equity portfolio has a market value of $20,000,000 and the stock index future is priced at 1150 with a multiplier of 250. Calculate the profit on the stock index futures position. a. $1,550,000 b. −$2,000,000 c. $2,050,000 d. −$5,000,000 e. $2,400,000 ANSWER: c 99. Refer to Exhibit 15.10. Calculate the overall profit. a. $1,550,000 b. −$2,000,000 c. $2,050,000 d. −$5,000,000 e. $2,400,000 ANSWER: a Exhibit 15.11 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

richard@qwconsultancy.com

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As a portfolio manager, you are responsible for a $150 million portfolio, 90 percent of which is invested in equities, with a portfolio beta of 1.25. You are utilizing the S&P 500 as your passive benchmark. Currently the S&P 500 is valued at 1202. The value of the S&P 500 futures contract is equal to $250 times the value of the index. The beta of the futures contract is 1.0.

100. Refer to Exhibit 15.11. If you anticipate a cash inflow of $2 million next week, how many futures contracts should you buy or sell in order to mitigate the effect of this inflow on the portfolio's performance (rounded to the nearest integer)? a. sell six contracts b. buy six contracts c. sell eight contracts d. buy eight contracts e. buy seven contracts ANSWER: b 101. Refer to Exhibit 15.11. If you anticipate a cash outflow of $5 million next week, how many futures contracts should you buy or sell in order to mitigate the effect of this outflow on the portfolio's performance (rounded to the nearest integer)? a. sell 21 contracts b. buy 21 contracts c. sell 17 contracts d. buy 17 contracts e. buy 13 contracts ANSWER: a 102. Refer to Exhibit 15.11. How many contracts should you buy or sell in order to increase the portfolio beta to 1.30 (rounded to the nearest integer)? a. sell 70 contracts b. buy 70 contracts c. buy 87 contracts d. buy 98 contracts e. sell 67 contracts ANSWER: c 103. Refer to Exhibit 15.11. How many contracts should you buy or sell in order to reduce the portfolio beta to 0.80 (rounded to the nearest integer)? a. sell 162 contracts b. buy 162 contracts c. sell 324 contracts d. buy 324 contracts e. buy 234 contracts ANSWER: a Exhibit 15.12 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) richard@qwconsultancy.com

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The S&P 500 stock index is at 1300. The annualized interest rate is 4.0 percent, and the annualized dividend is 2 percent. You are currently considering purchasing a two-month futures contract for your portfolio.

104. Refer to Exhibit 15.12. Calculate the current price of the futures contract. a. 1295.66 b. 1304.34 c. 1342.75 d. 1379.29 e. 1393.49 ANSWER: b 105. Refer to Exhibit 15.12. If the futures contract was currently available for 1280, indicate the appropriate strategy that would earn an arbitrage profit. a. long futures and short the index b. short futures and long the index c. long futures and long the index d. short futures and short the index e. None of these are correct.

ANSWER: a 106. Refer to Exhibit 15.12. If the futures contract was currently available for 1350, calculate the arbitrage profit. a. $8.33 b. $28.45 c. $45.67 d. $50.00 e. $54.33 ANSWER: c Exhibit 15.13 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a portfolio manager with a $10,000,000 equity portfolio under management. The manager wishes to hedge against a decline in share values using stock index futures. Currently a stock index future is priced at 1350 and has a multiplier of 250. The portfolio beta is 1.50.

107. Refer to Exhibit 15.13. 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 contracts short richard@qwconsultancy.com

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e. 75 contracts short ANSWER: c 108. Refer to Exhibit 15.13. Assume that a month later the equity portfolio has a market value of $9,500,000 and the stock index future is priced at 1300 with a multiplier of 250. Calculate the profit on the equity position. a. $100,000 b. $200,000 c. −$200,000 d. −$500,000 e. −$600,000 ANSWER: d 109. Refer to Exhibit 15.13. Assume that a month later the equity portfolio has a market value of $10,000,000 and the stock index future is priced at 1300 with a multiplier of 250. Calculate the profit (loss) on the stock index futures position. a. −$1,050,000 b. −$550,000 c. −$50,000 d. $550,000 e. $1,050,000 ANSWER: d 110. Refer to Exhibit 15.13. Calculate the overall profit. a. −$50,000 b. −$150,000 c. $50,000 d. $150,000 e. $550,000 ANSWER: c Exhibit 15.14 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) December futures on the S&P 500 stock index trade at 250 times the index value of 1187.70. Your broker requires an initial margin of 10 percent on futures contracts. The current value of the S&P 500 stock index is 1178.

111. Refer to Exhibit 15.14. How much must you deposit in a margin account if you wish to purchase one contract? a. $267,232.5 b. $29,450 c. $29,692.50 d. $30,000 e. $265,050 richard@qwconsultancy.com

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ANSWER: c 112. Refer to Exhibit 15.14. Suppose at expiration the futures contract price is 250 times the index value of 1170. Disregarding transaction costs, what is your percentage return? a. 1.87% b. −0.68% c. −14.90% d. 10.36% e. 13.58% ANSWER: c 113. Refer to Exhibit 15.14. Calculate the return on a cash investment in the S&P 500 stock index if the ending index value is 1170 over the same time period. a. 1.87% b. −0.68% c. −14.90% d. 10.36% e. 13.58% ANSWER: b 114. In the strategy known as _____, the arbitrageur will always hold the security denominated in the currency that is the least expensive to deliver in the futures market. a. stock index arbitrage b. covered interest arbitrage c. put call parity d. interest rate parity e. program trading ANSWER: b 115. Assume the exchange rate is GBP 1.35/USD, the US risk-free rate is 3.0 percent, and the UK risk-free rate is 6.5 percent. What is the implied one-year forward rate? a. GBP 1.40/USD b. GBP 1.35/USD c. GBP 1.30/USD d. GBP 1.25/USD e. GBP 1.20/USD ANSWER: a 116. Assume the exchange rate is GBP 1.35/USD, the US risk-free rate is 3.0 percent, and the UK risk-free rate is 3.0 percent. What is the implied one-year forward rate? a. GBP 1.40/USD b. GBP 1.35/USD c. GBP 1.30/USD d. GBP 1.25/USD e. GBP 1.20/USD richard@qwconsultancy.com

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ANSWER: b 117. Assume the exchange rate is GBP 1.35/USD, the US risk-free rate is 7.0 percent, and the UK risk-free rate is 3.0 percent. What is the implied one-year forward rate? a. GBP 1.40/USD b. GBP 1.35/USD c. GBP 1.30/USD d. GBP 1.25/USD e. GBP 1.20/USD ANSWER: c 118. Which of the following is NOT true about interest rate swaps? a. Payments are based on a notional principal. b. Floating rate payers profit if interest rates fall. c. Payments can be quarterly as well as semi-annually. d. Parities exchange debt obligations. e. Default risk is a possibility in the swaps market.

ANSWER: d 119. A ____ contract can be viewed as a prepackaged series of forward rate agreements to buy or sell LIBOR at the same fixed rate. a. swap b. cap c. floor d. collar e. ceiling ANSWER: a 120. A pay-fixed interest rate swap can be viewed as equivalent to a. a long position in a par-valued FRN and a long position in a par-valued, fixed-rate note. b. a long position in a par-valued FRN and a short position in a par-valued, fixed-rate note. c. a short position in a par-valued FRN and a long position in a par-valued, fixed-rate note. d. a short position in a par-valued FRN and a short position in a par-valued, fixed-rate note. e. a flat position in a par-valued FRN and a short position in a par-valued, fixed-rate note.

ANSWER: b 121. Consider a pension fund manager who wishes to convert $10 million from notes paying LIBOR to stocks using an equity swap. The equity swap should be structured so that a. pension fund receives LIBOR and pays an equity return based on a notional principal of $5 million. b. pension fund pays LIBOR and receives an equity return based on a notional principal of $5 million. c. pension fund receives LIBOR and pays an equity return based on a notional principal of $10 million. d. pension fund pays LIBOR and receives an equity return based on a notional principal of $10 million. richard@qwconsultancy.com

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e. pension fund pays LIBOR and receives an equity return based on a notional principal of $15 million.

ANSWER: d 122. The following are all advantages of having an equity swap market EXCEPT: a. These agreements allow investors to take advantage of overall price movements in a specific country's stock market. b. Creating a direct equity investment in a foreign country may be difficult for some investors where it is prohibited by law. c. These agreements eliminate the need for a counterparty because they are traded on the NYSE. d. An investment fund wanting to accumulate foreign index returns denominated in their domestic currency may not be legally permitted to obtain sufficient exchange-traded derivative contracts to hedge a direct equity investment. e. Equity swaps can reduce both the transaction costs and the tracking error.

ANSWER: c Exhibit 15.15 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3  6 FRA whereby you pay the dealer's quoted fixed rate of 4.5 percent in exchange for receiving three-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4 percent. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.)

123. Refer to Exhibit 15.15. Assuming that three-month LIBOR is 5.00 percent on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Darden. a. The dealer is obligated to pay Darden $19,500. b. The dealer is obligated to pay Darden $31,250. c. Darden is obligated to pay the dealer $19,500. d. Darden is obligated to pay the dealer $31,250. e. Darden is obligated to pay the dealer $32,150.

ANSWER: b 124. Refer to Exhibit 15.15. Assuming that three-month LIBOR is 5.00 percent on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Darden. a. The dealer is obligated to pay Darden $30,864.20. b. The dealer is obligated to pay Darden $19,359.61. c. Darden is obligated to pay the dealer $19,359.61. d. Darden is obligated to pay the dealer $30,864.20. e. Darden is obligated to pay the dealer $35,648.20. richard@qwconsultancy.com

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ANSWER: a 125. Refer to Exhibit 15.15. Assuming that three-month LIBOR is 5.00 percent on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and McIntire. a. The dealer is obligated to pay McIntire $62,500. b. The dealer is obligated to pay McIntire $57,500. c. McIntire is obligated to pay the dealer $62,500. d. McIntire is obligated to pay the dealer $57,500. e. McIntire is obligated to pay the dealer $55,700.

ANSWER: c 126. Refer to Exhibit 15.15. Assuming that three-month LIBOR is 5.00 percent on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and McIntire. a. The dealer is obligated to pay McIntire $61,728.40. b. The dealer is obligated to pay McIntire $56,389.16. c. McIntire is obligated to pay the dealer $56,389.16. d. McIntire is obligated to pay the dealer $61,728.40. e. McIntire is obligated to pay the dealer $66,728.40.

ANSWER: d 127. Refer to Exhibit 15.15. How much compensation does the dealer receive for transaction costs, credit risk, and other costs associated with matching the FRAs? a. $31,250 b. $21,350 c. $41,000 d. $48,150 e. $52,000 ANSWER: a Exhibit 15.16 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3  6 FRA whereby you pay the dealer's quoted fixed rate of 5.91 percent in exchange for receiving three-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85 percent. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.)

128. Refer to Exhibit 15.16. Assuming that three-month LIBOR is 5.6 percent on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Chimichango. richard@qwconsultancy.com

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a. The dealer is obligated to pay Chimichango $38,750. b. The dealer is obligated to pay Chimichango $31,250. c. Chimichango is obligated to pay the dealer $38,750. d. Chimichango is obligated to pay the dealer $31,250. e. Chimichango is obligated to pay the dealer $0 ANSWER: c 129. Refer to Exhibit 15.16. Assuming that three-month LIBOR is 5.6 percent on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Chimichango. a. The dealer is obligated to pay Chimichango $38,215.00 b. The dealer is obligated to pay Chimichango $30,818.54. c. Chimichango is obligated to pay the dealer $31,818.54. d. Chimichango is obligated to pay the dealer $38,215.00 e. Chimichango is obligated to pay the dealer $0 ANSWER: d 130. Refer to Exhibit 15.16. Assuming that three-month LIBOR is 5.6 percent on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Megabuks. a. The dealer is obligated to pay Megabuks $38,750. b. The dealer is obligated to pay Megabuks $31,250. c. Megabuks is obligated to pay the dealer $38,750. d. Megabuks is obligated to pay the dealer $31,250. e. The dealer is obligated to pay Megabuks $0.

ANSWER: b 131. Refer to Exhibit 15.16. Assuming that three-month LIBOR is 5.6 percent on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Megabuks. a. The dealer is obligated to pay Megabuks $38,215.00 b. Megabuks is obligated to pay the dealer $31,818. 54. c. Megabuks is obligated to pay the dealer $38,215.00 d. The dealer is obligated to pay Megabuks $30,818.54 e. The dealer is obligated to pay Megabuks $0.

ANSWER: d 132. Refer to Exhibit 15.16. How much compensation does the dealer receive for transaction costs, credit risk, and other costs associated with matching the FRAs? a. $30,000 b. $31,250 c. $7,500 d. $5,000 e. $0 ANSWER: c richard@qwconsultancy.com

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Exhibit 15.17 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The Skalmory Corporation has entered into a three-year interest rate swap, with semiannual settlement, to pay a fixed rate of 7.5 percent per year and receive six-month LIBOR. The notional principal is $10,000,000.

133. Refer to Exhibit 15.17. Assume that one year later the fixed rate on a new two-year receive fixed pay floating LIBOR swap has fallen to 7 percent per year. Settlement is on a semiannual basis.

Calculate the market value of the FRN based on $100 face value. a. $101.33 b. $100.58 c. $100.00 d. $98.67 e. $95.83 ANSWER: c 134. Refer to Exhibit 15.17. What is the market value of the swap to the Skalmory Corporation? a. −$9,000,000 b. −$1,804,000 c. −$87,654 d. $91,830 e. $7,620,000 ANSWER: d 135. Refer to Exhibit 15.17. Assuming that one year after the swap was initiated the fixed rate on a new two-year receive fixed pay floating LIBOR swap has fallen to 7 percent per year, calculate the market value of the 7.5 percent fixed rate bond based on a $100 face value. Settlement is on a semiannual basis. a. $101.33 b. $100.92 c. $100.00 d. $98.67 e. $95.83 ANSWER: b Exhibit 15.18 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) TexMex Corporation has decided to borrow $50,000,000 for six months in two three-month issues.

The corporation is concerned that interest rates will rise over the next three months. Thus, the corporation purchases a 3  6 FRA whereby the corporation pays the dealer's quoted fixed rate of 3.5 percent in exchange for receiving three-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Newport Inc. at its bid rate of 3 percent. The notional principal is $50,000,000 and that there are 60 days between month 3 and month 6.

richard@qwconsultancy.com

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136. Refer to Exhibit 15.18. Suppose that three-month LIBOR is 4.0 percent on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and TexMex. a. The dealer is obligated to pay TexMex $61,881. b. The dealer is obligated to pay TexMex $61,500. c. TexMex is obligated to pay the dealer $247,524. d. TexMex is obligated to pay the dealer $246,000. e. TexMex is obligated to pay the dealer $258,000.

ANSWER: b 137. Refer to Exhibit 15.18. Suppose that three-month LIBOR is 4.0 percent on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and TexMex. a. The dealer is obligated to pay TexMex $61,881. b. The dealer is obligated to pay TexMex $61,500. c. TexMex is obligated to pay the dealer $247,524. d. TexMex is obligated to pay the dealer $246,000. e. TexMex is obligated to pay the dealer $56,000.

ANSWER: a 138. Refer to Exhibit 15.18. Suppose that three-month LIBOR is 4.0 percent on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Newport. a. The dealer is obligated to pay Newport $125,000. b. The dealer is obligated to pay Newport $115,000. c. Newport is obligated to pay the dealer $125,000. d. Newport is obligated to pay the dealer $115,000. e. Newport is obligated to pay the dealer $105,000.

ANSWER: c 139. Refer to Exhibit 15.18. Suppose that three-month LIBOR is 4.00 percent 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. Newport is obligated to pay the dealer $132,762.

ANSWER: d 140. Refer to Exhibit 15.18. How much compensation does the dealer receive for transaction costs, credit risk, and other costs associated with matching the FRAs? a. $42,700 b. $62,500 c. $82,000 d. $96,300 richard@qwconsultancy.com

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e. $0 ANSWER: b Exhibit 15.19 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The WallMal Company has entered into a four-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8 percent per year and receive six-month LIBOR. The notional principal is $50,000,000.

141. Refer to Exhibit 15.19. Assume that one year later the fixed rate on a new three-year receive fixed pay floating LIBOR swap has fallen to 7 percent per year. Settlement is on a semiannual basis.

Calculate the market value of the FRN based on $100 face value. a. $102.66 b. $100.00 c. $95.56 d. $89.63 e. $70.77 ANSWER: b 142. Refer to Exhibit 15.19. Assuming that one year after the swap was initiated the fixed rate on a new three-year receive fixed pay floating LIBOR swap has fallen to 7 percent per year, calculate the market value of the 8 percent fixed rate bond based on a $100 face value. Settlement is on a semiannual basis. a. $102.66 b. $100.00 c. $95.56 d. $89.63 e. $70.77 ANSWER: a 143. Refer to Exhibit 15.19. Indicate the market value of the swap to the WallMal Company. a. $3,525,120 b. −$3,500,000 c. $1,332,150 d. −$1,332,150 e. $1,026,600 ANSWER: d 144. Refer to Exhibit 15.19 Assume that one year later the fixed rate on a new three-year receive fixed pay floating LIBOR swap has risen to 9 percent per year. Settlement is on a semiannual basis.

Calculate the market value of the FRN based on $100 face value. a. $97.42 b. $100.00 c. $92.56 richard@qwconsultancy.com

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d. $99.63 e. $75.77 ANSWER: b 145. Refer to Exhibit 15.19. Assume that one year after the swap was initiated the fixed rate on a new three-year receive fixed pay floating LIBOR swap has risen to 9 percent per year, calculate the market value of the 8 percent fixed rate bond based on $100 face value. Settlement is on a semiannual basis. a. $76.45 b. $101.24 c. $100.0 d. $97.42 e. $70.77 ANSWER: d 146. Refer to Exhibit 15.19. Indicate the market value of the swap to the WallMal Company. a. $5,786,345 b. −$3,575,987 c. $1,289,450 d. −$1,514,900 e. $1,250,075 ANSWER: c Exhibit 15.20 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) An international investment firm buys an interest rate swap that pays the difference between LIBOR and 6 percent if LIBOR exceeds 6 percent. Current LIBOR is 5 percent. The amount of the option is $1,500,000, and the settlement is every three months. Assume a 360-day year.

147. Refer to Exhibit 15.20. Find the payoff if LIBOR closes at 4.7 percent. a. −$45,000 b. −$11,250 c. $0 d. $11,250 e. $45,000 ANSWER: c 148. Refer to Exhibit 15.20. Find the payoff if LIBOR closes at 6.3 percent. a. −$45,000 b. −$11,250 c. $0 d. $11,250 e. $45,000 ANSWER: d richard@qwconsultancy.com

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Chapter 16 - Option Contracts True / False 1. The Chicago Board Options Exchange has the largest share of stock option trading. a. True b. False ANSWER: True 2. Index options are settled by delivery of the stocks that make up the index. a. True b. False ANSWER: False 3. In index options, the aggregate market takes the place of the individual stock issues being traded, as in stock options. a. True b. False ANSWER: True 4. Risk management is the driving force behind the futures options market. a. True b. False ANSWER: False 5. The longer the time to expiration, the greater the value of a call option. a. True b. False ANSWER: True 6. There is an inverse relationship between the market interest rate and the value of a call option. a. True b. False ANSWER: False 7. Credit risk in the options market is only a concern to the option seller. a. True b. False ANSWER: False 8. The standardization of option contracts and the creation of the Options Clearing Corporation are two important results of the opening of the Chicago Board of Options Exchange. a. True richard@qwconsultancy.com

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b. False ANSWER: True 9. Stock options expire on the Sunday following the third Saturday of the designated month. a. True b. False ANSWER: False 10. Index options can only be settled in cash. a. True b. False ANSWER: True 11. Unlike stock options, futures options require the holder to enter into a futures contract. a. True b. False ANSWER: False 12. The owner of a call option on a futures contract has the obligation to buy the futures contract at a predetermined strike price during a specified time period. a. True b. False ANSWER: False 13. Options on futures expire at the same time the futures contract expires. a. True b. False ANSWER: False 14. The Options Clearing Corporation (OCC) acts as the guarantor of each Chicago Board Options Exchange (CBOE) traded contract. a. True b. False ANSWER: True 15. It is always theoretically possible to use options as a perfect hedge against fluctuations in value of the underlying asset. a. True b. False ANSWER: True 16. Investors should purchase market index put options if they anticipate an increase in the index value. a. True b. False richard@qwconsultancy.com

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ANSWER: False 17. Risk management strategies involving interest rate agreements can be classified as forward-based or option-based. a. True b. False ANSWER: True 18. The most important input the investor must provide in determining option values is the strike price. a. True b. False ANSWER: False 19. A portfolio containing a share of stock and a put option will have the same value as a portfolio containing a call option and the risk-free bond. a. True b. False ANSWER: True 20. The binomial model is a continuous method for valuing options. a. True b. False ANSWER: False 21. In a binomial option pricing model, the initial value of the call can be determined by working backward through the tree and solving for each of the remaining intermediate option values. a. True b. False ANSWER: True 22. The binomial option pricing model and the Black and Scholes model are similar because they are both discrete models. a. True b. False ANSWER: False 23. The delta in the Black-Scholes model is simply the slope of a line tangent to the call option price curve. a. True b. False ANSWER: True 24. The binomial option pricing model approximates the price of an option obtained using the BlackScholes option pricing model as the number of subintervals increases. a. True richard@qwconsultancy.com

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b. False ANSWER: True 25. European options can only be exercised on the expiration date. a. True b. False ANSWER: True 26. The underlying stock price and the value of the put option are factors that impact the value of an American call option. a. True b. False ANSWER: False 27. A price spread (or vertical spread) involves buying and selling an option for the same stock and expiration date but with different exercise prices. a. True b. False ANSWER: True 28. A strip is a call option on a stock that is written by someone who owns the stock. a. True b. False ANSWER: False 29. The buyer of a straddle expects stock prices to move strongly in either direction. a. True b. False ANSWER: True 30. A long-strip position indicates that an investor is bullish but conservative. a. True b. False ANSWER: True 31. It is a violation of the securities laws to combine option contracts to achieve a customized payoff. a. True b. False ANSWER: False 32. The issuance of convertibles will ultimately lead to greater dilution than an initial issue of stock. a. True b. False ANSWER: True

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33. Convertibles provide the upside potential of common stock and the downside protection of a bond. a. True b. False ANSWER: True 34. By attaching a convertible feature to a bond issue, a firm can often get a lower rate of interest on its debt. a. True b. False ANSWER: True 35. The investment value of a convertible bond is the price that it would be expected to sell as a straight debt instrument. a. True b. False ANSWER: True 36. The conversion parity price is equal to the par value of a convertible bond divided by the number of shares into which it can be converted. a. True b. False ANSWER: False 37. A credit default swap (CDS) is better regarded as an option-like arrangement. a. True b. False ANSWER: True Multiple Choice 38. The creation of the CBOE led to all the following innovations in options EXCEPT a. the creation of a central marketplace. b. the introduction of a clearing corporation. c. the standardization of expiration dates. d. the creation of a primary market. e. the creation of a secondary market.

ANSWER: d 39. A currency call is like being ____ in the currency futures. a. out-of-the-money b. in-the-money c. long d. short e. at-the-money ANSWER: c richard@qwconsultancy.com

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40. The entity that acts as the guarantor of each CBOE-traded contract is the a. Federal Government. b. Securities and Exchange Commission. c. CBOE. d. Options Clearing Corporation. e. Federal Reserve Bank.

ANSWER: e 41. 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 these are correct.

ANSWER: d 42. Options on futures contracts are very popular because a. they require the holder to purchase at a future date. b. of their ability to create leverage. c. the seller of the futures contract is under no obligation. d. the amount of the underlying commodity is negotiable. e. None of these are correct.

ANSWER: b Exhibit 16.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Option Type Contract Size Expiry Strike $0.815 $0.820

Currency 50000 April Call $0.0118

Canadian dollar Canadian dollars

Put $0.0068

43. Refer to Exhibit 16.1. How much must an investor pay for one call option contract? a. $680 b. $815 c. $625 d. $590 e. $340 ANSWER: d

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44. Refer to Exhibit 16.1. How much must an investor pay for one put option contract? a. $680 b. $815 c. $340 d. $625 e. $590 ANSWER: c 45. Refer to Exhibit 16.1. If the spot rate at expiration is $0.90 and the call option was purchased, what is the dollar gain or loss? a. $0 b. $3750 gain c. $3660 gain d. $4650 loss e. $2680 loss ANSWER: c 46. Refer to Exhibit 16.1. If the spot rate at expiration is $0.80 and the call option was purchased, what is the dollar gain or loss? a. $123 gain b. $590 loss c. $312 gain d. $237 gain e. $0 ANSWER: b 47. Refer to Exhibit 16.1. If the spot rate at expiration is $0.85 and the put option was purchased, what is the dollar gain or loss? a. $340 loss b. $125 gain c. $750 gain d. $750 loss e. $200 loss ANSWER: a 48. Refer to Exhibit 16.1. If the spot rate at expiration is $0.75 and the put option was purchased, what is the dollar gain or loss? a. $0 b. $200 loss c. $200 gain d. $3160 gain e. $1187 loss ANSWER: d 49. In the Black-Scholes option pricing model, an increase in security price (S) will cause richard@qwconsultancy.com

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a. an increase in call value and an increase in put value. b. an increase in call value and a decrease in put value. c. a decrease in call value and an increase in put value. d. a decrease in call value and a decrease in put value. e. an increase in call value and an increase or decrease in put value.

ANSWER: b 50. In the Black-Scholes option pricing model, an increase in exercise price (X) will cause a. an increase in call value and an increase in put value. b. an increase in call value and a decrease in put value. c. a decrease in call value and an increase in put value. d. a decrease in call value and a decrease in put value. e. an increase in call value and an increase or decrease in put value.

ANSWER: c 51. In the Black-Scholes option pricing model, an increase in time to expiration (T) will cause a. an increase in call value and an increase in put value. b. an increase in call value and a decrease in put value. c. a decrease in call value and an increase in put value. d. a decrease in call value and a decrease in put value. e. an increase in call value and an increase or decrease in put value.

ANSWER: e 52. In the Black-Scholes option pricing model, an increase in the risk-free rate (RFR) will cause a. In the Black-Scholes option pricing model, an increase in the risk-free rate (RFR) will cause b. an increase in call value and a decrease in put value. c. a decrease in call value and an increase in put value. d. a decrease in call value and a decrease in put value. e. an increase in call value and an increase or decrease in put value.

ANSWER: b 53. In the Black-Scholes option pricing model, an increase in security volatility () will cause a. an increase in call value and an increase in put value. b. an increase in call value and a decrease in put value. c. a decrease in call value and an increase in put value. d. a decrease in call value and a decrease in put value. e. an increase in call value and an increase or decrease in put value.

ANSWER: a 54. The Black-Scholes model assumes that stock price movements can be described by a. geometric moving averages. b. arithmetic moving averages. c. regression towards the mean. richard@qwconsultancy.com

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d. geometric Brownian motion. e. stochastic time lags.

ANSWER: d 55. Which of the following is not a variable required to determine an option's value in the BlackScholes valuation model? a. future security price b. exercise price c. time to expiration d. risk-free rate e. security price volatility ANSWER: a 56. In the Black-Scholes model N(d1) represents the a. hedge ratio. b. partial derivative of the call's value with respect to the stock price. c. change in the option's value given a one dollar change in the underlying security's price. d. option's delta. e. All of these are correct.

ANSWER: e 57. The calculation of a weighted average of the implied volatility estimates from options on the Standard & Poor's 500 index using a wide range of exercise prices is known as a. Spider. b. QQQ. c. VIX. d. CIN. e. VOL. ANSWER: c Exhibit 16.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The following information is provided in the context of a two-period (two six-month periods) binomial option pricing model. A stock currently trades at $60 per share, and a call option on the stock has an exercise price of $65. The stock is equally likely to rise by 15 percent or fall by 15 percent during each six-month period. The one-year risk free rate is 3 percent.

58. Refer to Exhibit 16.2. Calculate the possible prices of the stock at the end of one year. a. $69, $51, $79.35 b. $51, $79.35, $58.65 c. $79.35, $58.65, $43.35 d. $58.65, $43.35, $14.35 e. $72.65, $53.35, $17.25 richard@qwconsultancy.com

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ANSWER: c 59. Refer to Exhibit 16.2. Calculate the price of the call option after the stock price has already moved up in value once (Cu). a. $7.77 b. $14.35 c. $0 d. $4.21 e. $6.44 ANSWER: a 60. Refer to Exhibit 16.2. Calculate the price of the call option after the stock price has already moved down in value once (Cd). a. $7.77 b. $14.35 c. $0 d. $4.21 e. $6.44 ANSWER: c 61. Refer to Exhibit 16.2. Calculate the price of the call option today (C0). a. $7.77 b. $14.35 c. $0 d. $4.21 e. $6.44 ANSWER: d Exhibit 16.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A stock currently trades for $130 per share. Options on the stock are available with a strike price of $125. The options expire in 10 days. The risk-free rate is 3 three over this time period, and the expected volatility is 0.35.

62. Refer to Exhibit 16.3. Use the Black-Scholes option pricing model to calculate the price of a call option. a. $5.19 b. $4.35 c. $3.93 d. $6.19 e. $8.17 ANSWER: d

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63. Refer to Exhibit 16.3. Calculate the price of the put option. a. $1.086 b. $0.862 c. $6.234 d. $0.623 e. $2.317 ANSWER: a 64. Which of the following is NOT a factor needed to calculate the value of an American call option? a. the stock price b. the exercise price c. the exchange on which the option is listed d. the volatility of the underlying stock e. the interest rate ANSWER: c 65. If the hedge ratio is 0.50, this indicates that the portfolio should hold a. two shares of stock for every call option written. b. one share of stock for every two call options written. c. two shares of stock for every call option purchased. d. one share of stock for every two call options purchased. e. two call options for every put option written.

ANSWER: b 66. Options can be used to a. modify an equity portfolio's systematic risk. b. modify an equity portfolio's unsystematic risk. c. manage currency exposures in international equity portfolios. d. change a portfolio's exposure to a particular asset. e. All of these are correct.

ANSWER: e 67. A calendar spread requires the purchase and sale of two calls or two puts in the same stock with a. the same expiration date but different exercise prices. b. the same exercise price but different expiration dates. c. different exercise prices and different expiration dates. d. the same exercise price and the same expiration month. e. traded in different markets.

ANSWER: b 68. In a money spread, an investor would a. buy two in-the-money call options on the same stock with different exercise dates. b. buy two out-of-the-money call options on the same stock with different exercise dates. c. sell two in-the-money call options on the same stock with different exercise dates. richard@qwconsultancy.com

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d. sell an out-of-the-money call and purchase an in-the-money call on the same stock with the same exercise date. e. sell two out-of-the-money call options on the same stock with different exercise dates.

ANSWER: b 69. A money spread involves buying and selling call options in the same stock with a. the same time period and exercise price. b. the same time period but different exercise price. c. a different time period but same exercise price. d. a different time period and different exercise price. e. options in different markets.

ANSWER: b 70. If you were to purchase an October option with an exercise price of 50 for $8 and simultaneously sell an October option with an exercise price of 60 for $2, you would be a. bullish and taking a high risk. b. bullish and conservative. c. bearish and taking a high risk. d. bearish and conservative. e. neutral.

ANSWER: b 71. You own a stock that has risen from $10 per share to $32 per share. You wish to delay taking the profit, but you are troubled about the short-run behavior of the stock market. An effective action on your part would be to a. purchase a put. b. purchase a call. c. purchase an index option. d. utilize a bearish spread. e. utilize a bullish spread.

ANSWER: a 72. If you were to purchase an October option with an exercise price of 50 for $8 and simultaneously sell an October option with an exercise price of 60 for $2, you would be a. bullish and taking a high risk. b. bullish and conservative. c. bearish and taking a high risk. d. bearish and conservative. e. neutral.

ANSWER: b 73. A vertical spread involves buying and selling call options in the same stock with a. the same time period and price. b. the same time period but different price. c. a different time period but same price. richard@qwconsultancy.com

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d. a different time period and different price. e. options in different markets.

ANSWER: b 74. Assume that you have just sold a stock for a loss at a price of $75 for tax purposes. You still wish to maintain exposure to the sold stock. Suppose that you buy a call with a strike price of $70 and a price of $6.75. Calculate the effective price paid to repurchase the stock if the price after 35 days is $65. a. $71.75 b. $76.75 c. $58.25 d. $81.75 e. $85.25 ANSWER: a 75. Assume that you have just sold a stock for a loss at a price of $75 for tax purposes. You still wish to maintain exposure to the sold stock. Suppose that you buy a call with a strike price of $70 and a price of $6.75. Calculate the effective price paid to repurchase the stock if the price after 35 days is $80. a. $81.75 b. $73.25 c. $86.75 d. $76.75 e. $85.25 ANSWER: d 76. Assume that you have just sold a stock for a loss at a price of $75 for tax purposes. You still wish to maintain exposure to the sold stock. Suppose that you sell a put with a strike price of $80 and a price of $7.25. Calculate the effective price paid to repurchase the stock if the price after 35 days is $70. a. $77.75 b. $87.25 c. $82.25 d. $72.75 e. $85.25 ANSWER: d 77. Assume that you have just sold a stock for a loss at a price of $75 for tax purposes. You still wish to maintain exposure to the sold stock. Suppose that you sell a put with a strike price of $80 and a price of $7.25. Calculate the effective price paid to repurchase the stock if the price after 35 days is $85. a. $77.75 b. $87.25 c. $82.25 d. $72.75 e. $85.25 ANSWER: a richard@qwconsultancy.com

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Exhibit 16.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the following information on put and call options for Citigroup Strike Price $32.50

Put Price $2.85

Call Price $1.65

78. Refer to Exhibit 16.4. Calculate the net value of a protective put position at a stock price at expiration of $20 and a stock price at expiration of $45. a. $6.35, $18.85 b. $29.65, $42.15 c. $21.65, $34.15 d. $8, $8 e. −$8, −$8 ANSWER: b 79. Refer to Exhibit 16.4. A protective put is an appropriate strategy if a. an investor wishes to generate additional income. b. an investor wished to insure against a decline in share values. c. an investor expected share prices to be volatile. d. an investor expected share prices to remain in a trading range. e. an investor expected share prices to be volatile but was inclined to be bullish.

ANSWER: b 80. Refer to Exhibit 16.4. Calculate the net value of a covered call position at a stock price at expiration of $20 and a stock price at expiration of $45. a. $6.35, $18.85 b. $29.65, $42.15 c. $21.65, $34.15 d. $8, $8 e. −$8, −$8 ANSWER: c 81. Refer to Exhibit 16.4. A covered call is an appropriate strategy if a. an investor wishes to generate additional income. b. an investor wished to insure against a decline in share values. c. an investor expected share prices to be volatile. d. an investor expected share prices to remain in a trading range. e. an investor expected share prices to be volatile but was inclined to be bullish.

ANSWER: a 82. Refer to Exhibit 16.4. Calculate the payoffs of a long straddle at a stock price at expiration of $20 and a stock price at expiration of $45. richard@qwconsultancy.com

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a. $6.35, $18.85 b. $29.65, $42.15 c. $21.65, $34.15 d. $8, $8 e. −$8, −$8 ANSWER: d 83. Refer to Exhibit 16.4. A long straddle is an appropriate strategy if a. an investor wishes to generate additional income. b. an investor wished to insure against a decline in share values. c. an investor expected share prices to be volatile. d. an investor expected share prices to remain in a trading range. e. an investor expected share prices to be volatile but was inclined to be bullish.

ANSWER: c 84. Refer to Exhibit 16.4. Calculate the payoffs of a short straddle at a stock price at expiration of $20 and a stock price at expiration of $45. a. $6.35, $18.85 b. $29.65, $42.15 c. $21.65, $34.15 d. $8, $8 e. −$8, −$8 ANSWER: e 85. Refer to Exhibit 16.4. A short straddle is an appropriate strategy if a. an investor wishes to generate additional income. b. an investor wished to insure against a decline in share values. c. an investor expected share prices to be volatile. d. an investor expected share prices to remain in a trading range. e. an investor expected share prices to be volatile but was inclined to be bullish.

ANSWER: d 86. Refer to Exhibit 16.4. Calculate the payoffs of a long strap at a stock price at expiration of $20 and a stock price at expiration of $45. a. $6.35, $18.85 b. $29.65, $42.15 c. $21.65, $34.15 d. $8, $8 e. −$8, −$8 ANSWER: a 87. Refer to Exhibit 16.4. A long strap is an appropriate strategy if a. an investor wishes to generate additional income. b. an investor wished to insure against a decline in share values. richard@qwconsultancy.com

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c. an investor expected share prices to be volatile. d. an investor expected share prices to remain in a trading range. e. an investor expected share prices to be volatile but was inclined to be bullish.

ANSWER: e Exhibit 16.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The information provided is relevant in the context of a one period (one year) binomial option pricing model. A stock currently trades at $50 per share, and a call option on the stock has an exercise price of $45. The stock is equally likely to rise by 25 percent or fall by 25 percent. The one-year, risk-free rate is 2 percent.

88. Refer to Exhibit 16.5. Calculate the possible prices of the stock one year from today. a. $37.50 or $17.50. b. $62.50 or $37.50. c. $62.50 or $17.50. d. $50 or $45. e. None of the above.

ANSWER: b 89. Refer to Exhibit 16.5. Estimate n, which is the number of call options that must be written. a. −1.4286 b. −2.9286 c. −2.8571 d. −2.5714 e. −1.1111 ANSWER: a 90. Refer to Exhibit 16.5. Calculate the price of the call option today (C0). a. $7.56 b. $17.48 c. $9.26 d. $5.0 e. $17.15 ANSWER: c Exhibit 16.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) GE Corporation has a put option selling for $2.90 and a call option selling for $1.95, both with a strike price of $29.00.

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91. Refer to Exhibit 16.6. What would the net value of a protective put position be if the stock price at expiration is $35? a. $3.10 b. $30.15 c. $32.10 d. $34.05 e. $35.00 ANSWER: c 92. Refer to Exhibit 16.6. What would the net value of a covered call position be if the stock price at expiration is $35? a. $29.00 b. $30.65 c. $33.55 d. $36.00 e. $36.65 ANSWER: b 93. a. b. c. d. e.

ANSWER: c 94. Refer to Exhibit 16.6. What would the net value of a short straddle position be if the stock price at expiration is $35? a. −36.15 b. −7.15 c. −$1.15 d. $1.15 e. $7.15 ANSWER: c 95. Refer to Exhibit 16.6. What would the net value of a long strap position be if the stock price at expiration is $35? a. −$1.15 b. −$2.30 c. $1.15 d. $2.30 e. $5.20 ANSWER: e

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96. Refer to Exhibit 16.6. Which strategy is most appropriate for an investor who expects share prices to be volatile but was inclined to be bullish? a. protective put b. covered call c. long straddle d. short straddle e. long strap ANSWER: e Exhibit 16.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the following information on put and call options for a common stock.

Strike Price $22.50

Put Price $2.65

Call Price $1.85

97. Refer to Exhibit 16.7. Calculate the net value of a protective put position at an expiration stock price of $20. a. $2.85 b. $17.15 c. $19.85 d. $21.65 e. $22.85 ANSWER: c 98. a. b. c. d. e.

ANSWER: d 99. Refer to Exhibit 16.7. Calculate the payoff of a long straddle at an expiration stock price of $20. a. −$4.50 b. −$2.00 c. $2.00 d. $4.50 e. $20.50 ANSWER: c 100. Refer to Exhibit 16.7. Calculate the payoff of a short straddle at an expiration stock price of $20. a. −$4.50 richard@qwconsultancy.com

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b. −$2.00 c. $2.00 d. $4.50 e. $20.50 ANSWER: b Exhibit 16.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) XYZ CORP Exercise Calls

Puts

Date OCT OCT OCT OCT OCT OCT

Price 85 90 95 85 90 95

Price 16 3/4 12 7 5/8 1/8 3/8 13/16

NYSE Close 101 11/16 101 11/16 101 11/16 101 11/16 101 11/16 101 11/16

101. Refer to Exhibit 16.8. If you establish a long straddle 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. $18.75 loss b. $18.75 gain c. $1,668.75 gain d. $1,668.75 loss e. $1,687.50 loss ANSWER: a 102. Refer to Exhibit 16.8. 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 ANSWER: d 103. Refer to Exhibit 16.8. If you establish a long strip 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. $1,668.75 gain b. $1,700.00 gain c. $1,700.00 loss d. $31.25 gain e. $31.25 loss ANSWER: e richard@qwconsultancy.com

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104. Refer to Exhibit 16.8. If you establish a long straddle using the options with a 90 exercise price, what is your dollar gain or loss if at expiration XYZ is still trading at 101 11/16? a. $68.75 loss b. $68.75 gain c. $37.50 loss d. $1,200.00 loss e. $1,200.00 gain ANSWER: a 105. Refer to Exhibit 16.8. If you establish a long strap using the options with a 90 exercise price, what is your dollar gain or loss if at expiration XYZ is still trading at 101 11/16? a. $37.50 loss b. $37.50 gain c. $100.00 loss d. $100.00 gain e. $2,437.50 loss ANSWER: c 106. Refer to Exhibit 16.8. If you establish a long strip using the options with a 90 exercise price, what is your dollar gain or loss if at expiration XYZ is still trading at 101 11/16? a. $106.25 gain b. $106.25 loss c. $1,275.00 loss d. $1,275.00 gain e. $75.00 loss ANSWER: b 107. Refer to Exhibit 16.8. If you establish a long straddle using the options with a 95 exercise price, what is your dollar gain or loss if at expiration XYZ is still trading at 101 11/16? a. $668.75 gain b. $668.75 loss c. $94.56 gain d. $94.56 loss e. $81.25 loss ANSWER: d 108. Refer to Exhibit 16.8. If you establish a long strap using the options with a 95 exercise price, what is your dollar gain or loss if at expiration XYZ is still trading at 101 11/16? a. $81.25 loss b. $1,606.25 gain c. $1,606.25 loss d. $268.75 loss e. $268.75 gain ANSWER: d

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109. Refer to Exhibit 16.8. If you establish a long strip using the options with a 95 exercise price, what is your dollar gain or loss if at expiration XYZ is still trading at 101 11/16? a. $256.25 loss b. $256.25 gain c. $925.00 loss d. $668.75 gain e. $668.75 loss ANSWER: a 110. Refer to Exhibit 16.8. If XYZ were trading at $90/share and you formed a bull money spread, what is your profit if XYZ is trading at $110 at expiration? a. $912.50 loss b. $87.50 gain c. $87.50 loss d. $1,000.00 gain e. $1,000.00 loss ANSWER: b 111. All of the following are normal characteristics of a convertible bond, EXCEPT a. conversion at the option of the issuer. b. conversion into a fixed number of shares of common stock. c. a conversion price initially above the market price of the common stock. d. an interest rate lower than that on straight debentures. e. subordination.

ANSWER: a 112. An advantage of convertible bonds is a. investors get the upside potential of a bond. b. investors get the upside potential of a stock. c. issuing firms can get a lower rate of interest on its debt. d. a and b e. b and c ANSWER: e 113. All of the following are normal characteristics of a convertible bond, EXCEPT a. conversion at the option of the issuer. b. conversion into a fixed number of shares of common stock. c. a conversion price initially above the market price of the common stock. d. an interest rate lower than that on straight debentures. e. subordination.

ANSWER: a 114. The minimum price of a convertible bond is a. min (Bond Value, Conversion Value). b. max (Bond Value, Conversion Value). richard@qwconsultancy.com

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c. min (Stock Value, Conversion Value). d. max (Stock Value, Conversion Value). e. None of these are correct.

ANSWER: b 115. The conversion premium for a convertible bond is calculated as a. (Market Price + Minimum Value)/Minimum Value. b. (Market Price/Minimum Value)  Minimum Value. c. (Market Price + Minimum Value)  Minimum Value. d. (Market Price − Minimum Value)/Minimum Value. e. (Market Price  Minimum Value)/Minimum Value.

ANSWER: d 116. The conversion price parity for a convertible bond is defined as a. Market Price of Convertible Bond / Conversion Ration. b. Market Price of Convertible Bond  Conversion Ration. c. Market Price of Convertible Bond − Conversion Ration. d. Market Price of Convertible Bond + Conversion Ration. e. None of these are correct.

ANSWER: a 117. The payment of any compensation for loss is contingent on the actual occurrence of a creditrelated event under a a. total return swap. b. credit default swap. c. collar. d. forward rate agreement. e. swap agreement.

ANSWER: b 118. In convertible bonds, the value of the common stock price upon immediate conversion is the a. put-call parity price. b. conversion parity price. c. cash equivalent price. d. convertible price. e. redemption price.

ANSWER: b Exhibit 16.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11 percent payable semiannually, and they mature in 10 years.

richard@qwconsultancy.com

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119. Refer to Exhibit 16.9. Calculate the conversion value of the bond if the stock price is $27.00 per share. a. $600.00 b. $700.00 c. $800.00 d. $900.00 e. $1,000.00 ANSWER: d 120. Refer to Exhibit 16.9. Calculate the straight-bond value assuming that bonds of equivalent risk and maturity are yielding 14 percent per year compounded semiannually. a. $757.37 b. $796.83 c. $841.07 d. $889.82 e. $902.65 ANSWER: c 121. Refer to Exhibit 16.9. At present, what would be the minimum value of the bond? a. $600.00 b. $796.83 c. $889.82 d. $900.00 e. $1000.00 ANSWER: d 122. The common stock of BioTech Industries pays a dividend of $1 per share and has a current market price of $27 per share. The convertible bond is selling for $1100. The payback or breakeven time for the bond is a. 1.75 years. b. 2.89 years. c. 3.20 years. d. 3.60 years. e. 4.32 years.

ANSWER: b

Chapter 17 - Professional Money Management, Alternative Assets, and Industry Ethics True / False 1. Management and advisory firms can advise clients on how to structure their own portfolios. a. True b. False richard@qwconsultancy.com

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ANSWER: True 2. In an investment company, the invested funds belong to many individuals. a. True b. False ANSWER: True 3. A portfolio is generally managed by the board of directors of an investment company. a. True b. False ANSWER: False 4. The total market value of all assets of a mutual fund divided by the number of shares of the fund is known as the net asset value. a. True b. False ANSWER: True 5. When securities are held in an investment company the appropriate way to value a client's investment is by net asset value (NAV). a. True b. False ANSWER: True 6. A closed-end investment company is normally referred to as a mutual fund. a. True b. False ANSWER: False 7. The market price of shares of a closed-end fund is typically determined by supply and demand. a. True b. False ANSWER: False 8. 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 ANSWER: True 9. Open-end investment companies continue to sell and repurchase shares after their initial public offering. a. True b. False ANSWER: True richard@qwconsultancy.com

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10. Open-end and closed-end investment companies are similar in that both companies will repurchase shares on demand. a. True b. False ANSWER: False 11. An open-end investment company functions like any other public firm. a. True b. False ANSWER: False 12. The market price of shares of a closed-end fund is typically determined by supply and demand. a. True b. False ANSWER: True 13. Closed-end investment companies never sell at discounts to their NAV. a. True b. False ANSWER: False 14. A no-load fund imposes a substantial sales charge and sells shares at their NAV. a. True b. False ANSWER: False 15. The offering price for a share of a load fund equals the net asset value of the share. a. True b. False ANSWER: False 16. All investment firms charge annual management fees to compensate the professional manager of the fund. a. True b. False ANSWER: True 17. Diversifying a portfolio to eliminate unsystematic risk is one of the major benefits of investing in mutual funds. a. True b. False ANSWER: True 18. High portfolio turnover lowers mutual fund costs. richard@qwconsultancy.com

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a. True b. False ANSWER: False 19. The total market value of all assets of a mutual fund divided by the number of shares of the fund is known as the net asset value. a. True b. False ANSWER: True 20. Income distributions and capital gains distributions are the only source of returns for mutual funds. a. True b. False ANSWER: False 21. The returns received by the average individual investor on funds managed by investment companies will probably be superior to the average results for a specific U.S. or international market. a. True b. False ANSWER: False 22. Hedge funds are far less liquid than mutual fund shares. a. True b. False ANSWER: True 23. Hedge funds have no limitations on when and how often capital can be contributed or removed from the partnership. a. True b. False ANSWER: False 24. Fund of funds gives investors access to hedge fund managers who may otherwise be unavailable to them. a. True b. False ANSWER: True 25. A common hedge fund strategy known as long-short equity is a type of arbitrage strategy. a. True b. False ANSWER: False

richard@qwconsultancy.com

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26. Convertible arbitrage hedge funds profit from disparities in the relationship between prices for convertible bonds and fixed-income bonds. a. True b. False ANSWER: False 27. The primary purpose of government regulations and voluntary standards in the professional asset management industry is to ensure that managers deal with all investors fairly and equitably and that information about investment performance is accurately reported. a. True b. False ANSWER: True 28. Agency conflicts always exist in the investment management business because the entire industry is based on handling someone else’s money. a. True b. False ANSWER: True 29. An investor should be cautious when selecting a fund based solely on the manager's past performance because past performance may not be repeated in the future. a. True b. False ANSWER: True 30. It is quite common for investors to form a “portfolio” of managers with different capabilities. a. True b. False ANSWER: True 31. A function your portfolio manager may perform for you is to maintain the diversification of your portfolio within your desired risk class. a. True b. False ANSWER: True Multiple Choice 32. Which of the following is an approach to asset management? a. management and advisory firms b. investment banks c. strategic management d. stock brokerage firms e. chartered banks ANSWER: a

richard@qwconsultancy.com

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33. In the case of investment companies, a. investors deal with a fund company and do not have separate accounts tailored to their specific needs. b. investors deal with a fund company and have separate accounts tailored to their specific needs. c. investors deal with an asset manager and do not have separate accounts tailored to their specific needs. d. investors deal with an asset manager and have separate accounts tailored to their specific needs. e. None of these are correct.

ANSWER: a 34. An investment company is a. a corporation that handles the administrative functions for a fund. b. a corporation that has its major assets in a portfolio of securities. c. a corporation that invests in financial services firms. d. a corporation that arranges IPOs. e. a corporation that handles the trust functions for a fund.

ANSWER: b 35. An investment management company is a. a corporation that handles the administrative functions for a fund. b. a corporation that has its major assets in a portfolio of securities. c. a corporation that invests in financial services firms. d. a corporation that arranges IPOs. e. a corporation that handles the trust functions for a fund.

ANSWER: a 36. In the case of private management firms, a. investors deal with a fund company and do not have separate accounts tailored to their specific needs. b. investors deal with a fund company and have separate accounts tailored to their specific needs. c. investors deal with an asset manager and do not have separate accounts tailored to their specific needs. d. investors deal with an asset manager and have separate accounts tailored to their specific needs. e. None of these are correct.

ANSWER: d 37. An open-end investment company is commonly referred to as a(n) a. balanced fund. b. mutual fund. c. money market fund. d. accessible fund. e. unit trust. richard@qwconsultancy.com

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ANSWER: b 38. The main difference between a closed-end fund and an open-end fund is a. the way each is traded after the initial public offering. b. there is no significant difference. c. the minimum initial investment. d. the type of allowable investments. e. the way in which each is regulated by the SEC. ANSWER: a 39. The closed-end fund index is a. value weighted and based on market values. b. value weighted and based on NAVs. c. price weighted and based on market values. d. price weighted and based on NAVs. e. equally weighted and based on market values.

ANSWER: c 40. Open-end mutual funds that charge a sales fee when the fund is initially offered to the investor are known as a. 12b-1. b. americus trusts. c. unit investment trusts. d. load funds. e. contingency funds.

ANSWER: d 41. Which of the following statements regarding the closed-end investment company's net asset value (NAV) is FALSE? a. NAV is computed throughout the day based on prevailing market prices for the portfolio of securities. b. The market price of the shares is determined by how they trade on the exchange. c. NAV and market price of a closed-end fund are almost never the same. d. No new investment dollars are available for the investment company unless it makes another public sale of securities. e. All of these are correct.

ANSWER: e 42. Investment companies or mutual funds that continue to sell and repurchase shares after their initial public offerings are referred to as a. closed-end. b. open-end. c. no-load. d. load. e. public. richard@qwconsultancy.com

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ANSWER: b 43. Net asset value (NAV) is determined by a. the total market value of all its assets multiplied by the number of fund shares outstanding. b. the total market value of all its assets divided by the number of fund shares outstanding. c. the total market value of all its assets divided by the number of shareholders. d. supply and demand for the investment company stock in the secondary market. e. supply and demand for the investment company stock in the primary market.

ANSWER: b 44. The market price of a closed-end investment company has generally been a. 5 to 20 percent below the NAV. b. 25 to 35 percent below the NAV. c. equal to the NAV (within a 2 percent range). d. 5 to 20 percent above the NAV. e. 25 to 35 percent above the NAV. ANSWER: a 45. A 12b-1 plan allows funds to a. charge a redemption fee. b. deduct 7 to 8 percent commission at the initial offering. c. deduct .75 percent of the average net assets per year. d. charge a contingent deferred sales load. e. switch from closed-end to open-end.

ANSWER: c 46. All investment companies charge an annual a. 12b-1 fee. b. marketing and distribution. c. management fee. d. maintenance fee. e. market adjustment.

ANSWER: c 47. When the offer price and the NAV of a mutual fund are equal, it is an indication that a. the fund's assets are in equilibrium. b. the fund is trading at par. c. it is strictly a coincidence. d. the fund has no initial fee. e. the fund is backloaded.

ANSWER: d 48. The offering price of a load fund equals the NAV of the fund a. less an initial requirement. richard@qwconsultancy.com

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b. plus a sales charge. c. plus a sales charge and an administrative fee. d. less a negotiated discount. e. at its stated value.

ANSWER: b 49. Funds that normally contain a combination of common stock and fixed income securities are known as a. section 401(k) plans. b. balanced funds. c. contractual plans. d. income funds. e. flexible funds.

ANSWER: b 50. Funds that attempt to provide current income, safety of principal and liquidity are known as a. balanced funds. b. flexible funds. c. income funds. d. money market funds. e. index funds.

ANSWER: b 51. A money market fund would be likely to invest in a portfolio containing all of the following EXCEPT a. commercial paper. b. banker's acceptances. c. U.S. Treasury bills. d. bank certificates of deposit. e. U.S. Treasury notes.

ANSWER: e 52. A mutual fund typically performs all of the following functions, EXCEPT that it a. provides alternative risk-return options. b. eliminates unsystematic risk. c. provides diversification. d. derives a risk-adjusted performance that is consistently superior to risk-adjusted net return of the aggregate market. e. administers the account, keeps records, and provides timely information.

ANSWER: d 53. Mutual fund performance studies have shown that most funds a. have risks and returns that are inconsistent with their stated objectives. b. have risks and returns that are consistent with their stated objectives. c. do not have stated objectives. richard@qwconsultancy.com

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d. have experienced risk-adjusted returns above the market. e. have changed their objectives over time.

ANSWER: b 54. Funds that adjust the asset allocation weights in the portfolio to match the needs of an investor who is nearing retirement are known as a. balanced funds. b. flexible portfolio funds. c. lifetime funds. d. money market funds. e. target date funds.

ANSWER: e 55. The gross return of closed-end investments companies has typically been a. 10–20 percent less than their NAV. b. 10–15 percent less than their NAV. c. 5–20 percent less than their NAV. d. about the same as the net return. e. less than the net return.

ANSWER: a 56. A major question in modern finance regarding closed-end investment companies is a. why do these funds sell at a premium? b. why do the premiums differ between funds? c. what are the returns available to investors from funds that sell at a large discount? d. what are the returns available to investors from funds that sell at a large premium? e. what is the average premium?

ANSWER: c 57. In the case of open-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 the investment company. d. are bought without a sales fee. e. show that no new investment dollars are available after the IPO. ANSWER: b 58. In the case of closed-end investment companies, shares of the company a. are determined by the investment company. b. can be bought from or sold to the investment company at the NAV. c. are determined by supply and demand. d. are traded like those of a private firm. e. All of these are correct.

ANSWER: c richard@qwconsultancy.com

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59. The following are examples of mutual fund companies: a. private equity. b. bond funds. c. hedge funds. d. venture capital. e. buyout-oriented private equity.

ANSWER: b Exhibit 24.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Suppose ABC Mutual fund owned only four stocks as follows: Stock W X Y Z

Shares 2500 2100 2700 1900

Price $11 14 23 15

60. Refer to Exhibit 24.1. The fund originated by selling $100,000 of stock at $10.00 per share. What is its current NAV? a. $1.47 b. $14.75 c. $16.03 d. $27.62 e. $234.12 ANSWER: b 61. Refer to Exhibit 24.1. What is the offering price for the fund if the NAV is $25.25 and the load is 6 percent? a. $26.19 b. $23.74 c. $25.25 d. $26.77 e. $24.13 ANSWER: d 62. Suppose Mega Mutual Fund owns only the four stocks shown below with no liabilities.

Stock A B C D

Shares 1800 2200 2300 1900

Price 15 11 9 18

The fund originated by selling $300,000 of stock at $30.00 per share. What is its current NAV? richard@qwconsultancy.com

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a. $106.10 b. $12.94 c. $129.40 d. $10.61 e. $16.94 ANSWER: d 63. Suppose Under Mutual Fund owns only the three stocks shown below with no liabilities.

Stock A B C

Shares 2900 3100 3200

Price 15 14 12

The fund originated by selling $500,000 of stock at $50.00 per share. What is its current NAV? a. $12.53 b. $15.29 c. $152.90 d. $125.30 e. $150.50 ANSWER: a 64. Suppose you consider investing $1,000 in a load fund which charges a fee of 2 percent, and you expect the fund to earn 14 percent over the next year. Alternatively, you could invest in a no-load fund with similar risk that is expected to earn 9 percent and charges a 1/2 percent redemption fee.

Which is better and by how much? a. funds are equal b. load fund by $32.65 c. load fund by $50.55 d. no-load fund by $64.55 e. no-load fund by $44.30 ANSWER: b 65. Suppose you consider investing $1,000 in a load fund that charges a fee of 2 percent, and you expect the fund to earn 11 percent over the next year. Alternatively, you could invest in a no-load fund with similar risk that is expected to earn 7 percent and charges a 1/2 percent redemption fee.

Which is better and by how much? a. funds are equal b. no-load fund by $36.98 c. load fund by $45.25 d. load fund by $23.15 e. no-load fund by $15.52 ANSWER: d 66. Suppose you consider investing $15,000 in a load fund from which a fee of 5 percent is deducted and you expect the fund to earn 12 percent over the next year. Alternatively, you could invest in a no-

richard@qwconsultancy.com

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load fund that is expected to earn 10 percent and which takes a 1/2 percent redemption fee. Which is better and by how much? a. load fund by $318.45 b. no load fund by $457.50 c. funds are equal d. load fund by $415.10 e. no load fund by $211.51 ANSWER: b 67. Suppose you consider investing $10,000 in a load fund from which a fee of 3 percent is deducted and you expect the fund to earn 12 percent over the next year. Alternatively, you could invest in a noload fund that is expected to earn 10 percent and which takes a 0 percent redemption fee. Which is better and by how much? a. load fund by $151 b. no load fund by $136 c. funds are equal d. no load fund by $421 e. load fund by $115 ANSWER: d 68. Suppose you consider investing $5,000 in a load fund from which a fee of 8 percent is deducted and you expect the fund to earn 12 percent over the next year. Alternatively, you could invest in a noload fund that is expected to earn 10 percent and which takes a 1/2 percent redemption fee. Which is better and by how much? a. load fund by $320.50 b. load fund by $575.50 c. funds are equal d. no load fund by $320.50 e. no load fund by $575.50 ANSWER: d 69. On January 2, 2017, you invest $10,000 in Megabucks Mutual Fund, a load fund that charges a fee of 2 percent. The fund's returns were 13 percent in 2017, 11 percent in 2018, and 8 percent in 2019.

On December 31, 2019, you redeem all your shares. The dollar value is a. $13,600.00. b. $13,275.51. c. $13,297.67. d. $13,995.75. e. $10,000.00.

ANSWER: b 70. On January 2, 2017, you invest $50,000 in the Lizbiz Mutual Fund, a load fund that charges a fee of 5 percent. The fund's returns were 14.6 percent in 2017, −6.4 percent in 2018, and 15.2 percent in 2019. On December 31, 2019, you redeem all your shares. The dollar value is a. $66,722.27. b. $15,200.00. richard@qwconsultancy.com

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c. $58,695.74. d. $33,366.25. e. $10,000.00.

ANSWER: c 71. $100,000.00.On January 2, 2017, you invest $100,000 in the Jeffers Mutual Fund, a load fund that charges a fee of 5 percent. The fund's returns were −14.6 percent in 2017, −6.4 percent in 2018, and 35 percent in 2019. On December 31, 2019, you redeem all your shares. The dollar value is a. $95,600.57. b. $102,515.90. c. $83,297.75. d. $133,995.75. e. $100,000.00.

ANSWER: b 72. On January 2, 2017, you invest $10,000 in the Tiger Fund, a load fund that charges a fee of 6 percent. The fund's returns were 25 percent in 2017, 35 percent in 2018, and −5 percent in 2019. On December 31, 2019, you redeem all your shares of Tiger. The dollar value is a. $5,200.89. b. $13,345.89. c. $7,931.25. d. $15,896.34. e. $8,646.91.

ANSWER: c 73. On January 2, 2017, you invest $10,000 in the W.O.W. Mutual Fund, a load fund that charges a fee of 5 percent. The fund's returns were 13.6 percent in 2017, 12.2 percent in 2018, and 8.3 percent in 2019. On December 31, 2019, you redeem all your W.O.W. shares. The dollar value is a. $13,600.00. b. $13,664.13. c. $10,000.00. d. $131,136.40. e. $13,113.64.

ANSWER: e 74. On January 2, 2017, you invest $10,000 in the Dog Mutual Fund, a load fund that charges a fee of 7 percent. The fund's returns were 12.8 percent in 2017, 13.9 percent in 2018, and 7.9 percent in 2019.

On December 31, 2019, you redeem all your shares. The dollar value is a. $12,800.00. b. $12,892.50. c. $100,000.00. d. $128,925.00. e. $10,000.00.

ANSWER: b

richard@qwconsultancy.com

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75. On January 2, 2017, you invest $50,000 in A Mutual Fund, a load fund that charges a fee of 7 percent. The fund's returns were 12.8 percent in 2017, 13.9 percent in 2018, and 7.9 percent in 2019.

On December 31, 2019, you redeem all your shares in A. The dollar value is a. $64,462.57. b. $644,625.70. c. $50,000.00. d. $6,446.25. e. $10,000.00.

ANSWER: a 76. On January 2, 2017, you invest $100,000 in Righteous, a load fund that charges a fee of 7 percent.

The fund's returns were 12.8 percent in 2017, 13.9 percent in 2018, and 7.9 percent in 2019. On December 31, 2019, you redeem all your Righteous shares. The dollar value is a. $12,800.00. b. $12,892.50. c. $100,000.00. d. $128,925.00. e. $10,000.00.

ANSWER: d 77. Consider the Defiance Bond Fund that consists of the three bonds shown below and has no liabilities.

Company Komko Hijack Mitsue

Current Bond Value 980 1010 1200

# Bonds 120 150 100

If initially the value of the fund was $250,000 and the original shares were offered to the public with a NAV of $25 per share, what is the current NAV of the fund? a. $25.00 b. $38.91 c. $39.81 d. $31.98 e. $39.91 ANSWER: b 78. Consider X Bond Fund which consists of the five bonds shown below with no liabilities.

Company Komko Hijack Mitsue Smitsu Jones

Current Bond Value 980 1010 1200 800 600

# Bonds 120 150 100 120 150

If initially the value of the fund was $1,000,000 and the original shares were offered to the public with a NAV of $25 per share, what is the current NAV of the fund? richard@qwconsultancy.com

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a. $25.00 b. $27.68 c. $25.68 d. $28.76 e. $26.78 ANSWER: d 79. Consider the Compliance Bond Fund that consists of the seven bonds shown below and has no liabilities.

Company Komko Hijack Mitsue Smitsu Jones GMM ATP

Current Bond Value 980 1010 1200 800 600 1000 950

# Bonds 120 150 100 120 150 150 150

If initially the value of the fund was $2,500,000 and the original shares were offered to the public with a NAV of $25 per share, what is the current NAV of the fund? a. $27.11 b. $25.00 c. $26.11 d. $21.67 e. $26.27 ANSWER: a 80. Given the following fees and expected returns for fund X and assuming an initial investment of $1000, calculate the value of the investment at the end of five years.

Investment X

E(Return) 10%

Load 2.5%

12b-1 fee 0.25%

Rear-end load 0%

Years 5 years

a. $1069.82 b. $1550.77 c. $1042.36 d. $1689.95 e. $1389.95 ANSWER: b 81. Given the following fees and expected returns for fund Y and assuming an initial investment of $1000, calculate the value of the investment at the end of five years.

Investment Y

E(Return) 8%

Load 0%

12b-1 fee 0.50%

Rear-end load 3%

Years 5 years

a. $1069.82 richard@qwconsultancy.com

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b. $1550.77 c. $1642.36 d. $1362.59 ANSWER: d 82. Calculate the annual rate of return for a mutual fund with the following fees and expected returns.

Investment Mutual Fund

E(Return) 7%

Load 4%

12b-1 fee 0.50%

Years Held 7 years

a. 4.95% b. 5.0% c. 5.85% d. 2.5% e. 6.55% ANSWER: c 83. If the Micro mutual fund was originated by selling $250,000 of stock at $10.00 per share.

Calculate its current NAV if the fund consists of the following four stocks.

Stock Q R S T

Shares 9,500 7,200 4,500 6,800

Price $10.75 $13.90 $22.25 $14.75

a. $5.78 b. $10.00 c. $12.43 d. $16.11 e. $19.21 ANSWER: d 84. What is the offering price for a mutual fund with a NAV of $22.50 and a load of 5 percent? a. $21.38 b. $21.79 c. $22.50 d. $23.63 e. $27.50 ANSWER: d 85. You are considering investing $50,000 in two mutual funds. The first fund is a load fund with a fee of 6 percent, and you expect the fund to earn 11 percent over the next year. Alternatively, you could invest in a no-load fund that is expected to earn 8 percent and has a 0.5 percent redemption fee.

What fund has a higher return and how much more value will it have after the first year? a. load fund by $1,360 b. load fund by $580 richard@qwconsultancy.com

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c. no load fund by $580 d. no load fund by $1,560 e. no load fund by $1,820 ANSWER: d 86. On January 1, 2017, you invest $20,000 in Libby Mutual Fund, a load fund that charges a fee of 2.5 percent. The fund's returns were 9 percent in 2017, 8 percent in 2018, and 3 percent in 2019. If you redeem all your shares on December 31, 2019, what is the dollar value? a. $24,250.32 b. $24,000.32 c. $23,644.06 d. $23,195.17 e. $21,501.80 ANSWER: c 87. Suppose NBT Mutual Fund has no liabilities and owns only three stocks with the following number of shares and respective market prices.

Stock X Y Z

Shares 7900 8100 9200

Price 16 15 12

The fund originated by selling $500,000 of stock at $100.00 per share. What is its current NAV? a. $0.72 b. $14.33 c. $15.21 d. $71.66 e. $70.25 ANSWER: d 88. You are considering investing $1,000 in a load fund that charges a fee of 2.5 percent, with an expected return of 12 percent over the next year. Alternatively, you could invest in a no-load fund with similar risk that is expected to earn 8 percent and charges a 1/2 percent redemption fee. Which is better and by how much? a. load fund by $12.00 b. load fund by $15.32 c. load fund by $17.40 d. no-load fund by $6.55 e. no-load fund by $1.30 ANSWER: c 89. What is the offering price for a mutual fund with a NAV of $36.50 and a load of 4 percent? a. $34.78 b. $35.51 c. $35.77 d. $36.50 richard@qwconsultancy.com

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e. $37.96 ANSWER: e 90. The 12b-1 plan permits funds to deduct as much as ____ percent of average net asset per year to cover distribution costs, brokers' commissions, and general marketing expenses. a. 0.25 b. 0.50 c. 0.75 d. 1.00 e. 1.50 ANSWER: c 91. An example of an international fund would be one that consisted of investments in securities from a. the U.S., Germany, and Japan. b. Germany, Italy, and the U.K. c. the U.S., Korea, and Argentina. d. the U.S., Germany, and Italy. e. the U.S. and Canada.

ANSWER: b 92. What type of funds are typically no-load funds that impose no penalty for early withdrawal and generally allow holders to write checks against their account? a. mutual funds b. open-end funds c. closed-end funds d. money market funds e. balanced funds ANSWER: d 93. Which of the following is NOT an example of an alternative asset class? a. hedge funds b. private equity c. real estate d. commodities e. All of these are correct.

ANSWER: e 94. When alternative assets of investors are pooled together into a single pool of assets, a. the collection of assets is formed as a limited partnership. b. one or more general partners are responsible for running the organization. c. the limited partners are only liable to the extent of their investments. d. the limited partners provide most of the capital. e. All of these are correct.

ANSWER: e

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95. Investing in emerging markets can be viewed as a global application of a. fixed-income arbitrage. b. convertible arbitrage. c. merger arbitrage. d. distressed opportunistic strategies. e. equity market neutral.

ANSWER: d 96. An investment vehicle that acts like a mutual fund of hedge funds and allows investors access to managers that may otherwise be unavailable is known as a. managed futures funds. b. long-short equity funds. c. fund of funds. d. private equity funds. e. leveraged Buyouts (LBOs).

ANSWER: c 97. Which of the following is a characteristic of hedge funds? a. They are generally less restricted in how and where they can make investments. b. They are more liquid than mutual fund shares. c. They have no limitations on when and how often investment capital can be contributed or removed. d. They are more restricted in how and where they can make investments. e. They are highly correlated with traditional asset class investments.

ANSWER: a 98. In a long short hedge fund strategy, a. managers take long positions in undervalued stocks and short positions in overvalued stocks. b. managers take short positions in undervalued stocks and long positions in overvalued stocks. c. managers take offsetting risk positions on the long and short side. d. managers take long positions in undervalued stocks and long positions in overvalued stocks. e. managers take short positions in undervalued stocks and short positions in overvalued stocks.

ANSWER: a 99. In a convertible arbitrage strategy, hedge fund managers attempt to a. generate profits by taking advantage of convertible bond pricing disparities caused by changing market events. b. generate profits by taking advantage of disparities in the relationship between prices for convertible bonds and the underlying common stock. c. generate profits by taking advantage of disparities in the relationship between prices for convertible bonds and the underlying common stock option. d. purchase bonds of distressed companies. richard@qwconsultancy.com

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e. profit from changes in the global economy.

ANSWER: b 100. Hedge funds that are organized as a limited partnership a. are less restricted in how they make investments than general partnership hedge funds. b. typically have larger abnormal returns than general partnership hedge funds. c. are usually less correlated with traditional asset class investments than general partnership hedge funds. d. have less liquid investments than mutual funds. e. have more liquid investments than mutual funds.

ANSWER: d 101. The Investment Company Act of 1940 a. contains various anti-fraud provisions and record keeping and reporting requirements for fund advisors. b. regulates broker-dealers. c. requires federal registration of all public offerings of securities. d. regulates the structure and operations of mutual funds. e. contains a code of ethics and standards of professional conduct.

ANSWER: d 102. The Securities Act of 1933 a. contains various anti-fraud provisions and record keeping and reporting requirements for fund advisors. b. regulates broker-dealers. c. requires federal registration of all public offerings of securities. d. regulates the structure and operations of mutual funds. e. contains a code of ethics and standards of professional conduct.

ANSWER: c 103. The Securities Exchange Act of 1934 a. contains various anti-fraud provisions and record keeping and reporting requirements for fund advisors. b. regulates broker-dealers. c. requires federal registration of all public offerings of securities. d. regulates the structure and operations of mutual funds. e. contains a code of ethics and standards of professional conduct.

ANSWER: b 104. The Investment Advisors Act of 1940 a. contains various anti-fraud provisions and record keeping and reporting requirements for fund advisors. b. regulates broker-dealers. c. requires federal registration of all public offerings of securities. d. regulates the structure and operations of mutual funds. richard@qwconsultancy.com

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e. contains a code of ethics and standards of professional conduct.

ANSWER: a 105. Soft dollars are generated when a. a manager commits to paying a higher than normal brokerage fee in exchange for additional bundled services. b. a manager commits to paying a higher than normal brokerage fee in exchange for secretarial services. c. a manager commits to paying a higher than normal brokerage fee in exchange for office equipment. d. a manager commits to paying a higher than normal brokerage fee in exchange for research services. e. All of these are correct.

ANSWER: d 106. Ethical conflicts may arise as a result of a. incentive compensation schemes. b. soft dollar arrangements. c. marketing investment management services. d. agency conflicts. e. All of these are correct.

ANSWER: e 107. Which of the following are guiding principles for ethical behavior in the asset management industry as put forward by the CFA Center for Financial Market Integrity? a. The interests of investment professional come first. b. The preferred method for promoting fair and efficient markets is to set up a central oversight board. c. Financial markets in various countries should develop high-quality standards for reporting financial information that reflect local customs. d. Financial statements should be reported from the perspective of firm shareholders. e. All of these are correct.

ANSWER: d 108. Which of the following are functions that a portfolio manager should perform for clients? a. determine investment objectives and constraints, diversify the portfolio, and eliminate tax payments b. determine investment objectives, diversify the portfolio, maintain ethical standards, and eliminate tax payments c. determine investment objectives and constraints, diversify the portfolio, and maintain ethical standards d. determine constraints, diversify the portfolio, and eliminate tax payments e. determine investment objectives and constraints, diversify the portfolio, eliminate tax payments, and achieve risk adjusted return superior to the relevant benchmark ANSWER: c

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109. A portfolio manager should be able to perform all of the following functions, EXCEPT a. determine risk-return preferences. b. eliminate systematic risk. c. maintain diversification ensuring a stabilized risk class. d. attempt to derive a risk-adjusted performance that is superior to the market. e. administer the account, keep records, and provide timely information.

ANSWER: b

Chapter 18 - Evaluation of Portfolio Performance True / False 1. The two main questions when assessing the performance of an investment manager are: how did the portfolio manager actually perform, and, why did the portfolio manager perform as he or she did? a. True b. False ANSWER: True 2. Investors want their portfolio managers to completely diversify their portfolio, that is, eliminate all systematic risk. a. True b. False ANSWER: True 3. A peer group comparison collects the returns produced by a representative universe of investors over a specific period of time and displays them in a simple boxplot format. a. True b. False ANSWER: True 4. The typical proxy for the market portfolio is the S&P 500 Index because it is diversified and price weighted. a. True b. False ANSWER: False 5. Maximum drawdown calculates the largest percentage decline in value—from peak to trough— wherever during the horizon that occurs. a. True b. False ANSWER: True 6. The most common manner of evaluating portfolio managers is a peer group comparison. a. True b. False richard@qwconsultancy.com

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ANSWER: True 7. Treynor's performance measure implicitly assumes a completely diversified portfolio. a. True b. False ANSWER: True 8. A negative Treynor measure (negative T) for a portfolio always indicates that the portfolio would plot below the SML. a. True b. False ANSWER: False 9. Sharpe's performance assumes that all portfolios are completely diversified. a. True b. False ANSWER: True 10. The Sharpe measure examines the risk premium per unit of systematic risk. a. True b. False ANSWER: False 11. The Sharpe and Treynor measures complement each other and thus both should be used to measure portfolio performance. a. True b. False ANSWER: True 12. The Sharpe and Treynor measures always give different rankings. a. True b. False ANSWER: False 13. The Jensen measure requires that each period's rates of return and risk-free rate be measured, rather than using the long-term averages as in the Treynor and Sharpe measures. a. True b. False ANSWER: True 14. The ranking differences between the Sharpe, Treynor, and Jensen performance measures occur because of the differences in diversification. a. True b. False ANSWER: True richard@qwconsultancy.com

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15. The portfolio performance measure that can be most affected by a benchmark error is the Sharpe measure. a. True b. False ANSWER: False 16. Treynor developed the first composite measure of portfolio performance by introducing the capital market line, which defines the relationship between the return of a portfolio over time and the return for the market portfolio. a. True b. False ANSWER: False 17. The Sharpe measure of portfolio performance divides the portfolio's risk premium by the portfolio's beta. a. True b. False ANSWER: False 18. The market rewards investors for bearing total risk. a. True b. False ANSWER: False 19. The Sortino ratio takes into account the downside risk exposure in the portfolio. a. True b. False ANSWER: False 20. The information ratio permits only relative assessments of performance for different portfolios in a style class. a. True b. False ANSWER: True 21. When applying the Jensen's alpha measure, the alpha level and significance can vary greatly depending on the specification of the return-generating model. a. True b. False ANSWER: True 22. The advantage of evaluating a fund’s alpha using a multifactor approach is that it is designed to control for market style (SMB and HML) and momentum (MOM) risk. a. True b. False richard@qwconsultancy.com

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ANSWER: True 23. Grinblatt and Titman showed that the manager’s security selection ability can be established by how they adjusted portfolio weights. a. True b. False ANSWER: True 24. An advantage of the GT statistic is that it can be computed without reference to any specific benchmark. a. True b. False ANSWER: True 25. Attribution analysis separates a portfolio manager's performance into an allocation effect and selection effect. a. True b. False ANSWER: True 26. Funds with low levels of diversification tend to "beat the market." a. True b. False ANSWER: False 27. 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 ANSWER: False 28. In evaluating bond performance, the Barclays Aggregate Bond Index is an appropriate risk measure. a. True b. False ANSWER: True 29. The policy effect is a difference in bond portfolio performance from that of a benchmark index due to a difference in duration. a. True b. False ANSWER: True 30. Duration is considered a good measure of risk for a bond portfolio because it indicates the relative volatility of the bond or portfolio due to interest rate changes and the rating of the bonds. a. True richard@qwconsultancy.com

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b. False ANSWER: False 31. A test of bond performance over time indicated that bond portfolio managers are more consistent over time than equity managers. a. True b. False ANSWER: False 32. A portfolio manager should be evaluated many times and in a variety of market environments before a final judgment is reached regarding his/her strengths and weaknesses. a. True b. False ANSWER: True 33. Two desirable attributes of a portfolio manager's performance are the ability to derive aboveaverage returns for a given risk class and the ability to time the market. a. True b. False ANSWER: False 34. Overall performance is the total return above the risk-free rate. a. True b. False ANSWER: True 35. Normal portfolios, which are customized benchmarks that reflect the specific styles of alternative managers. a. True b. False ANSWER: True 36. One example of a flawed benchmark is using the median manager from a broad universe in a peer group comparison. a. True b. False ANSWER: True 37. Money-weighted returns set the present value of future cash flows (including future investment contributions and withdrawals) equal to the level of the initial investment. a. True b. False ANSWER: True 38. According to Global Investment Performance Standards (GIPS), time-weighted rates of return must be used. richard@qwconsultancy.com

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a. True b. False ANSWER: True 39. One of the goals of the Global Investment Performance Standards (GIPS) is to obtain worldwide acceptance of a single standard for the calculation and presentation of investment performance based on the principles of fair representation and full disclosure. a. True b. False ANSWER: True 40. According to Global Investment Performance Standards (GIPS), time-weighted rates of return must be used. a. True b. False ANSWER: True 41. The CFA Institute encourages managers to disclose the volatility of the composite return and to identify benchmarks that parallel the risk or investment style that the composite tracks. a. True b. False ANSWER: True Multiple Choice 42. The major requirements of a portfolio manager include the following, EXCEPT a. follow the client's policy statement. b. completely diversify the portfolio to eliminate all unsystematic risk. c. the ability to derive above-average risk adjusted returns. d. completely diversify the portfolio to eliminate all systematic risk. e. deliver on expectations and produce an additional alpha component.

ANSWER: d 43. The two questions when assessing the performance measurement of an investment manager include: a. did the manager follow the client's policy statement? b. did the manager completely diversify the portfolio to eliminate all unsystematic risk? c. why did the portfolio manager perform as he or she did? d. did the manager have the ability to derive above-average risk adjusted returns? e. did the manager deliver on expectations and produce an additional alpha component?

ANSWER: d 44. Portfolio managers are often evaluated using a boxplot of returns for a universe of investors over a specific period of time which is known as a(n) a. return adjusted comparison. richard@qwconsultancy.com

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b. efficient frontier comparison. c. time plot comparison. d. peer group comparison. e. None of these are correct.

ANSWER: d 45. Treynor showed that rational, risk-averse investors always prefer portfolio possibility lines that have a. zero slopes. b. slightly negative slopes. c. highly negative slopes. d. highly positive slopes. e. highly positive slopes.

ANSWER: e 46. The measure of performance that divides the portfolio's risk premium by the portfolio's beta is the a. Sharpe measure. b. Jensen measure. c. Fama measure. d. Alternative components model (MCV). e. Treynor measure.

ANSWER: e 47. Sharpe's performance measure divides the portfolio's risk premium by the a. standard deviation of the rate of return. b. variance of the rate of return. c. slope of the fund's characteristic line. d. beta. e. risk-free rate.

ANSWER: a 48. Which measure of portfolio performance allows analysts to determine the statistical significance of abnormal returns? a. Sharpe measure b. Jensen measure c. Fama measure d. Alternative components model (MCV) e. Treynor measure ANSWER: b 49. Information ratio portfolio performance measures a. adjust portfolio risk to match benchmark risk. b. compare portfolio returns to expected returns under CAPM. c. evaluate portfolio performance on the basis of return per unit of risk.

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d. indicate historic average differential return per unit of historic variability of differential return. e. the average market beta per unit of risk.

ANSWER: d 50. Relative return portfolio performance measures a. adjust portfolio risk to match benchmark risk. b. compare portfolio returns to expected returns under CAPM. c. evaluate portfolio performance on the basis of return per unit of risk. d. indicate historic average differential return per unit of historic variability of differential return. e. the average market beta per unit of risk.

ANSWER: c 51. Excess return portfolio performance measures a. adjust portfolio risk to match benchmark risk. b. compare portfolio returns to expected returns under CAPM. c. evaluate portfolio performance on the basis of return per unit of risk. d. indicate historic average differential return per unit of historic variability of differential return. e. the average market beta per unit of risk.

ANSWER: b 52. For a poorly diversified portfolio the appropriate measure of portfolio performance would be a. the Treynor measure because it evaluates portfolio performance on the basis of return and diversification. b. the Sharpe measure because it evaluates portfolio performance on the basis of return and diversification. c. the Treynor measure because it uses standard deviation as the risk measure. d. the Sharpe measure because it uses beta as the risk measure. e. the Jensen measure because it measures the risk-adjusted performance.

ANSWER: b 53. Which of the following statements concerning performance measures is false? a. The Sharpe measure examines both unsystematic and systematic risk. b. The Treynor measure examines systematic risk. c. The Jensen measure examines systematic risk. d. All three measures examine both unsystematic and systematic risk. e. None of these are correct.

ANSWER: d 54. A more recent adjustment to the Sharpe measurement for portfolio evaluation is a. to divide the portfolio risk premium by total risk rather than the portfolio's beta. b. to divide the portfolio risk premium by standard deviation rather than the portfolio's beta. c. to divide the portfolio risk premium by the excess portfolio return rather than total risk. richard@qwconsultancy.com

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d. to divide the excess portfolio return by the portfolio's standard deviation. e. to divide the excess portfolio return by the portfolio's beta.

ANSWER: c 55. Which portfolio measurement uses the mean excess return in the numerator divided by the amount of residual risk that the investor incurred in pursuit of those excess returns? a. Jensen measure b. Fama measure c. Sharpe measure d. Treynor ratio e. Information ratio ANSWER: e 56. The cost of active management is the coefficient ER, and it is sometimes referred to as a. market timing. b. reward for risk. c. excess reward. d. excess risk. e. tracking error.

ANSWER: e 57. A disadvantage of the Treynor and Sharpe measures is that a. they produce absolute performance rankings. b. the beta and standard deviation are static. c. they are both difficult to compute. d. they produce relative performance rankings. e. they give very different measurements for well-diversified portfolios.

ANSWER: d 58. The Sortino measure differs from the Sharpe ratio in that a. it measures the portfolio's average return in excess of a user-selected minimum acceptable return threshold. b. it measures the portfolio beta. c. higher values of the Sortino measure are not desirable, while higher values in the Sharpe ratio are desirable. d. it measures standard deviation of total portfolio return. e. it measures portfolio beta relative to the market index proxy.

ANSWER: a 59. Suppose the expected return for the market portfolio and risk-free rate are 13 percent and 3 percent respectively. Stocks A, B, and C have Treynor measures of 0.24, 0.16, and 0.11, respectively.

Based on this information, an investor should a. buy stocks A, B, and C. b. buy stocks A and B and sell stock C. c. buy stock A and sell stocks B and C. richard@qwconsultancy.com

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d. sell stocks A, B, and C. e. hold stocks A, B, and C. ANSWER: a 60. Which of the following performance measures is the most rigorous risk-adjustment process separating systematic and unsystematic risk? a. Treynor ratio b. Sharpe ratio c. Jensen's Alpha d. Information ratio e. Sortino ratio ANSWER: c Exhibit 18.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The portfolios identified below are being considered for investment. During the period under consideration, Rf = .03.

Portfolio A B C D

Return 0.16 0.22 0.11 0.18

Beta 1.0 1.5 0.6 1.1

 0.15 0.10 0.08 0.12

61. Refer to Exhibit 18.1. Using the Sharpe Measure, which portfolio performed best? a. A b. B c. C d. D e. Two portfolios are tied.

ANSWER: b 62. Refer to Exhibit 18.1. According to the Treynor Measure, which portfolio performed best? a. A b. B c. C d. D e. Two portfolios are tied ANSWER: d Exhibit 18.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

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The portfolios identified below are being considered for investment. Assume that during the period under consideration, Rf = .04.

Portfolio W X Y Z

Return 0.18 0.21 0.13 0.16

Beta 1.8 0.9 0.7 1.5

 0.06 0.10 0.03 0.07

63. Refer to Exhibit 18.2. Using the Sharpe Measure, which portfolio performed best? a. W b. X c. Y d. Z e. Two portfolios are tied.

ANSWER: c 64. Refer to Exhibit 18.2. According to the Treynor Measure, which portfolio performed best? a. W b. X c. Y d. Z e. Two portfolios are tied.

ANSWER: b Exhibit 18.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the data presented below on three mutual funds and the market.

Fund

Beta

Standard Deviation (%)

AAA BBB CCC Market

0.75 1.05 0.89 1.00

7.0 5.0 8.0 8.0

Return (%) 14 18 20 12

Rf (%) 3 3 3 3

65. Refer to Exhibit 18.3. Compute the Sharpe Measure for the AAA fund. a. 4.49 b. 2.74 c. 1.57 d. 1.70 e. 1.27 ANSWER: c richard@qwconsultancy.com

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66. Refer to Exhibit 18.3. Compute the Jensen Measure for the BBB fund. a. 4.49 b. 2.74 c. 4.25 d. 5.55 e. 8.99 ANSWER: d 67. Refer to Exhibit 18.3. Compute the Treynor Measure for the CCC fund. a. 14.7 b. 15.3 c. 19.1 d. 17.0 e. 12.7 ANSWER: a Exhibit 18.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The data presented below has been collected at this point in time.

Fund

Beta

Standard Deviation (%)

Return (%)

AAA BBB CCC Market

1.05 1.00 0.92 1.00

4.98 4.04 3.13 3.75

16 15 11 13

Rf (%) 6 6 6 6

68. Refer to Exhibit 18.4. Compute the Sharpe Measure for the AAA fund. a. 2.01 b. 2.74 c. 2.91 d. 5.43 e. 1.72 ANSWER: a 69. Refer to Exhibit 18.4. Compute the Jensen Measure for the BBB fund. a. 2.10 b. 2.74 c. 5.43 d. 2.00 e. 1.65 ANSWER: d 70. Refer to Exhibit 18.4. Compute the Treynor Measure for the CCC fund. richard@qwconsultancy.com

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a. 5.43 b. 2.74 c. 2.19 d. 2.00 e. 1.65 ANSWER: a Exhibit 18.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The data presented below has been collected at this point in time.

Fund

Beta

Standard Deviation (%)

Return (%)

XXX YYY ZZZ Market

1.07 1.02 0.86 1.00

5.13 4.28 3.52 3.80

19 17 12 13

Rf (%) 6 6 6 6

71. Refer to Exhibit 18.5. Compute the Sharpe Measure for the XXX fund. a. 6.98 b. 2.35 c. 2.53 d. 3.86 e. 1.72 ANSWER: c 72. Refer to Exhibit 18.5. Compute the Jensen Measure for the YYY fund. a. 6.98 b. 2.35 c. 2.53 d. 3.86 e. 1.72 ANSWER: d 73. Refer to Exhibit 18.5. Compute the Treynor Measure for the ZZZ fund. a. 6.98 b. 2.35 c. 2.53 d. 3.86 e. 1.72 ANSWER: a 74. What is the Sharpe measure for the S&P 500 over the last ten years if the standard deviation was 8 percent and the return was 14 percent? richard@qwconsultancy.com

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a. 1.55 b. 1.69 c. 1.75 d. 1.99 e. 2.09 ANSWER: c Exhibit 18.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the following information for four portfolios, the market, and the risk-free rate (RFR): Portfolio A1 A2 A3 A4 Market RFR

Return 0.15 0.1 0.12 0.08 0.11 0.03

Beta 1.25 0.9 1.1 0.8 1 0

SD 0.182 0.223 0.138 0.125 0.2 0

75. Refer to Exhibit 18.6. Calculate the Sharpe Measure for each portfolio. a. A1 = 0.40, A2 = 0.31, A3 = 0.65, A4 = 0.66 b. A1 = 0.31, A2 = 0.66, A3 = 0.65, A4 = 0.40 c. A1 = 0.66, A2 = 0.65, A3 = 0.31, A4 = 0.40 d. A1 = 0.66, A2 = 0.31, A3 = 0.65, A4 = 0.40 e. A1 = 0.54, A2 = 0.68, A3 = 0.65, A4 = 0.40 ANSWER: d 76. Refer to Exhibit 18.6. Calculate the Jensen alpha Measure for each portfolio. a. A1 = 0.014, A2 = −0.002, A3 = 0.002, A4 = −0.02 b. A1 = 0.002, A2 = −0.02, A3 = 0.002, A4 = −0.014 c. A1 = 0.02, A2 = −0.002, A3 = 0.002, A4 = −0.014 d. A1 = 0.02, A2 = −0.002, A3 = 0.02, A4 = −0.14 e. A1 = 0.03, A2 = −0.002, A3 = 0.02, A4 = −0.14 ANSWER: c 77. Refer to Exhibit 18.6. Calculate the Treynor Measure for each portfolio. a. A1 = 0.0625, A2 = 0.0778, A3 = 0.0818, A4 = 0.096 b. A1 = 0.096, A2 = 0.0778, A3 = 0.0818, A4 = 0.0625 c. A1 = 0.096, A2 = 0.0818, A3 = 0.0778, A4 = 0.0625 d. A1 = 0.0778, A2 = 0.096, A3 = 0.0818, A4 = 0.0625 e. A1 = 0.086, A2 = 0.096, A3 = 0.0818, A4 = 0.0625 ANSWER: b Exhibit 18.7 richard@qwconsultancy.com

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USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The last year's performance for four mutual funds is presented below. The market return was 10.70 percent, the standard deviation was 13.1 percent last year, and the risk-free rate of return was 5%.

Fund A B C D

Beta 1.50 1.20 0.90 0.50

Standard Deviation (%) 18.95 12.41 9.30 8.10

Return (%) 12.5 13.0 11.2 9.5

78. Refer to Exhibit 18.7. Compute the Sharpe Measure for the A fund. a. 0.012 b. 0.040 c. 0.069 d. 0.396 e. 1.142 ANSWER: d 79. Refer to Exhibit 18.7. Compute the Jensen Measure for the B fund. a. 1.16% b. 2.31% c. 6.90% d. 9.60% e. 10.13% ANSWER: a 80. Refer to Exhibit 18.7. Compute the Treynor Measure for the C fund. a. 0.012 b. 0.040 c. 0.069 d. 0.396 e. 1.142 ANSWER: c 81. Refer to Exhibit 18.7. Based on the Sharpe Measure, which portfolio preformed best? a. A b. B c. C d. D e. market ANSWER: c 82. Refer to Exhibit 18.7. Based on the Treynor Measure, which portfolio preformed best? richard@qwconsultancy.com

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a. A b. B c. C d. D e. market ANSWER: d Exhibit 18.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) An analyst is considering investing in funds A, B, C, and D. The market portfolio, M, is expected to be 11 percent next period, and the risk-free rate of return is 3 percent. The market portfolio had a standard deviation over the past ten years of 0.20. The analyst gathered the following information on the four funds.

Stock A B C D

Return 17% 20% 10% 15%

Beta 1.7 2.1 0.9 1.2

 .21 .25 .12 .16

83. Refer to Exhibit 18.8. Rank the four funds and market portfolio in order from highest to lowest based on their Treynor performance measures. a. A, B, C, D, M b. B, C, M, D, A c. C, A, M, D, B d. D, A, B, M, C e. D, B, A, C, M ANSWER: d 84. a. b. c. d. e.

ANSWER: e 85. Refer to Exhibit 18.8. Compute the Jensen Measure for the C fund. a. 0.16 percent b. 1.80 percent c. 7.20 percent d. 9.00 percent e. 9.13 percent ANSWER: b richard@qwconsultancy.com

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86. Selectivity measures how well a portfolio performed relative to a a. market portfolio (S&P 400). b. portfolio of the same securities in the previous period. c. naively selected portfolio of equal risk. d. naively selected portfolio of equal return. e. world market portfolio.

ANSWER: c 87. A manager's superior returns could have occurred due to a. an insightful asset allocation strategy that over weighted an asset class that earned high returns. b. investing in undervalued sectors. c. selecting individual securities that earned above average returns. d. timing broad market movements. e. All of these are correct.

ANSWER: e 88. In the evaluation of bond portfolio performance, the policy effect refers to a. the difference in portfolio duration and index duration. b. the extra return attributable to acquiring bonds that are temporarily mispriced relative to risk. c. short-run changes in the portfolio during a specific period. d. the differential return from changing duration of the portfolio during a specific period. e. None of these are correct.

ANSWER: a 89. In the evaluation of bond portfolio performance, the interest rate anticipation effect refers to a. the difference in portfolio duration and index duration. b. the extra return attributable to acquiring bonds that are temporarily mispriced relative to risk. c. short-run changes in the portfolio during a specific period. d. the differential return from changing duration of the portfolio during a specific period. e. None of these are correct.

ANSWER: d 90. In the evaluation of bond portfolio performance, the analysis effect refers to a. the difference in portfolio duration and index duration. b. the extra return attributable to acquiring bonds that are temporarily mispriced relative to risk. c. short-run changes in the portfolio during a specific period. d. the differential return from changing duration of the portfolio during a specific period. e. None of these are correct.

ANSWER: b

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91. In the Grinblatt-Titman (GT) performance measure, a. portfolio performance is measured by assessing the quality of services provided by money managers by looking at adjustments made to the content of their portfolios. b. portfolio performance is measured by examining both unsystematic and systematic risk. c. portfolio performance is measured by comparing the returns of each stock in the portfolio to the return of a benchmark portfolio. d. portfolio performance is measured on the basis of return per unit of risk. e. portfolio performance is measured on the basis of historic average differential return per unit of historic variability of differential return.

ANSWER: a 92. In the Characteristic Selectivity (CS) performance measure, a. portfolio performance is measured by assessing the quality of services provided by money managers by looking at adjustments made to the content of their portfolios. b. portfolio performance is measured by examining both unsystematic and systematic risk. c. portfolio performance is measured by comparing the returns of each stock in the portfolio to the return of a benchmark portfolio. d. portfolio performance is measured on the basis of return per unit of risk. e. portfolio performance is measured on the basis of historic average differential return per unit of historic variability of differential return.

ANSWER: c Exhibit 18.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Given the following information evaluate the performance of Cloud Incorporated (CI).

RCI = 0.17

BCI = 1.05

Rf = 0.07

Rm = 0.12

93. Refer to Exhibit 18.9. Calculate CI's overall performance. a. 0.1225 b. 0.1000 c. 0.0525 d. 0.0475 e. 0.0325 ANSWER: b 94. Refer to Exhibit 18.9. Calculate CI's selectivity. a. 0.1225 b. 0.1000 c. 0.0525 d. 0.0475 e. 0.0325 ANSWER: d 95. Refer to Exhibit 18.9. Calculate CI's risk. richard@qwconsultancy.com

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a. 0.1225 b. 0.1000 c. 0.0525 d. 0.0475 e. 0.0325 ANSWER: c Exhibit 18.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Given the following information, evaluate the performance of Tyler Incorporated (TI).

RTI = 0.18

BTI = 1.06

Rf = 0.06

Rm = 0.11

96. Refer to Exhibit 18.10. Calculate TI's overall performance. a. 0.0113 b. 0.1200 c. 0.0670 d. 0.0530 e. 0.0696 ANSWER: b 97. Refer to Exhibit 18.10. Calculate TI's selectivity. a. 0.0113 b. 0.1200 c. 0.0687 d. 0.0530 e. 0.0696 ANSWER: c 98. Refer to Exhibit 18.10. Calculate TI's risk. a. 0.0113 b. 0.1200 c. 0.0670 d. 0.0530 e. 0.0696 ANSWER: d 99. Portfolio managers who anticipate an increase in interest rates should a. act to keep the duration constant. b. decrease the portfolio duration. c. increase the portfolio duration. d. assume higher risk in the market. e. invest in junk bonds. richard@qwconsultancy.com

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ANSWER: b 100. A portfolio performance measurement technique that decomposes the return of a manager's holdings to a predetermined benchmark's returns and separates the difference into an allocation and selection is called a. immunization analysis. b. performance attribution analysis. c. tactical rankings. d. convexity utilization. e. duration matching attrition.

ANSWER: b 101. Under the performance attribution analysis method, the ____ measures the manager's decision to over- or underweight a particular market segment in terms of that segment's return performance relative to the overall return to the benchmark. a. selection effect b. allocation effect c. distribution effect d. diversification effect e. attribution effect ANSWER: b 102. Under the performance attribution analysis method, the ____ measures the manager's ability to form specific market segment portfolios that generate superior returns relative to the way in which the comparable market segment is defined in the benchmark portfolio weighted by the manager's actual market segment investment proportions. a. selection effect b. allocation effect c. distribution effect d. diversification effect e. attribution effect ANSWER: a Exhibit 18.11 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Weights Policy 50% stocks 50% bonds

Actual 60% stocks 40% bonds

Returns Index 8% stocks 5% bonds

Actual 9% stocks 7% bonds

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103. Refer to Exhibit 18.11. Which of the following statements is TRUE? a. The portfolio manager earned an extra 0.3% because of a shift in allocation out of bonds and into stocks. b. The portfolio manager earned an extra 0.3% because of a shift in allocation out of stocks and into bonds. c. The portfolio manager earned an extra 6.5% because of a shift in allocation out of bonds and into stocks. d. The portfolio manager earned an extra 6.5% because of a shift in allocation out of stocks and into bonds. e. None of these are correct.

ANSWER: a 104. Refer to Exhibit 18.11. Which of the following statements is TRUE? a. Sector/security selection hurt the portfolio performance; returns were 1.4% less than if the manager invested the funds in stocks and bond indexes. b. Sector/security selection improved the port-folio performance by 1.4%; each sector return was higher than for index value. c. Sector/security selection hurt the portfolio performance; returns were 6.8% less than if the manager invested the funds in stocks and bond indexes. d. Sector/security selection improved the port-folio performance by 6.8%; each sector return was higher than for index return. e. None of these are correct.

ANSWER: b Exhibit 18.12 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the following information for a portfolio manager:

Stocks Bonds Cash

Policy Weight 0.65 0.3 0.05

Actual Weight 0.7 0.25 0.05

Index Returns 0.11 0.07 0.03

Actual Returns 0.12 0.08 0.025

105. Refer to Exhibit 18.12. Calculate the percentage return that can be attributed to the asset allocation decision. a. 0.105 percent b. 0.925 percent c. 0.20 percent d. 0.96 percent e. 0.94 percent ANSWER: c 106. Refer to Exhibit 18.12. Calculate the percentage return that can be attributed to the security selection decision. a. 0.105 percent richard@qwconsultancy.com

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b. 0.925 percent c. 0.20 percent d. 0.96 percent e. 0.94 percent ANSWER: b 107. Bailey, Richards, and Tierney maintain that any useful benchmark should have the following characteristics: a. ambiguous. b. investable. c. value-weighted. d. use the median manager from a peer group. e. reflective of past investment opinions.

ANSWER: c 108. If the return increases as more global investments with low correlation are added to the market portfolio, the efficient frontier moves a. up and right. b. up and left. c. down and right. d. down and left. e. up only.

ANSWER: b 109. A portfolio manager has the following sequence of cash flows over a two-year period: Time outflows inflows

0

1

2

−$2,000

−$500 $50

$3,090

Calculate the portfolio manager's dollar weighted return. a. 13.56 percent b. 11.48 percent c. 15.50 percent d. 8.75 percent e. 10.67 percent ANSWER: a 110. A portfolio manager has the following sequence of cash flows over a two-year period:

Time 0 1 2

Market Value before cash flow $0 $3,200 $6,000

Cash In $3,000 $1,950 −$ 90

Market Value after cash flow $3,000 $5,150 $5,910

Calculate the portfolio manager's time weighted return. richard@qwconsultancy.com

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a. 13.56 percent b. 11.48 percent c. 15.50 percent d. 8.75 percent e. 10.67 percent ANSWER: b 111. Global Investment Performance Standards (GIPS), were intended to accomplish which of the following goals? a. to assess the quality of services provided by money managers by looking at adjustments made to the content of their portfolios b. to measure both unsystematic and systematic risk c. to establish investment industry best practices for calculating and presenting investment performance that promote investor interests and instill investor confidence d. to measure portfolio performance on the basis of return per unit of risk e. to measure portfolio performance on the basis of historic average differential return per unit of historic variability of differential return ANSWER: c

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