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NAME: ______________________________ Midterm: FINC 673 1. Which of the following portfolio construction methods starts with asset allocation?
NAME: ______________________________
Midterm: FINC 673
1. Which of the following portfolio construction methods starts with asset allocation?
A. Top-down
B. Bottom-up
C. Middle-out
D. Buy and hold
E. Asset allocation
2. In order for you to be indifferent between the after-tax returns on a corporate bond paying 8.5% and a tax-exempt municipal bond paying 6.12%, what would your tax bracket need to be?
A. 33%
B. 72%
C. 15%
D. 28%
E. Cannot tell from the information given
3. You purchased JNJ stock at $50 per share. The stock is currently selling at $65. Your gains may be protected by placing a
A. stop-buy order.
B. limit-buy order.
C. market order.
D. limit-sell order.
E. None of the options
4. The securities act of 1933
I) requires full disclosure of relevant information relating to the issue of new securities.
II) requires registration of new securities.
III) requires issuance of a prospectus detailing financial prospects of the firm.
IV) established the SEC.
V) requires periodic disclosure of relevant financial information.
VI) empowers SEC to regulate exchanges, OTC trading, brokers, and dealers.
A. I, II, and III
B. I, II, III, IV, V, and VI
C. I, II, and V
D. I, II, and IV
E. IV only
5. Multiple Mutual Funds had year-end assets of $457,000,000 and liabilities of $17,000,000. There were 24,300,000 shares in the fund at year-end. What was Multiple Mutual's net asset value?
A. $18.11
B. $18.81
C. $69.96
D. $7.00
E. $181.07
6. The Profitability Fund had NAV per share of $17.50 on January 1, 2012. On December 31 of the same year, the fund's NAV was $19.47. Income distributions were $0.75, and the fund had capital gain distributions of $1.00. Without considering taxes and transactions costs, what rate of return did an investor receive on the Profitability Fund last year?
A. 11.26%
B. 15.54%
C. 16.97%
D. 21.26%
E. 9.83%
7. A mutual fund had average daily assets of $3.0 billion in 2012. The fund sold $600 million worth of stock and purchased $700 million worth of stock during the year. The fund's turnover ratio is
A. 27.5%.
B. 12%.
C. 15%.
D. 25%.
E. 20%.
8. If the nominal return is constant, the after-tax real rate of return
A. declines as the inflation rate increases.
B. increases as the inflation rate increases.
C. declines as the inflation rate declines.
D. increases as the inflation rate decreases.
E. declines as the inflation rate increases and increases as the inflation rate decreases.
9. You have been given this probability distribution for the holding-period return for GM stock:
What is the expected standard deviation for GM stock?
A. 16.91%
B. 16.13%
C. 13.79%
D. 15.25%
E. 14.87%
10. If a portfolio had a return of 8%, the risk-free asset return was 3%, and the standard deviation of the portfolio's excess returns was 20%, the Sharpe measure would be
A. 0.08.
B. 0.03.
C. 0.20.
D. 0.11.
E. 0.25.
11. In a return-standard deviation space, which of the following statements is(are) true for risk-averse investors? (The vertical and horizontal lines are referred to as the expected return-axis and the standard deviation-axis, respectively.)
I) an investor's own indifference curves might intersect.
II) Indifference curves have negative slopes.
III) In a set of indifference curves, the highest offers the greatest utility.
IV) Indifference curves of two investors might intersect.
A. I and II only
B. II and III only
C. I and IV only
D. III and IV only
E. None of the options
12. According to the mean-variance criterion, which one of the following investments dominates all others?
A. E(r) = 0.15; Variance = 0.20
B. E(r) = 0.10; Variance = 0.20
C. E(r) = 0.10; Variance = 0.25
D. E(r) = 0.15; Variance = 0.25
E. None of these options dominates the other alternatives.
13. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________ and __________, respectively.
A. 0.114; 0.12
B. 0.087; 0.06
C. 0.295; 0.06
D. 0.087; 0.12
E. None of the options
14. The capital market line
I) is a special case of the capital allocation line.
II) represents the opportunity set of a passive investment strategy.
III) has the one-month T-Bill rate as its intercept.
IV) uses a broad index of common stocks as its risky portfolio.
A. I, III, and IV
B. II, III, and IV
C. III and IV
D. I, II, and III
E. I, II, III, and IV
15. Which of the following statement(s) is(are) true regarding the variance of a portfolio of two risky securities?
I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.
II) here is a linear relationship between the securities' coefficient of correlation and the portfolio variance.
III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securities.
A. I only
B. II only
C. III only
D. I and II
E. I and III
16. Which of the following statement(s) is(are) true regarding the selection of a portfolio from those that lie on the capital allocation line?
I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors.
II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors.
II) Investors choose the portfolio that maximizes their expected utility.
A. I only
B. II only
C. III only
D. I and III
E. II and III
17. The individual investor's optimal portfolio is designated by:
A. The point of tangency with the indifference curve and the capital allocation line.
B. The point of highest reward to variability ratio in the opportunity set.
C. The point of tangency with the opportunity set and the capital allocation line.
D. The point of the highest reward to variability ratio in the indifference curve.
E. None of the options.
18. Security X has expected return of 12% and standard deviation of 18%. Security Y has expected return of 15% and standard deviation of 26%. If the two securities have a correlation coefficient of 0.7, what is their covariance?
A. 0.038
B. 0.070
C. 0.018
D. 0.033
E. 0.054
19. When borrowing and lending at a risk-free rate are allowed, which capital allocation line (CAL) should the investor choose to combine with the efficient frontier?
I) The one with the highest reward-to-variability ratio.
II) The one that will maximize his utility.
III) The one with the steepest slope.
IV) The one with the lowest slope.
A. I and III
B. I and IV
C. II and IV
D. I only
E. I, II, and III
20. In the single-index model represented by the equation ri = E(ri) + βiF + ei, the term ei represents
A. the impact of unanticipated macroeconomic events on security i's return.
B. the impact of unanticipated firm-specific events on security i's return.
C. the impact of anticipated macroeconomic events on security i's return.
D. the impact of anticipated firm-specific events on security i's return.
E. the impact of changes in the market on security i's return.
21. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.18 and σM was 0.22, the β of the portfolio would be approximately
A. 0.64.
B. 1.19.
C. 0.82.
D. 1.56.
22. The exploitation of security mispricing in such a way that risk-free economic profits may be earned is called
A. arbitrage.
B. capital asset pricing.
C. factoring.
D. fundamental analysis.
E. None of the options
23. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in portfolio _________.
A. A, A
B. A, B
C. B, A
D. B, B
24. The risk-free rate and the expected market rate of return are 0.056 and 0.125, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.25 is equal to
A. 0.142.
B. 0.144.
C. 0.153.
D. 0.134.
E. 0.117.
25. Which statement is not true regarding the capital market line (CML)?
A. The CML is the line from the risk-free rate through the market portfolio.
B. The CML is the best attainable capital allocation line.
C. The CML is also called the security market line.
D. The CML always has a positive slope.
E. The risk measure for the CML is standard deviation.
26. Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
27. As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 5% and the expected market rate of return is 10%. Your company has a beta of 0.67 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be
A. 10%.
B. 5%.
C. 8.35%.
D. 28.35%.
E. 0.67%.
28. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in portfolio _________.
A. A, A
B. A, B
C. B, A
D. B, B
29. Consider the multifactor APT with two factors. Stock A has an expected return of 16.4%, a beta of 1.4 on factor 1 and a beta of .8 on factor 2. The risk premium on the factor 1 portfolio is 3%. The risk-free rate of return is 6%. What is the risk-premium on factor 2 if no arbitrage opportunities exist?
A. 2%
B. 3%
C. 4%
D. 7.75%
30. Consider a single factor APT. Portfolio A has a beta of 2.0 and an expected return of 22%. Portfolio B has a beta of 1.5 and an expected return of 17%. The risk-free rate of return is 4%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _______.
A. A, A
B. A, B
C. B, A
D. B, B
E. A, the riskless asset
31. In an efficient market the correlation coefficient between stock returns for two nonoverlapping time periods should be
A. positive and large.
B. positive and small.
C. zero.
D. negative and small.
E. negative and large.
32. Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth quarter. Nicholas had an abnormal return of -1.2% yesterday. This suggests that
A. the market is not efficient.
B. Nicholas' stock will probably rise in value tomorrow.
C. investors expected the earnings increase to be larger than what was actually announced.
D. investors expected the earnings increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.
33. Some economists believe that the anomalies literature is consistent with investors'
A. ability to always process information correctly and therefore they infer correct probability distributions about future rates of return; and given a probability distribution of returns, they always make consistent and optimal decisions.
B. inability to always process information correctly and therefore they infer incorrect probability distributions about future rates of return; and given a probability distribution of returns, they always make consistent and optimal decisions.
C. ability to always process information correctly and therefore they infer correct probability distributions about future rates of return; and given a probability distribution of returns, they often make inconsistent or suboptimal decisions.
D. inability to always process information correctly and therefore they infer incorrect probability distributions about future rates of return; and given a probability distribution of returns, they often make inconsistent or suboptimal decisions.
34. An example of ________ is that a person may reject an investment when it is posed in terms of risk surrounding potential gains, but may accept the same investment if it is posed in terms of risk surrounding potential losses.
A. framing
B. regret avoidance
C. overconfidence
D. conservatism
35. Arbitrageurs may be unable to exploit behavioral biases due to
I) fundamental risk.
II) implementation costs.
III) model risk.
IV) conservatism.
V) regret avoidance.
A. I and II only
B. I, II, and III
C. I, II, III, and V
D. II, III, and IV
E. IV and V
36. The efficient market hypothesis
A. implies that security prices properly reflect information available to investors.
B. has little empirical validity.
C. implies that active traders will find it difficult to outperform a buy-and-hold strategy.
D. has little empirical validity and implies that active traders will find it difficult to outperform a buy-and-hold strategy.
E. implies that security prices properly reflect information available to investors and that active traders will find it difficult to outperform a buy-and-hold strategy.
37. Behavioral finance argues that
A. even if security prices are wrong, it may be difficult to exploit them.
B. the failure to uncover successful trading rules or traders cannot be taken as proof of market efficiency.
C. investors are rational.
D. even if security prices are wrong, it may be difficult to exploit them and the failure to uncover successful trading rules or traders cannot be taken as proof of market efficiency.
E. All of the options
38. In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor (the factors) that appeared to have significant explanatory power in explaining security returns was (were)
A. the change in the expected rate of inflation.
B. the risk premium on corporate bonds.
C. the unexpected change in the rate of inflation.
D. industrial production.
E. the risk premium on corporate bonds, the unexpected change in the rate of inflation, and industrial production.
39. If a professionally managed portfolio consistently outperforms the market proxy on a risk-adjusted basis and the market is efficient, it should be concluded that
A. the CAPM is invalid.
B. the proxy is inadequate.
C. either the CAPM is invalid or the proxy is inadequate.
D. the CAPM is valid and the proxy is adequate.
E. None of the options
40. Which of the following must be done to test the multifactor CAPM or the APT?
I) Specify the risk factors
II) Identify portfolios that hedge the risk factors
III) Test the explanatory power of hedge portfolios
IV) Test the risk premiums of hedge portfolios
A. I and II
B. II and IV
C. II and III
D. I, II, and IV
E. I, II, III, and IV
SHORT ANSWER
1. List and discuss two of the assumptions of the CAPM.
2. Discuss the advantages of the multifactor APT over the single factor APT and the CAPM. What is one shortcoming of the multifactor APT and how does this shortcoming compare to CAPM implications?
3. With regard to market efficiency, what is meant by the term "anomaly"? Give three examples of market anomalies and explain why each is considered to be an anomaly.
4. Compare and contrast the efficient market hypothesis with the school of thought termed behavioral finance.
