投资学第7版Test Bank答案09

Multiple Choice Questions1. The term structure of interest rates is:A) The relationship between the rates of interest on all securities.B) The relationship between the interest rate on a security and its time to maturity.C) The relationship between the yield on a bond and its default rate.D) All of the above.E) None of the above.Answer: B Difficulty: EasyRationale: The term structure of interest rates is the relationship between two variables, years and yield to maturity (holding all else constant).2. The yield curve shows at any point in time:A) The relationship between the yield on a bond and the duration of the bond.B) The relationship between the coupon rate on a bond and time to maturity of thebond.C) The relationship between yield on a bond and the time to maturity on the bond.D) All of the above.E) None of the above.Answer: C Difficulty: Easy3. An inverted yield curve implies that:A) Long-term interest rates are lower than short-term interest rates.B) Long-term interest rates are higher than short-term interest rates.C) Long-term interest rates are the same as short-term interest rates.D) Intermediate term interest rates are higher than either short- or long-term interestrates.E) none of the above.Answer: A Difficulty: EasyRationale: The inverted, or downward sloping, yield curve is one in which short-term rates are higher than long-term rates. The inverted yield curve has been observedfrequently, although not as frequently as the upward sloping, or normal, yield curve.4. An upward sloping yield curve is a(n) _______ yield curve.A) normal.B) humped.C) inverted.D) flat.E) none of the above.Answer: A Difficulty: EasyRationale: The upward sloping yield curve is referred to as the normal yield curve, probably because, historically, the upward sloping yield curve is the shape that has been observed most frequently.5. According to the expectations hypothesis, a normal yield curve implies thatA) interest rates are expected to remain stable in the future.B) interest rates are expected to decline in the future.C) interest rates are expected to increase in the future.D) interest rates are expected to decline first, then increase.E) interest rates are expected to increase first, then decrease.Answer: C Difficulty: EasyRationale: An upward sloping yield curve is based on the expectation that short-term interest rates will increase.6. Which of the following is not proposed as an explanation for the term structure ofinterest rates?A) The expectations theory.B) The liquidity preference theory.C) The market segmentation theory.D) Modern portfolio theory.E) A, B, and C.Answer: D Difficulty: EasyRationale: A, B, and C are all theories that have been proposed to explain the term structure.7. The expectations theory of the term structure of interest rates states thatA) forward rates are determined by investors' expectations of future interest rates.B) forward rates exceed the expected future interest rates.C) yields on long- and short-maturity bonds are determined by the supply and demandfor the securities.D) all of the above.E) none of the above.Answer: A Difficulty: EasyRationale: The forward rate equals the market consensus expectation of future short interest rates.8. Which of the following theories state that the shape of the yield curve is essentiallydetermined by the supply and demands for long-and short-maturity bonds?A) Liquidity preference theory.B) Expectations theory.C) Market segmentation theory.D) All of the above.E) None of the above.Answer: C Difficulty: EasyRationale: Market segmentation theory states that the markets for different maturities are separate markets, and that interest rates at the different maturities are determined by the intersection of the respective supply and demand curves.9. According to the "liquidity preference" theory of the term structure of interest rates, theyield curve usually should be:A) inverted.B) normal.C) upward slopingD) A and B.E) B and C.Answer: E Difficulty: EasyRationale: According to the liquidity preference theory, investors would prefer to be liquid rather than illiquid. In order to accept a more illiquid investment, investors require a liquidity premium and the normal, or upward sloping, yield curve results.Use the following to answer questions 10-13:Suppose that all investors expect that interest rates for the 4 years will be as follows:10. What is the price of 3-year zero coupon bond with a par value of $1,000?A) $863.83B) $816.58C) $772.18D) $765.55E) none of the aboveAnswer: B Difficulty: ModerateRationale: $1,000 / (1.05)(1.07)(1.09) = $816.5811. If you have just purchased a 4-year zero coupon bond, what would be the expected rateof return on your investment in the first year if the implied forward rates stay the same?(Par value of the bond = $1,000)A) 5%B) 7%C) 9%D) 10%E) none of the aboveAnswer: A Difficulty: ModerateRationale: The forward interest rate given for the first year of the investment is given as 5% (see table above).12. What is the price of a 2-year maturity bond with a 10% coupon rate paid annually? (Parvalue = $1,000)A) $1,092B) $1,054C) $1,000D) $1,073E) none of the aboveAnswer: D Difficulty: ModerateRationale: [(1.05)(1.07)]1/2 - 1 = 6%; FV = 1000, n = 2, PMT = 100, i = 6, PV =$1,073.3413. What is the yield to maturity of a 3-year zero coupon bond?A) 7.00%B) 9.00%C) 6.99%D) 7.49%E) none of the aboveAnswer: C Difficulty: ModerateRationale: [(1.05)(1.07)(1.09)]1/3 - 1 = 6.99.Use the following to answer questions 14-16:The following is a list of prices for zero coupon bonds with different maturities and par value of $1,000.14. What is, according to the expectations theory, the expected forward rate in the thirdyear?A) 7.00%B) 7.33%C) 9.00%D) 11.19%E) none of the aboveAnswer: C Difficulty: ModerateRationale: 881.68 / 808.88 - 1 = 9%15. What is the yield to maturity on a 3-year zero coupon bond?A) 6.37%B) 9.00%C) 7.33%D) 10.00%E) none of the aboveAnswer: C Difficulty: ModerateRationale: (1000 / 808.81)1/3 -1 = 7.33%16. What is the price of a 4-year maturity bond with a 12% coupon rate paid annually? (Parvalue = $1,000)A) $742.09B) $1,222.09C) $1,000.00D) $1,141.92E) none of the aboveAnswer: D Difficulty: DifficultRationale: (1000 / 742.09)1/4 -1 = 7.74%; FV = 1000, PMT = 120, n = 4, i = 7.74, PV = $1,141.9217. The market segmentation theory of the term structure of interest ratesA) theoretically can explain all shapes of yield curves.B) definitely holds in the "real world".C) assumes that markets for different maturities are separate markets.D) A and B.E) A and C.Answer: E Difficulty: EasyRationale: Although this theory is quite tidy theoretically, both investors and borrows will depart from their "preferred maturity habitats" if yields on alternative maturities are attractive enough.18. An upward sloping yield curveA) may be an indication that interest rates are expected to increase.B) may incorporate a liquidity premium.C) may reflect the confounding of the liquidity premium with interest rateexpectations.D) all of the above.E) none of the above.Answer: D Difficulty: EasyRationale: One of the problems of the most commonly used explanation of termstructure, the expectations hypothesis, is that it is difficult to separate out the liquidity premium from interest rate expectations.19. The "break-even" interest rate for year n that equates the return on an n-periodzero-coupon bond to that of an n-1-period zero-coupon bond rolled over into a one-year bond in year n is defined asA) the forward rate.B) the short rate.C) the yield to maturity.D) the discount rate.E) None of the above.Answer: A Difficulty: EasyRationale: The forward rate for year n, fn, is the "break-even" interest rate for year n that equates the return on an n-period zero- coupon bond to that of an n-1-periodzero-coupon bond rolled over into a one-year bond in year n.20. When computing yield to maturity, the implicit reinvestment assumption is that theinterest payments are reinvested at the:A) Coupon rate.B) Current yield.C) Yield to maturity at the time of the investment.D) Prevailing yield to maturity at the time interest payments are received.E) The average yield to maturity throughout the investment period.Answer: C Difficulty: ModerateRationale: In order to earn the yield to maturity quoted at the time of the investment, coupons must be reinvested at that rate.21. Which one of the following statements is true?A) The expectations hypothesis indicates a flat yield curve if anticipated futureshort-term rates exceed the current short-term rate.B) The basic conclusion of the expectations hypothesis is that the long-term rate isequal to the anticipated long-term rate.C) The liquidity preference hypothesis indicates that, all other things being equal,longer maturities will have lower yields.D) The segmentation hypothesis contends that borrows and lenders are constrained toparticular segments of the yield curve.E) None of the above.Answer: D Difficulty: ModerateRationale: A flat yield curve indicates expectations of existing rates. Expectations hypothesis states that the forward rate equals the market consensus of expectations of future short interest rates. The reverse of C is true.22. The concepts of spot and forward rates are most closely associated with which one ofthe following explanations of the term structure of interest rates.A) Segmented Market theoryB) Expectations HypothesisC) Preferred Habitat HypothesisD) Liquidity Premium theoryE) None of the aboveAnswer: B Difficulty: ModerateRationale: Only the expectations hypothesis is based on spot and forward rates. A andC assume separate markets for different maturities; liquidity premium assumes higheryields for longer maturities.Use the following to answer question 23:23. Given the bond described above, if interest were paid semi-annually (rather thanannually), and the bond continued to be priced at $850, the resulting effective annual yield to maturity would be:A) Less than 12%B) More than 12%C) 12%D) Cannot be determinedE) None of the aboveAnswer: B Difficulty: ModerateRationale: FV = 1000, PV = -850, PMT = 50, n = 40, i = 5.9964 (semi-annual);(1.059964)2 - 1 = 12.35%.24. Interest rates might declineA) because real interest rates are expected to decline.B) because the inflation rate is expected to decline.C) because nominal interest rates are expected to increase.D) A and B.E) B and C.Answer: D Difficulty: EasyRationale: The nominal rate is comprised of the real interest rate plus the expectedinflation rate.25. Forward rates ____________ future short rates because ____________.A) are equal to; they are both extracted from yields to maturity.B) are equal to; they are perfect forecasts.C) differ from; they are imperfect forecasts.D) differ from; forward rates are estimated from dealer quotes while future short ratesare extracted from yields to maturity.E) are equal to; although they are estimated from different sources they both are usedby traders to make purchase decisions.Answer: C Difficulty: EasyRationale: Forward rates are the estimates of future short rates extracted from yields to maturity but they are not perfect forecasts because the future cannot be predicted with certainty; therefore they will usually differ.26. The pure yield curve can be estimatedA) by using zero-coupon bonds.B) by using coupon bonds if each coupon is treated as a separate "zero."C) by using corporate bonds with different risk ratings.D) by estimating liquidity premiums for different maturities.E) A and B.Answer: E Difficulty: ModerateRationale: The pure yield curve is calculated using zero coupon bonds, but coupon bonds may be used if each coupon is treated as a separate "zero."27. The on the run yield curve isA) a plot of yield as a function of maturity for zero-coupon bonds.B) a plot of yield as a function of maturity for recently issued coupon bonds trading ator near par.C) a plot of yield as a function of maturity for corporate bonds with different riskratings.D) a plot of liquidity premiums for different maturities.E) A and B.Answer: B Difficulty: Moderate28. The market segmentation and preferred habitat theories of term structureA) are identical.B) vary in that market segmentation is rarely accepted today.C) vary in that market segmentation maintains that borrowers and lenders will notdepart from their preferred maturities and preferred habitat maintains that marketparticipants will depart from preferred maturities if yields on other maturities areattractive enough.D) A and B.E) B and C.Answer: E Difficulty: ModerateRationale: Borrowers and lenders will depart from their preferred maturity habitats if yields are attractive enough; thus, the market segmentation hypothesis is no longerreadily accepted.29. The yield curveA) is a graphical depiction of term structure of interest rates.B) is usually depicted for U. S. Treasuries in order to hold risk constant acrossmaturities and yields.C) is usually depicted for corporate bonds of different ratings.D) A and B.E) A and C.Answer: D Difficulty: EasyRationale: The yield curve (yields vs. maturities, all else equal) is depicted for U. S.Treasuries more frequently than for corporate bonds, as the risk is constant acrossmaturities for Treasuries.Use the following to answer questions 30-32:30. What should the purchase price of a 2-year zero coupon bond be if it is purchased at thebeginning of year 2 and has face value of $1,000?A) $877.54B) $888.33C) $883.32D) $893.36E) $871.80Answer: A Difficulty: DifficultRationale: $1,000 / [(1.064)(1.071)] = $877.5431. What would the yield to maturity be on a four-year zero coupon bond purchased today?A) 5.80%B) 7.30%C) 6.65%D) 7.25%E) none of the above.Answer: C Difficulty: ModerateRationale: [(1.058) (1.064) (1.071) (1.073)]1/4 - 1 = 6.65%32. Calculate the price at the beginning of year 1 of a 10% annual coupon bond with facevalue $1,000 and 5 years to maturity.A) $1,105B) $1,132C) $1,179D) $1,150E) $1,119Answer: B Difficulty: DifficultRationale: i = [(1.058) (1.064) (1.071) (1.073) (1.074)]1/5 - 1 = 6.8%; FV = 1000, PMT = 100, n = 5, i = 6.8, PV = $1,131.9133. Given the yield on a 3 year zero-coupon bond is 7.2% and forward rates of 6.1% in year1 and 6.9% in year 2, what must be the forward rate in year 3?A) 8.4%B) 8.6%C) 8.1%D) 8.9%E) none of the above.Answer: B Difficulty: ModerateRationale: f3 = (1.072)3 / [(1.061) (1.069)] - 1 = 8.6%34. An inverted yield curve is oneA) with a hump in the middle.B) constructed by using convertible bonds.C) that is relatively flat.D) that plots the inverse relationship between bond prices and bond yields.E) that slopes downward.Answer: E Difficulty: EasyRationale: An inverted yield curve occurs when short-term rates are higher thanlong-term rates.35. Investors can use publicly available financial date to determine which of the following?I)the shape of the yield curveII)future short-term ratesIII)the direction the Dow indexes are headingIV)the actions to be taken by the Federal ReserveA) I and IIB) I and IIIC) I, II, and IIID) I, III, and IVE) I, II, III, and IVAnswer: A Difficulty: ModerateRationale: Only the shape of the yield curve and future inferred rates can be determined.The movement of the Dow Indexes and Federal Reserve policy are influenced by term structure but are determined by many other variables also.36. Which of the following combinations will result in a sharply increasing yield curve?A) increasing expected short rates and increasing liquidity premiumsB) decreasing expected short rates and increasing liquidity premiumsC) increasing expected short rates and decreasing liquidity premiumsD) increasing expected short rates and constant liquidity premiumsE) constant expected short rates and increasing liquidity premiumsAnswer: A Difficulty: ModerateRationale: Both of the forces will act to increase the slope of the yield curve.37. The yield curve is a component ofA) the Dow Jones Industrial Average.B) the consumer price index.C) the index of leading economic indicators.D) the producer price index.E) the inflation index.Answer: C Difficulty: EasyRationale: Since the yield curve is often used to forecast the business cycle, it is used as one of the leading economic indicators.38. The most recently issued Treasury securities are calledA) on the run.B) off the run.C) on the market.D) off the market.E) none of the above.Answer: A Difficulty: EasyUse the following to answer questions 39-42:Suppose that all investors expect that interest rates for the 4 years will be as follows:39. What is the price of 3-year zero coupon bond with a par value of $1,000?A) $889.08B) $816.58C) $772.18D) $765.55E) none of the aboveAnswer: A Difficulty: ModerateRationale: $1,000 / (1.03)(1.04)(1.05) = $889.0840. If you have just purchased a 4-year zero coupon bond, what would be the expected rateof return on your investment in the first year if the implied forward rates stay the same?(Par value of the bond = $1,000)A) 5%B) 3%C) 9%D) 10%E) none of the aboveAnswer: B Difficulty: ModerateRationale: The forward interest rate given for the first year of the investment is given as 3% (see table above).41. What is the price of a 2-year maturity bond with a 5% coupon rate paid annually? (Parvalue = $1,000)A) $1,092.97B) $1,054.24C) $1,028.51D) $1,073.34E) none of the aboveAnswer: C Difficulty: ModerateRationale: [(1.03)(1.04)]1/2 - 1 = 3.5%; FV = 1000, n = 2, PMT = 50, i = 3.5, PV =$1,028.5142. What is the yield to maturity of a 3-year zero coupon bond?A) 7.00%B) 9.00%C) 6.99%D) 4%E) none of the aboveAnswer: D Difficulty: ModerateRationale: [(1.03)(1.04)(1.05)]1/3 - 1 = 4%.Use the following to answer questions 43-46:The following is a list of prices for zero coupon bonds with different maturities and par value of $1,000.43. What is, according to the expectations theory, the expected forward rate in the thirdyear?A) 7.23B) 9.37%C) 9.00%D) 10.9%E) none of the aboveAnswer: B Difficulty: ModerateRationale: 862.57 / 788.66 - 1 = 9.37%44. What is the yield to maturity on a 3-year zero coupon bond?A) 6.37%B) 9.00%C) 7.33%D) 8.24%E) none of the aboveAnswer: D Difficulty: ModerateRationale: (1000 / 788.66)1/3 -1 = 8.24%45. What is the price of a 4-year maturity bond with a 10% coupon rate paid annually? (Parvalue = $1,000)A) $742.09B) $1,222.09C) $1,035.66D) $1,141.84E) none of the aboveAnswer: C Difficulty: DifficultRationale: (1000 / 711.00)1/4 -1 = 8.9%; FV = 1000, PMT = 100, n = 4, i = 8.9, PV =$1,035.6646. You have purchased a 4-year maturity bond with a 9% coupon rate paid annually. Thebond has a par value of $1,000. What would the price of the bond be one year from now if the implied forward rates stay the same?A) $995.63B) $1,108.88C) $1,000.00D) $1,042.78E) none of the aboveAnswer: A Difficulty: DifficultRationale: (925.16 / 711.00)]1/3 - 1.0 = 9.17%; FV = 1000, PMT = 90, n = 3, i = 9.17, PV = $995.63Use the following to answer question 47:47. Given the bond described above, if interest were paid semi-annually (rather thanannually), and the bond continued to be priced at $917.99, the resulting effective annual yield to maturity would be:A) Less than 10%B) More than 10%C) 10%D) Cannot be determinedE) None of the aboveAnswer: B Difficulty: ModerateRationale: FV = 1000, PV = -917.99, PMT = 45, n = 36, i = 4.995325 (semi-annual);(1.4995325)2 - 1 = 10.24%.Use the following to answer questions 48-50:48. What should the purchase price of a 2-year zero coupon bond be if it is purchased at thebeginning of year 2 and has face value of $1,000?A) $877.54B) $888.33C) $883.32D) $894.21E) $871.80Answer: D Difficulty: DifficultRationale: $1,000 / [(1.055)(1.06)] = $894.2149. What would the yield to maturity be on a four-year zero coupon bond purchased today?A) 5.75%B) 6.30%C) 5.65%D) 5.25%E) none of the above.Answer: A Difficulty: ModerateRationale: [(1.05) (1.055) (1.06) (1.065)]1/4 - 1 = 5.75%50. Calculate the price at the beginning of year 1 of an 8% annual coupon bond with facevalue $1,000 and 5 years to maturity.A) $1,105.47B) $1,131.91C) $1,084.25D) $1,150.01E) $719.75Answer: C Difficulty: DifficultRationale: i = [(1.05) (1.055) (1.06) (1.065) (1.07)]1/5 - 1 = 6%; FV = 1000, PMT = 80, n = 5, i = 6, PV = $1084.2551. Given the yield on a 3 year zero-coupon bond is 7% and forward rates of 6% in year 1and 6.5% in year 2, what must be the forward rate in year 3?A) 7.2%B) 8.6%C) 8.5%D) 6.9%E) none of the above.Answer: C Difficulty: ModerateRationale: f3 = (1.07)3 / [(1.06) (1.065)] - 1 = 8.5%Use the following to answer questions 52-61:52. What should the purchase price of a 1-year zero coupon bond be if it is purchased todayand has face value of $1,000?A) $966.37B) $912.87C) $950.21D) $956.02E) $945.51Answer: D Difficulty: DifficultRationale: $1,000 / (1.046) = $956.0253. What should the purchase price of a 2-year zero coupon bond be if it is purchased todayand has face value of $1,000?A) $966.87B) $911.37C) $950.21D) $956.02E) $945.51Answer: B Difficulty: DifficultRationale: $1,000 / [(1.046)(1.049)] = $911.3754. What should the purchase price of a 3-year zero coupon bond be if it is purchased todayand has face value of $1,000?A) $887.42B) $871.12C) $879.54D) $856.02E) $866.32Answer: E Difficulty: DifficultRationale: $1,000 / [(1.046)(1.049)(1.052)] = $866.3255. What should the purchase price of a 4-year zero coupon bond be if it is purchased todayand has face value of $1,000?A) $887.42B) $821.15C) $879.54D) $856.02E) $866.32Answer: B Difficulty: DifficultRationale: $1,000 / [(1.046)(1.049)(1.052)(1.055)] = $821.1556. What should the purchase price of a 5-year zero coupon bond be if it is purchased todayand has face value of $1,000?A) $776.14B) $721.15C) $779.54D) $756.02E) $766.32Answer: A Difficulty: DifficultRationale: $1,000 / [(1.046)(1.049)(1.052)(1.055)(1.058)] = $776.1457. What is the yield to maturity of a 1-year bond?A) 4.6%B) 4.9%C) 5.2%D) 5.5%E) 5.8%Answer: A Difficulty: ModerateRationale: 4.6% (given in table)58. What is the yield to maturity of a 5-year bond?A) 4.6%B) 4.9%C) 5.2%D) 5.5%E) 5.8%Answer: C Difficulty: ModerateRationale: [(1.046)(1.049)(1.052)(1.055)(1.058)]1/5 -1 = 5.2%59. What is the yield to maturity of a 4-year bond?A) 4.69%B) 4.95%C) 5.02%D) 5.05%E) 5.08%Answer: C Difficulty: ModerateRationale: [(1.046)(1.049)(1.052)(1.055)]1/4 -1 = 5.05%60. What is the yield to maturity of a 3-year bond?A) 4.6%B) 4.9%C) 5.2%D) 5.5%E) 5.8%Answer: B Difficulty: ModerateRationale: [(1.046)(1.049)(1.052)]1/3 -1 = 4.9%61. What is the yield to maturity of a 2-year bond?A) 4.6%B) 4.9%C) 5.2%D) 4.7%E) 5.8%Answer: D Difficulty: ModerateRationale: [(1.046)(1.049)]1/2 -1 = 4.7%Essay Questions62. Discuss the three theories of the term structure of interest rates. Include in yourdiscussion the differences in the theories, and the advantages/disadvantages of each.Difficulty: ModerateAnswer:The expectations hypothesis is the most commonly accepted theory of term structure.The theory states that the forward rate equals the market consensus expectation of future short-term rates. Thus, yield to maturity is determined solely by current and expected future one-period interest rates. An upward sloping, or normal, yield curve wouldindicate that investors anticipate an increase in interest rates. An inverted, or downward sloping, yield curve would indicate an expectation of decreased interest rates. Ahorizontal yield curve would indicate an expectation of no interest rate changes.The liquidity preference theory of term structure maintains that short-term investorsdominate the market; thus, in general, the forward rate exceeds the expected short-term rate. In other words, investors prefer to be liquid to illiquid, all else equal, and willdemand a liquidity premium in order to go long term. Thus, liquidity preference readily explains the upward sloping, or normal, yield curve. However, liquidity preferencedoes not readily explain other yield curve shapes.Market segmentation and preferred habitat theories indicate that the markets fordifferent maturity debt instruments are segmented. Market segmentation maintains that the rates for the different maturities are determined by the intersection of the supply and demand curves for the different maturity instruments. Market segmentation readilyexplains all shapes of yield curves. However, market segmentation is not observed in the real world. Investors and issuers will leave their preferred maturity habitats if yields are attractive enough on other maturities.The purpose of this question is to ascertain that students understand the variousexplanations (and deficiencies of these explanations) of term structure.63. Term structure of interest rates is the relationship between what variables? What isassumed about other variables? How is term structure of interest rates depictedgraphically?Difficulty: ModerateAnswer:Term structure of interest rates is the relationship between yield to maturity and term to maturity, all else equal. The "all else equal" refers to risk class. Term structure ofinterest rates is depicted graphically by the yield curve, which is usually a graph of U.S.governments of different yields and different terms to maturity. The use of U.S.governments allows one to examine the relationship between yield and maturity,holding risk constant. The yield curve depicts this relationship at one point in time only.This question is designed to ascertain that students understand the relationshipsinvolved in term structure, the restrictions on the relationships, and how therelationships are depicted graphically.64. Although the expectations of increases in future interest rates can result in an upwardsloping yield curve; an upward sloping yield curve does not in and of itself imply the expectations of higher future interest rates. Explain.Difficulty: ModerateAnswer:The effects of possible liquidity premiums confound any simple attempt to extractexpectation from the term structure. That is, the upward sloping yield curve may be due to expectations of interest rate increases, or due to the requirement of a liquiditypremium, or both. The liquidity premium could more than offset expectations ofdecreased interest rates, and an upward sloping yield would result.The purpose of this question is to assure that the student understands the confounding of the liquidity premium with the expectations hypothesis, and that the interpretations of term structure are not clear-cut.。

Multiple Choice Questions1. In the context of the Capital Asset Pricing Model (CAPM) the relevantmeasure of risk isA) unique risk.B) beta.C) standard deviation of returns.D) variance of returns.E) none of the above.Answer: B Difficulty: EasyRationale: Once, a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.2. According to the Capital Asset Pricing Model (CAPM) a well diversifiedportfolio's rate of return is a function ofA) market riskB) unsystematic riskC) unique risk.D) reinvestment risk.E) none of the above.Answer: A Difficulty: EasyRationale: With a diversified portfolio, the only risk remaining is market, or systematic, risk. This is the only risk that influences returnaccording to the CAPM.3. The market portfolio has a beta ofA) 0.B) 1.C) -1.D) .E) none of the aboveAnswer: B Difficulty: EasyRationale: By definition, the beta of the market portfolio is 1.4. The risk-free rate and the expected market rate of return are and ,respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of is equal toA) .B) .C) .D)E)Answer: D Difficulty: EasyRationale: E(R) = 6% + (12 - 6) = %.5. The risk-free rate and the expected market rate of return are and ,respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of is equal toA)B) .C) .D)E)Answer: A Difficulty: EasyRationale: E(R) = % + - = %.6. Which statement is not true regarding the market portfolioA) It includes all publicly traded financial assets.B) It lies on the efficient frontier.C) All securities in the market portfolio are held in proportion to theirmarket values.D) It is the tangency point between the capital market line and theindifference curve.E) All of the above are true.Answer: D Difficulty: ModerateRationale: The tangency point between the capital market line and the indifference curve is the optimal portfolio for a particular investor.7. Which statement is not true regarding the Capital Market Line (CML)A) The CML is the line from the risk-free rate through the marketportfolio.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.Answer: C Difficulty: ModerateRationale: Both the Capital Market Line and the Security Market Line depict risk/return relationships. However, the risk measure for the CML is standard deviation and the risk measure for the SML is beta (thus C is not true; the other statements are true).8. The market risk, beta, of a security is equal toA) the covariance between the security's return and the market returndivided by the variance of the market's returns.B) the covariance between the security and market returns divided by thestandard deviation of the market's returns.C) the variance of the security's returns divided by the covariancebetween the security and market returns.D) the variance of the security's returns divided by the variance of themarket's returns.E) none of the above.Answer: A Difficulty: ModerateRationale: Beta is a measure of how a security's return covaries with the market returns, normalized by the market variance.9. According to the Capital Asset Pricing Model (CAPM), the expected rateof return on any security is equal toA) R f+ β [E(R M)].B) R f + β [E(R M) - R f].C) β [E(R M) - R f].D) E(R M) + R f.E) none of the above.Answer: B Difficulty: ModerateRationale: The expected rate of return on any security is equal to the risk free rate plus the systematic risk of the security (beta) times themarket risk premium, E(RM - Rf).10. The Security Market Line (SML) isA) the line that describes the expected return-beta relationship forwell-diversified portfolios only.B) also called the Capital Allocation Line.C) the line that is tangent to the efficient frontier of all risky assets.D) the line that represents the expected return-beta relationship.E) the line that represents the relationship between an individualsecurity's return and the market's return.Answer: D Difficulty: ModerateRationale: The SML is a measure of expected return per unit of risk, where risk is defined as beta (systematic risk).11. According to the Capital Asset Pricing Model (CAPM), fairly pricedsecuritiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: B Difficulty: ModerateRationale: A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).12. According to the Capital Asset Pricing Model (CAPM), under pricedsecuritiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: D Difficulty: Moderate13. According to the Capital Asset Pricing Model (CAPM), over pricedsecuritiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: C Difficulty: ModerateRationale: A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).14. According to the Capital Asset Pricing Model (CAPM),A) a security with a positive alpha is considered overpriced.B) a security with a zero alpha is considered to be a good buy.C) a security with a negative alpha is considered to be a good buy.D) a security with a positive alpha is considered to be underpriced.E) none of the above.Answer: D Difficulty: ModerateRationale: A security with a positive alpha is one that is expected to yield an abnormal positive rate of return, based on the perceived risk of the security, and thus is underpriced.15. According to the Capital Asset Pricing Model (CAPM), which one of thefollowing statements is falseA) The expected rate of return on a security decreases in directproportion to a decrease in the risk-free rate.B) The expected rate of return on a security increases as its betaincreases.C) A fairly priced security has an alpha of zero.D) In equilibrium, all securities lie on the security market line.E) All of the above statements are true.Answer: A Difficulty: ModerateRationale: Statements B, C, and D are true, but statement A is false.16. In a well diversified portfolioA) market risk is negligible.B) systematic risk is negligible.C) unsystematic risk is negligible.D) nondiversifiable risk is negligible.E) none of the above.Answer: C Difficulty: ModerateRationale: Market, or systematic, or nondiversifiable, risk is present in a diversified portfolio; the unsystematic risk has been eliminated.17. Empirical results regarding betas estimated from historical data indicatethatA) betas are constant over time.B) betas of all securities are always greater than one.C) betas are always near zero.D) betas appear to regress toward one over time.E) betas are always positive.Answer: D Difficulty: ModerateRationale: Betas vary over time, betas may be negative or less than one, betas are not always near zero; however, betas do appear to regress toward one over time.18. Your personal opinion is that a security has an expected rate of returnof . It has a beta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 11% = 5% + (9% - 5%) = %; therefore, the security is fairly priced.19. The risk-free rate is 7 percent. The expected market rate of return is15 percent. If you expect a stock with a beta of to offer a rate of returnof 12 percent, you shouldA) buy the stock because it is overpriced.B) sell short the stock because it is overpriced.C) sell the stock short because it is underpriced.D) buy the stock because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 12% < 7% + (15% - 7%) = %; therefore, stock is overpriced and should be shorted.20. You invest $600 in a security with a beta of and $400 in another securitywith a beta of . The beta of the resulting portfolio isA)B)C)D)E)Answer: D Difficulty: ModerateRationale: + = .21. A security has an expected rate of return of and a beta of . The marketexpected rate of return is and the risk-free rate is . The alpha of the stock isA) %.B) %.C) %.D) %.E) none of the above.Answer: A Difficulty: ModerateRationale: 10% - [5% +(8% - 5%)] = %.22. Your opinion is that CSCO has an expected rate of return of . It has abeta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: B Difficulty: ModerateRationale: % - 4% + % - 4%) = %; therefore, the security is overpriced.23. Your opinion is that CSCO has an expected rate of return of . It has abeta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: % - 4% + % - 4%) = %; therefore, the security is fairly priced.24. Your opinion is that CSCO has an expected rate of return of . It has abeta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: 15% - 4% + % - 4%) = %; therefore, the security is under priced.25. Your opinion is that Boeing has an expected rate of return of . It hasa beta of . The risk-free rate is and the market expected rate of returnis . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: % - 4% + (10% - 4%) = %; therefore, the security is under priced.26. Your opinion is that Boeing has an expected rate of return of . It hasa beta of . The risk-free rate is and the market expected rate of returnis . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: % - 4% + (10% - 4%) = %; therefore, the security is fairly priced.27. Your opinion is that Boeing has an expected rate of return of . It hasa beta of . The risk-free rate is and the market expected rate of returnis . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: % - 4% + (10% - 4%) = %; therefore, the security is overpriced.28. The risk-free rate is 4 percent. The expected market rate of return is11 percent. If you expect CAT with a beta of to offer a rate of returnof 10 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 10% < 4% + (11% - 4%) = %; therefore, stock is overpriced and should be shorted.29. The risk-free rate is 4 percent. The expected market rate of return is11 percent. If you expect CAT with a beta of to offer a rate of returnof 11 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: E Difficulty: ModerateRationale: 11% = 4% + (11% - 4%) = %; therefore, stock is fairly priced.30. The risk-free rate is 4 percent. The expected market rate of return is11 percent. If you expect CAT with a beta of to offer a rate of returnof 13 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: D Difficulty: ModerateRationale: 13% > 4% + (11% - 4%) = %; therefore, stock is under priced.31. You invest 55% of your money in security A with a beta of and the restof your money in security B with a beta of . The beta of the resultingportfolio isA)B)C)D)E)Answer: E Difficulty: Moderate Rationale: + = .32. Given the following two stocks A and BIf the expected market rate of return is and the risk-free rate is , which security would be considered the better buy and whyA) A because it offers an expected excess return of %.B) B because it offers an expected excess return of %.C) A because it offers an expected excess return of %.D) B because it offers an expected return of 14%.E) B because it has a higher beta.Answer: C Difficulty: ModerateRationale: A's excess return is expected to be 12% - [5% + (9% - 5%)] = %.B's excess return is expected to be 14% - [5% + (9% - 5%)] = %.33. Capital Asset Pricing Theory asserts that portfolio returns are bestexplained by:A) economic factors.B) specific risk.C) systematic risk.D) diversification.E) none of the above.Answer: C Difficulty: EasyRationale: The risk remaining in diversified portfolios is systematic risk;thus, portfolio returns are commensurate with systematic risk.34. According to the CAPM, the risk premium an investor expects to receiveon any stock or portfolio increases:A) directly with alpha.B) inversely with alpha.C) directly with beta.D) inversely with beta.E) in proportion to its standard deviation.Answer: C Difficulty: EasyRationale: The market rewards systematic risk, which is measured by beta, and thus, the risk premium on a stock or portfolio varies directly with beta.35. What is the expected return of a zero-beta securityA) The market rate of return.B) Zero rate of return.C) A negative rate of return.D) The risk-free rate.E) None of the above.Answer: D Difficulty: ModerateRationale: E(RS ) = rf+ 0(RM- rf) = rf.36. Standard deviation and beta both measure risk, but they are different inthatA) beta measures both systematic and unsystematic risk.B) beta measures only systematic risk while standard deviation is ameasure of total risk.C) beta measures only unsystematic risk while standard deviation is ameasure of total risk.D) beta measures both systematic and unsystematic risk while standarddeviation measures only systematic risk.E) beta measures total risk while standard deviation measures onlynonsystematic risk.Answer: B Difficulty: EasyRationale: B is the only true statement.37. The expected return-beta relationshipA) is the most familiar expression of the CAPM to practitioners.B) refers to the way in which the covariance between the returns on a stockand returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta.C) assumes that investors hold well-diversified portfolios.D) all of the above are true.E) none of the above is true.Answer: D Difficulty: ModerateRationale: Statements A, B and C all describe the expected return-beta relationship.38. The security market line (SML)A) can be portrayed graphically as the expected return-beta relationship.B) can be portrayed graphically as the expected return-standard deviationof market returns relationship.C) provides a benchmark for evaluation of investment performance.D) A and C.E) B and C.Answer: D Difficulty: ModerateRationale: The SML is a measure of expected return-beta (the CML is a measure of expected return-standard deviation of market returns). The SML provides the expected return-beta relationship for "fairly priced"securities; thus if a portfolio manager selects securities that are underpriced and produces a portfolio with a positive alpha, this portfolio manager would receive a positive evaluation.39. Research by Jeremy Stein of MIT resolves the dispute over whether betais a sufficient pricing factor by suggesting that managers should use beta to estimateA) long-term returns but not short-term returns.B) short-term returns but not long-term returns.C) both long- and short-term returns.D) book-to-market ratios.E) None of the above was suggested by Stein.Answer: A Difficulty: Difficult40. Studies of liquidity spreads in security markets have shown thatA) liquid stocks earn higher returns than illiquid stocks.B) illiquid stocks earn higher returns than liquid stocks.C) both liquid and illiquid stocks earn the same returns.D) illiquid stocks are good investments for frequent, short-term traders.E) None of the above is true.Answer: B Difficulty: Difficult41. An underpriced security will plotA) on the Security Market Line.B) below the Security Market Line.C) above the Security Market Line.D) either above or below the Security Market Line depending on itscovariance with the market.E) either above or below the Security Market Line depending on itsstandard deviation.Answer: C Difficulty: EasyRationale: An underpriced security will have a higher expected return than the SML would predict; therefore it will plot above the SML.42. The risk premium on the market portfolio will be proportional toA) the average degree of risk aversion of the investor population.B) the risk of the market portfolio as measured by its variance.C) the risk of the market portfolio as measured by its beta.D) both A and B are true.E) both A and C are true.Answer: D Difficulty: ModerateRationale: The risk premium on the market portfolio is proportional to the average degree of risk aversion of the investor population and the risk of the market portfolio measured by its variance.43. In equilibrium, the marginal price of risk for a risky security must beA) equal to the marginal price of risk for the market portfolio.B) greater than the marginal price of risk for the market portfolio.C) less than the marginal price of risk for the market portfolio.D) adjusted by its degree of nonsystematic risk.E) none of the above is true.Answer: A Difficulty: ModerateRationale: In equilibrium, the marginal price of risk for a risky security must be equal to the marginal price of risk for the market. If not, investors will buy or sell the security until they are equal.44. The capital asset pricing model assumesA) all investors are price takers.B) all investors have the same holding period.C) investors pay taxes on capital gains.D) both A and B are true.E) A, B and C are all true.Answer: D Difficulty: EasyRationale: The CAPM assumes that investors are price-takers with the same single holding period and that there are no taxes or transaction costs.45. If investors do not know their investment horizons for certainA) the CAPM is no longer valid.B) the CAPM underlying assumptions are not violated.C) the implications of the CAPM are not violated as long as investors'liquidity needs are not priced.D) the implications of the CAPM are no longer useful.E) none of the above is true.Answer: C Difficulty: ModerateRationale: This is discussed in the chapter's section about extensions to the CAPM. It examines what the consequences are when the assumptions are removed.46. The value of the market portfolio equalsA) the sum of the values of all equity securities.B) the sum of the values of all equity and fixed income securities.C) the sum the values of all equity, fixed income, and derivativesecurities.D) the sum of the values of all equity, fixed income, and derivativesecurities plus the value of all mutual funds.E) the entire wealth of the economy.Answer: E Difficulty: ModerateRationale: The market portfolio includes all assets in existence.47. The amount that an investor allocates to the market portfolio is negativelyrelated toI)the expected return on the market portfolio.II)the investor's risk aversion coefficient.III)the risk-free rate of return.IV)the variance of the market portfolioA) I and IIB) II and IIIC) II and IVD) II, III, and IVE) I, III, and IVAnswer: D Difficulty: ModerateRationale: The optimal proportion is given by y = (E(RM )-rf)/(.01xAσ2M).This amount will decrease as rf , A, and σ2Mdecrease.48. One of the assumptions of the CAPM is that investors exhibit myopicbehavior. What does this meanA) They plan for one identical holding period.B) They are price-takers who can't affect market prices through theirtrades.C) They are mean-variance optimizers.D) They have the same economic view of the world.E) They pay no taxes or transactions costs.Answer: A Difficulty: ModerateRationale: Myopic behavior is shortsighted, with no concern formedium-term or long-term implications.49. The CAPM applies toA) portfolios of securities only.B) individual securities only.C) efficient portfolios of securities only.D) efficient portfolios and efficient individual securities only.E) all portfolios and individual securities.Answer: E Difficulty: ModerateRationale: The CAPM is an equilibrium model for all assets. Each asset's risk premium is a function of its beta coefficient and the risk premium on the market portfolio.50. Which of the following statements about the mutual fund theorem is trueI)It is similar to the separation property.II)It implies that a passive investment strategy can be efficient.III)It implies that efficient portfolios can be formed only through active strategies.IV)It means that professional managers have superior security selection strategies.A) I and IVB) I, II, and IVC) I and IID) III and IVE) II and IVAnswer: C Difficulty: ModerateRationale: The mutual fund theorem is similar to the separation property.The technical task of creating mutual funds can be delegated toprofessional managers; then individuals combine the mutual funds with risk-free assets according to their preferences. The passive strategy of investing in a market index fund is efficient.51. The expected return -- beta relationship of the CAPM is graphicallyrepresented byA) the security market line.B) the capital market line.C) the capital allocation line.D) the efficient frontier with a risk-free asset.E) the efficient frontier without a risk-free asset.Answer: A Difficulty: EasyRationale: The security market line shows expected return on the verticalaxis and beta on the horizontal axis. It has an intercept of rfand a slopeof E(RM ) - rf.52. A “fairly priced” asset liesA) above the security market line.B) on the security market line.C) on the capital market line.D) above the capital market line.E) below the security market line.Answer: B Difficulty: EasyRationale: Securities that lie on the SML earn exactly the expected return generated by the CAPM. Their prices are proportional to their beta coefficients and they have alphas equal to zero.53. For the CAPM that examines illiquidity premiums, if there is correlationamong assets due to common systematic risk factors, the illiquidity premium on asset i is a function ofA) the market's volatility.B) asset i's volatility.C) the trading costs of security i.D) the risk-free rate.E) the money supply.Answer: C Difficulty: ModerateRationale: The formula for this extension to the CAPM relaxes theassumption that trading is costless.54. Your opinion is that security A has an expected rate of return of . Ithas a beta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: % = 4% + (11% - 4%) = %; therefore, the security is fairly priced.55. Your opinion is that security C has an expected rate of return of . Ithas a beta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: 4% + (10% - 4%) = %; therefore, the security is fairly priced.56. The risk-free rate is 4 percent. The expected market rate of return is12 percent. If you expect stock X with a beta of to offer a rate of returnof 10 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 10% < 4% + (12% - 4%) = %; therefore, stock is overpriced and should be shorted.57. The risk-free rate is 5 percent. The expected market rate of return is11 percent. If you expect stock X with a beta of to offer a rate of returnof 15 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 15% < 5% + (11% - 5%) = %; therefore, stock is overpriced and should be shorted.58. You invest 50% of your money in security A with a beta of and the restof your money in security B with a beta of . The beta of the resulting portfolio isA)B)C)D)E)Answer: B Difficulty: ModerateRationale: + = .59. You invest $200 in security A with a beta of and $800 in security B witha beta of . The beta of the resulting portfolio is A.A)B)C)D)Answer: C Difficulty: ModerateRationale: + = .60. Security A has an expected rate of return of and a beta of . The marketexpected rate of return is and the risk-free rate is . The alpha of the stock isA) %.B) %.C) %.D) %.E) none of the above.Answer: B Difficulty: ModerateRationale: 10% - [4% +(10% - 4%)] = %.61. A security has an expected rate of return of and a beta of . The marketexpected rate of return is and the risk-free rate is . The alpha of the stock isA) %.。

Multiple Choice Questions1. In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of riskisA) unique risk.B) beta.C) standard deviation of returns.D) variance of returns.E) none of the above.Answer: B Difficulty: EasyRationale: Once, a portfolio is diversified, the only risk remaining is systematic risk,which is measured by beta.2. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rateof return is a function ofA) market riskB) unsystematic riskC) unique risk.D) reinvestment risk.E) none of the above.Answer: A Difficulty: Easy Rationale: With a diversified portfolio, the only riskremaining is market, or systematic, risk. This is the only risk that influences returnaccording to the CAPM.3. The market portfolio has a beta ofA) 0.B) 1.C) -1.D) 0.5.E) none of the aboveAnswer: B Difficulty: Easy Rationale: By definition, the beta of the market portfolio is 1.4. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively.According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal toA) 0.06.B) 0.144C) 0.12.D) 0.132E) 0.18Answer: D Difficulty: EasyRationale: E(R) = 6% + 1.2(12 - 6) = 13.2%.5. 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 toA) 0.1225B) 0.144.C) 0.153.D) 0.134E) 0.117Answer: A Difficulty: EasyRationale: E(R) = 5.6% + 1.25(12.5 - 5.6) = 14.225%.6. Which statement is not true regarding the market portfolio?A) It includes all publicly traded financial assets.B) It lies on the efficient frontier.C) All securities in the market portfolio are held in proportion to their market values.D) It is the tangency point between the capital market line and the indifference curve.E) All of the above are true.Answer: D Difficulty: ModerateRationale: The tangency point between the capital market line and the indifference curve is the optimal portfolio for a particular investor.7. 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.Answer: C Difficulty: ModerateRationale: Both the Capital Market Line and the Security Market Line depict risk/return relationships. However, the risk measure for the CML is standard deviation and the risk measure for the SML is beta (thus C is not true; the other statements are true).8. The market risk, beta, of a security is equal toA) the covariance between the security's return and the market return divided by thevariance of the market's returns.B) the covariance between the security and market returns divided by the standarddeviation of the market's returns.C) the variance of the security's returns divided by the covariance between the securityand market returns.D) the variance of the security's returns divided by the variance of the market's returns.E) none of the above.Answer: A Difficulty: ModerateRationale: Beta is a measure of how a security's return covaries with the market returns, normalized by the market variance.9. According to the Capital Asset Pricing Model (CAPM), the expected rate of return on anysecurity is equal toA) Rf + B [E(M)]・B) R f + B[E(R M) - R f].C) B[E(R M) - R f].D) E(R M) + R f.E) none of the above.Answer: B Difficulty: ModerateRationale: The expected rate of return on any security is equal to the risk free rate plus the systematic risk of the security (beta) times the market risk premium, E(R M - R f).10. The Security Market Line (SML) isA) the line that describes the expected return-beta relationship for well-diversifiedportfolios only.B) also called the Capital Allocation Line.C) the line that is tangent to the efficient frontier of all risky assets.D) the line that represents the expected return-beta relationship.E) the line that represents the relationship between an individual security's return and themarket's return.Answer: D Difficulty: ModerateRationale: The SML is a measure of expected return per unit of risk, where risk is defined as beta (systematic risk).11. According to the Capital Asset Pricing Model (CAPM), fairly priced securitiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: B Difficulty: ModerateRationale: A zero alpha results when the security is in equilibrium (fairly priced for thelevel of risk).12. According to the Capital Asset Pricing Model (CAPM), under priced securitiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: D Difficulty: Moderate13. According to the Capital Asset Pricing Model (CAPM), over priced securitiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: C Difficulty: ModerateRationale: A zero alpha results when the security is in equilibrium (fairly priced for thelevel of risk).14. According to the Capital Asset Pricing Model (CAPM),A) a security with a positive alpha is considered overpriced.B) a security with a zero alpha is considered to be a good buy.C) a security with a negative alpha is considered to be a good buy.D) a security with a positive alpha is considered to be underpriced.E) none of the above.Answer: D Difficulty: ModerateRationale: A security with a positive alpha is one that is expected to yield an abnormal positive rate of return, based on the perceived risk of the security, and thus isunderpriced.15. According to the Capital Asset Pricing Model (CAPM), which one of the followingstatements is false?A) The expected rate of return on a security decreases in direct proportion to a decreasein the risk-free rate.B) The expected rate of return on a security increases as its beta increases.C) A fairly priced security has an alpha of zero.D) In equilibrium, all securities lie on the security market line.E) All of the above statements are true.Answer: A Difficulty: ModerateRationale: Statements B, C, and D are true, but statement A is false.16. In a well diversified portfolioA) market risk is negligible.B) systematic risk is negligible.C) unsystematic risk is negligible.D) nondiversifiable risk is negligible.E) none of the above.Answer: C Difficulty: ModerateRationale: Market, or systematic, or nondiversifiable, risk is present in a diversifiedportfolio; the unsystematic risk has been eliminated.17. Empirical results regarding betas estimated from historical data indicate thatA) betas are constant over time.B) betas of all securities are always greater than one.C) betas are always near zero.D) betas appear to regress toward one over time.E) betas are always positive.Answer: D Difficulty: ModerateRationale: Betas vary over time, betas may be negative or less than one, betas are not always near zero; however, betas do appear to regress toward one over time.18. Your personal opinion is that a security has an expected rate of return of 0.11. It has abeta of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09.According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: Moderate Rationale: 11% = 5% + 1.5(9% - 5%) = 11.0%; therefore, the security is fairly priced.19. The risk-free rate is 7 percent. The expected market rate of return is 15 percent. If youexpect a stock with a beta of 1.3 to offer a rate of return of 12 percent, you shouldA) buy the stock because it is overpriced.B) sell short the stock because it is overpriced.C) sell the stock short because it is underpriced.D) buy the stock because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: Moderate Rationale: 12% < 7% + 1.3(15% - 7%) = 17.40%;therefore, stock is overpriced and should be shorted.20. You invest $600 in a security with a beta of 1.2 and $400 in another security with a betaof 0.90. The beta of the resulting portfolio isA) 1.40B) 1.00C) 0.36D) 1.08E) 0.80Answer: D Difficulty: ModerateRationale: 0.6(1.2) + 0.4(0.90) = 1.08.21. A security has an expected rate of return of 0.10 and a beta of 1.1. The market expectedrate of return is 0.08 and the risk-free rate is 0.05. The alpha of the stock isA) 1.7%.B) -1.7%.C) 8.3%.D) 5.5%.E) none of the above.Answer: A Difficulty: Moderate Rationale: 10% - [5% +1.1(8% - 5%)] = 1.7%.22. Your opinion is that CSCO has an expected rate of return of 0.13. 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 isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: B Difficulty: Moderate Rationale: 11.5% - 4% + 1.3(11.5% - 4%) = -2.25%;therefore, the security is overpriced.23. 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 isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 13.75% - 4% + 1.3(11.5% - 4%) = 0.0%; therefore, the security is fairly priced.24. Your opinion is that CSCO has an expected rate of return of 0.15. 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 isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: 15% - 4% + 1.3(11.5% - 4%) = 1.25%; therefore, the security is under priced.25. Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of 0.92.The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: 11.2% - 4% + 0.92(10% - 4%) = 1.68%; therefore, the security is under priced.26. Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10. Accordingto the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 9.52% - 4% + 0.92(10% - 4%) = 0.0%; therefore, the security is fairly priced.27. Your opinion is that Boeing has an expected rate of return of 0.08. It has a beta of 0.92.The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 8.0% - 4% + 0.92(10% - 4%) = -1.52%; therefore, the security is overpriced. 28. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If youexpect CAT with a beta of 1.0 to offer a rate of return of 10 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: Moderate Rationale: 10% < 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is overpriced and should be shorted.29. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If youexpect CAT with a beta of 1.0 to offer a rate of return of 11 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: E Difficulty: ModerateRationale: 11% = 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is fairly priced.30. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If youexpect CAT with a beta of 1.0 to offer a rate of return of 13 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: D Difficulty: Moderate Rationale: 13% > 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is under priced.31. You invest 55% of your money in security A with a beta of 1.4 and the rest of your moneyin security B with a beta of 0.9. The beta of the resulting portfolio isA) 1.466B) 1.157C) 0.968D) 1.082E) 1.175Answer: E Difficulty: ModerateRationale: 0.55(1.4) + 0.45(0.90) = 1.175.32. Given the following two stocks A and B活亡cunty E 甜吐ctEdratE of 冗tum A -0 12 B0.14If the expected market rate of retur n is 0.09 and the risk-free rate is 0.05, which security would be con sidered the better buy and why? A) A because it offers an expected excess r eturn of 1.2%. B) B because it offers an expected excess r eturn of 1.8%. C) A because it offers an expected excess r eturn of 2.2%. D) B because it offers an expected return of 14%. E) B because it has a higher beta.An swer: C Difficulty: ModerateRationale: A's excess return is expected to be 12% - [5% + 1.2(9% - 5%)] = 2.2%. B's excess return is expected to be 14% - [5% + 1.8(9% - 5%)] = 1.8%.33. Capital Asset Pricing Theory asserts that portfolio returns are best explained by:A) economic factors. B) specific risk. C) systematic risk. D) diversification. E) none of the above.An swer: C Difficulty: EasyRati on ale: The risk remai ning in diversified portfolios is systematic risk; thus, portfolio returns are comme nsurate with systematic risk.34. According to the CAPM, the risk premium an investor expects to receive on any stock orportfolio in creases: A) directly with alpha. B) inversely with alpha. C) directly with beta. D) inversely with beta.E) in proportion to its standard deviation.An swer: C Difficulty: EasyRati on ale: The market rewards systematic risk, which is measured by beta, and thus, the risk premium on a stock or portfolio varies directly with beta.B 亡烧 L2- 1.835. What is the expected return of a zero-beta security?A) The market rate of return.B) Zero rate of return.C) A negative rate of return.D) The risk-free rate.E) None of the above.Answer: D Difficulty: ModerateRationale: E(R S) = r f + 0(R M - r f) = r f.36. Standard deviation and beta both measure risk, but they are different in thatA) beta measures both systematic and unsystematic risk.B) beta measures only systematic risk while standard deviation is a measure of totalrisk.C) beta measures only unsystematic risk while standard deviation is a measure of totalrisk.D) beta measures both systematic and unsystematic risk while standard deviationmeasures only systematic risk.E) beta measures total risk while standard deviation measures only nonsystematic risk.Answer: B Difficulty: EasyRationale: B is the only true statement.37. The expected return-beta relationshipA) is the most familiar expression of the CAPM to practitioners.B) refers to the way in which the covariance between the returns on a stock and returnson the market measures the contribution of the stock to the variance of the marketportfolio, which is beta.C) assumes that investors hold well-diversified portfolios.D) all of the above are true.E) none of the above is true.Answer: D Difficulty: ModerateRationale: Statements A, B and C all describe the expected return-beta relationship.38. The security market line (SML)A) can be portrayed graphically as the expected return-beta relationship.B) can be portrayed graphically as the expected return-standard deviation of marketreturns relationship.C) provides a benchmark for evaluation of investment performance.D) A and C.E) B and C.Answer: D Difficulty: ModerateRationale: The SML is a measure of expected return-beta (the CML is a measure of expected return-standard deviation of market returns). The SML provides the expected return-beta relationship for "fairly priced" securities; thus if a portfolio manager selects securities that are underpriced and produces a portfolio with a positive alpha, thisportfolio manager would receive a positive evaluation.39. Research by Jeremy Stein of MIT resolves the dispute over whether beta is a sufficientpricing factor by suggesting that managers should use beta to estimateA) long-term returns but not short-term returns.B) short-term returns but not long-term returns.C) both long- and short-term returns.D) book-to-market ratios.E) None of the above was suggested by Stein.Answer: A Difficulty: Difficult40. Studies of liquidity spreads in security markets have shown thatA) liquid stocks earn higher returns than illiquid stocks.B) illiquid stocks earn higher returns than liquid stocks.C) both liquid and illiquid stocks earn the same returns.D) illiquid stocks are good investments for frequent, short-term traders.E) None of the above is true.Answer: B Difficulty: Difficult41. An underpriced security will plotA) on the Security Market Line.B) below the Security Market Line.C) above the Security Market Line.D) either above or below the Security Market Line depending on its covariance with themarket.E) either above or below the Security Market Line depending on its standard deviation.Answer: C Difficulty: EasyRationale: An underpriced security will have a higher expected return than the SMLwould predict; therefore it will plot above the SML.42. The risk premium on the market portfolio will be proportional toA) the average degree of risk aversion of the investor population.B) the risk of the market portfolio as measured by its variance.C) the risk of the market portfolio as measured by its beta.D) both A and B are true.E) both A and C are true.Answer: D Difficulty: ModerateRationale: The risk premium on the market portfolio is proportional to the averagedegree of risk aversion of the investor population and the risk of the market portfolio measured by its variance.43. In equilibrium, the marginal price of risk for a risky security must beA) equal to the marginal price of risk for the market portfolio.B) greater than the marginal price of risk for the market portfolio.C) less than the marginal price of risk for the market portfolio.D) adjusted by its degree of nonsystematic risk.E) none of the above is true.Answer: A Difficulty: ModerateRationale: In equilibrium, the marginal price of risk for a risky security must be equal to the marginal price of risk for the market. If not, investors will buy or sell the security until they are equal.44. The capital asset pricing model assumesA) all investors are price takers.B) all investors have the same holding period.C) investors pay taxes on capital gains.D) both A and B are true.E) A, B and C are all true.Answer: D Difficulty: EasyRationale: The CAPM assumes that investors are price-takers with the same single holding period and that there are no taxes or transaction costs.45. If investors do not know their investment horizons for certainA) the CAPM is no longer valid.B) the CAPM underlying assumptions are not violated.C) the implications of the CAPM are not violated as long as investors' liquidity needsare not priced.D) the implications of the CAPM are no longer useful.E) none of the above is true.Answer: C Difficulty: ModerateRationale: This is discussed in the chapter's section about extensions to the CAPM. It examines what the consequences are when the assumptions are removed.46. The value of the market portfolio equalsA) the sum of the values of all equity securities.B) the sum of the values of all equity and fixed income securities.C) the sum the values of all equity, fixed income, and derivative securities.D) the sum of the values of all equity, fixed income, and derivative securities plus thevalue of all mutual funds.E) the entire wealth of the economy.Answer: E Difficulty: ModerateRationale: The market portfolio includes all assets in existence.47. The amount that an investor allocates to the market portfolio is negatively related toI) the expected return on the market portfolio.II) the investor's risk aversion coefficient.III) the risk-free rate of return.IV) the variance of the market portfolioA) I and IIB) II and IIIC) II and IVD) II, III, and IVE) I, III, and IVAnswer: D Difficulty: ModerateRati on ale: The optimal proporti on is give n by y = (E(R M)-r f)/(.01xA M). This amount will decrease as r, A, and M (decrease.48. One of the assumptions of the CAPM is that investors exhibit myopic behavior. Whatdoes this mean?A) They plan for one identical holding period.B) They are price-takers who can't affect market prices through their trades.C) They are mean-variance optimizers.D) They have the same economic view of the world.E) They pay no taxes or transactions costs.Answer: A Difficulty: ModerateRationale: Myopic behavior is shortsighted, with no concern for medium-term or long-term implications.49. The CAPM applies toA) portfolios of securities only.B) individual securities only.C) efficient portfolios of securities only.D) efficient portfolios and efficient individual securities only.E) all portfolios and individual securities.Answer: E Difficulty: ModerateRationale: The CAPM is an equilibrium model for all assets. Each asset's risk premium is a function of its beta coefficient and the risk premium on the market portfolio.50. Which of the following statements about the mutual fund theorem is true?I) It is similar to the separation property.II) It implies that a passive investment strategy can be efficient.III) It implies that efficient portfolios can be formed only through active strategies.IV) It means that professional managers have superior security selection strategies.A) I and IVB) I, II, and IVC) I and IID) III and IVE) II and IVAnswer: C Difficulty: ModerateRationale: The mutual fund theorem is similar to the separation property. The technical task of creating mutual funds can be delegated to professional managers; thenindividuals combine the mutual funds with risk-free assets according to theirpreferences. The passive strategy of investing in a market index fund is efficient.51. The expected return -- beta relationship of the CAPM is graphically represented byA) the security market line.B) the capital market line.C) the capital allocation line.D) the efficient frontier with a risk-free asset.E) the efficient frontier without a risk-free asset.Answer: A Difficulty: EasyRationale: The security market line shows expected return on the vertical axis and beta on the horizontal axis. It has an intercept of f rand a slope of E(R M) - r f.52. A “ fairly priced ” asset liesA) above the security market line.B) on the security market line.C) on the capital market line.D) above the capital market line.E) below the security market line.Answer: B Difficulty: EasyRationale: Securities that lie on the SML earn exactly the expected return generated by the CAPM. Their prices are proportional to their beta coefficients and they have alphas equal to zero.53. For the CAPM that examines illiquidity premiums, if there is correlation among assetsdue to common systematic risk factors, the illiquidity premium on asset i is a function ofA) the market's volatility.B) asset i's volatility.C) the trading costs of security i.D) the risk-free rate.E) the money supply.Answer: C Difficulty: Moderate Rationale: The formula for this extension to the CAPM relaxes the assumption that trading is costless.54. Your opinion is that security A has an expected rate of return of 0.145. It has a beta of1.5. The risk-free rate is 0.04 and the market expected rate of return is 0.11. Accordingto the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: Moderate Rationale: 14.5% = 4% + 1.5(11% - 4%) = 14.5%;therefore, the security is fairly priced.55. Your opinion is that security C has an expected rate of return of 0.106. It has a beta of1.1. The risk-free rate is 0.04 and the market expected rate of return is 0.10. Accordingto the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: 4% + 1.1(10% - 4%) = 10.6%; therefore, the security is fairly priced.56. The risk-free rate is 4 percent. The expected market rate of return is 12 percent. If youexpect stock X with a beta of 1.0 to offer a rate of return of 10 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: Moderate Rationale: 10% < 4% + 1.0(12% - 4%) = 12.0%;therefore, stock is overpriced and should be shorted.57. The risk-free rate is 5 percent. The expected market rate of return is 11 percent. If youexpect stock X with a beta of 2.1 to offer a rate of return of 15 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: Moderate Rationale: 15% < 5% + 2.1(11% - 5%) = 17.6%; therefore, stock is overpriced and should be shorted.58. You invest 50% of your money in security A with a beta of 1.6 and the rest of yourmoney in security B with a beta of 0.7. The beta of the resulting portfolio isA) 1.40B) 1.15C) 0.36D) 1.08E) 0.80Answer: B Difficulty: ModerateRationale: 0.5(1.6) + 0.5(0.70) = 1.15.。

（完整版）投资学第7版TestBank答案11Multiple Choice Questions1. If you believe in the ________ form of the EMH, you believe that stock prices reflect allrelevant information including historical stock prices and current public informationabout the firm, but not information that is available only to insiders.A) semistrongB) strongC) weakD) A, B, and CE) none of the aboveAnswer: A Difficulty: EasyRationale: The semistrong form of EMH maintains that stock prices immediately reflect all historical and current public information, but not inside information.2. Proponents of the EMH typically advocateA) an active trading strategy.B) investing in an index fund.C) a passive investment strategy.D) A and BE) B and CAnswer: E Difficulty: EasyRationale: Believers of market efficiency advocate passive investment strategies, andan investment in an index fund is one of the most practical passive investment strategies, especially for small investors.3. If you believe in the _______ form of the EMH, you believethat stock prices reflect allinformation that can be derived by examining market trading data such as the history of past stock prices, trading volume or short interest.A) semistrongB) strongC) weakD) all of the aboveE) none of the aboveAnswer: C Difficulty: EasyRationale: The information described above is market data, which is the data set for the weak form of market efficiency. The semistrong form includes the above plus all other public information. The strong form includes all public and private information.4. If you believe in the _________ form of the EMH, you believe that stock prices reflectall available information, including information that is available only to insiders.A) semistrongB) strongC) weakD) all of the aboveE) none of the aboveAnswer: B Difficulty: EasyRationale: The strong form includes all public and private information.5. If you believe in the reversal effect, you shouldA) buy bonds in this period if you held stocks in the last period.B) buy stocks in this period if you held bonds in the last period.C) buy stocks this period that performed poorly last period.D) go short.E) C and DAnswer: C Difficulty: EasyRationale: The reversal effect states that stocks that do well in one period tend toperform poorly in the subsequent period, and vice versa.6. __________ focus more on past price movements of a firm's stock than on theunderlying determinants of future profitability.A) Credit analystsB) Fundamental analystsC) Systems analystsD) Technical analystsE) All of the aboveAnswer: D Difficulty: EasyRationale: Technicians attempt to predict future stock prices based on historical stock prices.7. _________ above which it is difficult for the market to rise.A) Book value is a valueB) Resistance level is a valueC) Support level is a valueD) A and BE) A and CAnswer: B Difficulty: EasyRationale: When stock prices have remained stable for a long period, these prices are termed resistance levels; technicians believe it is difficult for the stock prices topenetrate these resistance levels.8. ___________ the return on a stock beyond what would be predicted from marketmovements alone.A) An excess economic return isB) An economic return isC) An abnormal return isD) A and BE) A and CAnswer: E Difficulty: EasyRationale: An economic return is the expected return, based on the perceived level of risk and market factors. When returns exceed these levels, the returns are calledabnormal or excess economic returns.9. The debate over whether markets are efficient will probably never be resolved becauseof ________.A) the lucky event issue.B) the magnitude issue.C) the selection bias issue.D) all of the above.E) none of the above.Answer: D Difficulty: EasyRationale: Factors A, B, and C all exist make rigid testing of market efficiency difficult or impossible.10. A common strategy for passive management is ____________.A) creating an index fundB) creating a small firm fundC) creating an investment clubD) A and CE) B and CAnswer: A Difficulty: EasyRationale: The index fund is, by definition, passively managed. The other investment alternatives may or may not be managed passively.11. Arbel (1985) found thatA) the January effect was highest for neglected firms.B) the book-to-market value ratio effect was highest in JanuaryC) the liquidity effect was highest for small firms.D) the neglected firm effect was independent of the small firm effect.E) small firms had higher book-to-market value ratios.Answer: A Difficulty: ModerateRationale: Arbel divided firms into highly researched, moderately researched, and neglected groups based on the number of institutions holding the stock.12. Researchers have found that most of the small firm effect occursA) during the spring months.B) during the summer months.C) in December.D) in January.E) randomly.Answer: D Difficulty: ModerateRationale: Much of the so-called small firm effect simply may be the tax-effect as investors sell stocks on which they have losses in December and reinvest the funds in January. As small firms are especially volatile, these actions affect small firms in amore dramatic fashion.13. Malkiel (1995) calculated that the average alphas, or abnormal returns, on a largesample of mutual funds between 1972 and 1991 wereA) significantly positive.B) significantly negative.C) statistically indistinguishable from zero.D) positive before 1981 and negative thereafter.E) negative before 1981 and positive thereafter.Answer: C Difficulty: ModerateRationale: Malkiel's study suggests that fund managers do not beat the market on arisk-adjusted basis.14. Basu (1977, 1983) found that firms with low P/E ratiosA) earned higher average returns than firms with high P/E ratios.B) earned the same average returns as firms with high P/E ratios.C) earned lower average returns than firms with high P/E ratios.D) had higher dividend yields than firms with high P/E ratios.E) none of the above.Answer: A Difficulty: ModerateRationale: Firms with high P/E ratios already have an inflated price relative to earnings and thus tend to have lower returns than low P/E ratio stocks. However, the P/E ratio may capture risk not fully impounded in market betas so this may represent an appropriate risk adjustment rather than a market anomaly.15. Jaffe (1974) found that stock prices _________ after insiders intensively bought shares.A) decreasedB) did not changeC) increasedD) became extremely volatileE) became much less volatileAnswer: C Difficulty: ModerateRationale: Insider trading may signal private information.16. Banz (1981) found that, on average, the risk-adjusted returns of small firmsA) were higher than the risk-adjusted returns of large firms.B) were the same as the risk-adjusted returns of large firms.C) were lower than the risk-adjusted returns of large firms.D) were unrelated to the risk-adjusted returns of large firms.E) were negative.Answer: A Difficulty: ModerateRationale: Banz found A to be true, although subsequent studies have attempted to explain the small firm effect as the January effect, the neglected firm effect, etc.17. Proponents of the EMH think technical analystsA) should focus on relative strength.B) should focus on resistance levels.C) should focus on support levels.D) should focus on financial statements.E) are wasting their time.Answer: E Difficulty: ModerateRationale: Technical analysts attempt to predict future stock prices from historic stock prices; proponents of EMH believe that stock price changes are random variables.18. Studies of positive earnings surprises have shown that there isA) a positive abnormal return on the day positive earnings surprises are announced.B) a positive drift in the stock price on the days following the earnings surpriseannouncement.C) a negative drift in the stock price on the days following the earnings surpriseannouncement.D) both A and B are true.E) both A and C are true.Answer: D Difficulty: ModerateRationale: The market appears to adjust to earnings information gradually, resulting in a sustained period of abnormal returns.19. On November 22, 2005 the stock price of Walmart was $39.50 and the retailer stockindex was 600.30. On November 25, 2005 the stock price of Walmart was $40.25 and the retailer stock index was 605.20. Consider the ratio of Walmart to the retailer index on November 22 and November 25. Walmart is _______ the retail industry andtechnical analysts who follow relative strength would advise _______ the stock.A) outperforming, buyingB) outperforming, sellingC) underperforming, buyingD) underperforming, sellingE) equally performing, neither buying nor sellingAnswer: A Difficulty: ModerateRationale: 11/22: $39.50/600.30 = 0.0658; 11/25: $40.25/605.20 = 0.0665; Thus,K-Mart's relative strength is improving and technicians using this technique would recommend buying.20. Work by Amihud and Mendelson (1986,1991)A) argues that investors will demand a rate of return premium to invest in less liquidstocks.B) may help explain the small firm effect.C) may be related to the neglected firm effect.D) B and C.E) A, B, and C.Answer: E Difficulty: ModerateRationale: Lack of liquidity may affect the returns of small and neglected firms;however the theory does not explain why the abnormal returns are concentrated inJanuary.21. Fama and French (1992) found that the stocks of firms within the highest decile ofmarket/book ratios had average monthly returns of _______ while the stocks of firms within the lowest decile of market/book ratios had average monthly returnsof________.A) greater than 1%, greater than 1%B) greater than 1%, less than 1%C) less than 1%, greater than 1%D) less than 1%, less than 1%E) less than 0.5%, greater than 0.5%Answer: C Difficulty: ModerateRationale: This finding suggests either that low market-to-book ratio firms arerelatively underpriced, or that the market-to-book ratio is serving as a proxy for a risk factor that affects expected equilibrium returns.22. A market decline of 23% on a day when there is no significant macroeconomic event______ consistent with the EMH because ________.A) would be, it was a clear response to macroeconomic news.B) would be, it was not a clear response to macroeconomic news.C) would not be, it was a clear response to macroeconomic news.D) would not be, it was not a clear response to macroeconomic news.E) none of the above.Answer: D Difficulty: ModerateRationale: This happened on October 19, 1987. Although this specific event is not mentioned in this edition of the book, it is an example of something that would beconsidered a violation of the EMH.23. In an efficient market, __________.A) security prices react quickly to new informationB) security prices are seldom far above or below their justified levelsC) security analysts will not enable investors to realize superior returns consistentlyD) one cannot make moneyE) A, B, and CAnswer: E Difficulty: EasyRationale: A, B, and C are true; however, even in an efficient market one should be able to earn the appropriate risk-adjustedrate of return.24. The weak form of the efficient market hypothesis asserts thatA) stock prices do not rapidly adjust to new information contained in past prices or pastdata.B) future changes in stock prices cannot be predicted from past prices.C) technicians cannot expect to outperform the market.D) A and BE) B and CAnswer: E Difficulty: EasyRationale: Stock prices do adjust rapidly to new information.25. A support level is the price range at which a technical analyst would expect theA) supply of a stock to increase dramatically.B) supply of a stock to decrease substantially.C) demand for a stock to increase substantially.D) demand for a stock to decrease substantially.E) price of a stock to fall.Answer: C Difficulty: EasyRationale: A support level is considered to be a level below that the price of the stock is unlikely to fall and is believed to be determined by market psychology.26. A finding that _________ would provide evidence against the semistrong form of theefficient market theory.A) low P/E stocks tend to have positive abnormal returnsB) trend analysis is worthless in determining stock pricesC) one can consistently outperform the market by adoptingthe contrarian approachexemplified by the reversals phenomenonD) A and BE) A and CAnswer: E Difficulty: ModerateRationale: Both A and C are inconsistent with the semistrong form of the EMH.27. The weak form of the efficient market hypothesis contradictsA) technical analysis, but supports fundamental analysis as valid.B) fundamental analysis, but supports technical analysis as valid.C) both fundamental analysis and technical analysis.D) technical analysis, but is silent on the possibility of successful fundamentalanalysis.E) none of the above.Answer: D Difficulty: ModerateRationale: The process of fundamental analysis makes the market more efficient, and thus the work of the fundamentalist more difficult. The data set for the weak form of the EMH is market data, which is the only data used exclusively by technicians.Fundamentalists use all public information.28. Two basic assumptions of technical analysis are that security prices adjustA) rapidly to new information and market prices are determined by the interaction ofsupply and demand.B) rapidly to new information and liquidity is provided by security dealers.C) gradually to new information and market prices are determined by the interaction ofsupply and demand.D) gradually to new information and liquidity is provided by security dealers.E) rapidly to information and to the actions of insiders.Answer: C Difficulty: ModerateRationale: Technicians follow market data--price changes and volume of trading (as indicator of supply and demand) believing that they can identify price trends as security prices adjust gradually.29. Cumulative abnormal returns (CAR)A) are used in event studies.B) are better measures of security returns due to firm-specific events than are abnormalreturns (AR).C) are cumulated over the period prior to the firm-specific event.D) A and B.E) A and C.Answer: D Difficulty: ModerateRationale: As leakage of information occurs, the accumulated abnormal returns that are abnormal returns summed over the period of interest (around the event date) are better measures of the effect of firm-specific events.30. Studies of mutual fund performanceA) indicate that one should not randomly select a mutual fund.B) indicate that historical performance is not necessarily indicative of futureperformance.C) indicate that the professional management of the fund insures above market returns.D) A and B.E) B and C.Answer: D Difficulty: EasyRationale: Studies show that all funds do not outperform the market and that historical performance is not necessarily an indicator of future performance.31. The likelihood of an investment newsletter's successfully predicting the direction of themarket for three consecutive years by chance should beA) between 50% and 70%.B) between 25% and 50%.C) between 10% and 25%.D) less than 10%.E) greater than 70%.Answer: C Difficulty: ModerateRationale: The probability of successful prediction for 3 consecutive years is 23, or12.5%.32. In an efficient market the correlation coefficient between stock returns for twonon-overlapping time periods should beA) positive and large.B) positive and small.C) zero.D) negative and small.E) negative and large.Answer: C Difficulty: ModerateRationale: In an efficient market there should be no serial correlation between returns from non-overlapping periods.33. The weather report says that a devastating and unexpected freeze is expected to hitFlorida tonight, during the peak of the citrus harvest. In an efficient market one would expect the price of Florida Orange's stock toA) drop immediately.B) remain unchanged.C) increase immediately.D) gradually decline for the next several weeks.E) gradually increase for the next several weeks.Answer: A Difficulty: ModerateRationale: In an efficient market the price of the stock should drop immediately when the bad news is announced. If later news changes the perceived impact to FloridaOrange, the price may once again adjust quickly to the new information. A gradual change is a violation of the EMH.34. Matthews Corporation has a beta of 1.2. The annualized market return yesterday was13%, and the risk-free rate is currently 5%. You observe that Matthews had anannualized return yesterday of 17%. Assuming that markets are efficient, this suggests thatA) bad news about Matthews was announced yesterday.B) good news about Matthews was announced yesterday.C) no news about Matthews was announced yesterday.D) interest rates rose yesterday.E) interest rates fell yesterday.Answer: B Difficulty: ModerateRationale: AR = 17% - (5% + 1.2 (8%)) = +2.4%. A positive abnormal return suggests that there was firm-specific good news.35. Nicholas Manufacturing just announced yesterday that its 4th quarter earnings will be10% higher than last year's 4th quarter. You observe that Nicholas had an abnormal return of -1.2% yesterday. This suggests thatA) 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 actuallyannounced.D) investors expected the earnings increase to be smaller than what was actuallyannounced.E) earnings are expected to decrease next quarter.Answer: C Difficulty: ModerateRationale: Anticipated earnings changes are impounded into a security's price as soon as expectations are formed. Therefore a negative market response indicates that the earnings surprise was negative, that is, the increase was less than anticipated.36. When Maurice Kendall first examined stock price patterns in 1953, he found thatA) certain patterns tended to repeat within the business cycle.B) there were no predictable patterns in stock prices.C) stocks whose prices had increased consistently for one week tended to have a netdecrease the following week.D) stocks whose prices had increased consistently for one week tended to have a netincrease the following week.E) the direction of change in stock prices was unpredictable, but the amount of changefollowed a distinct pattern.Answer: B Difficulty: EasyRationale: The first studies in this area were made possible by the development ofcomputer technology. Kendall's study was the first to indicate that markets wereefficient.37. If stock prices follow a random walkA) it implies that investors are irrational.B) it means that the market cannot be efficient.C) price levels are not random.D) price changes are random.E) price movements are predictable.Answer: D Difficulty: EasyRationale: A random walk means that the changes in prices are random andindependent.38. The main difference between the three forms of market efficiency is thatA) the definition of efficiency differs.B) the definition of excess return differs.C) the definition of prices differs.D) the definition of information differs.E) they were discovered by different people.Answer: D Difficulty: ModerateRationale: The main difference is that weak form encompasses historical data,semistrong form encompasses historical data and current public information, and strong form encompasses historical data, current public information, and inside information.All of the other definitions remain the same.39. Chartists practiceA) technical analysis.B) fundamental analysis.C) regression analysis.D) insider analysis.E) psychoanalysis.Answer: A Difficulty: EasyRationale: Chartist is another name for a technical analyst.40. Which of the following are used by fundamental analysts to determine proper stockprices?I)trendlinesII)earningsIII)dividend prospectsIV)expectations of future interest ratesV)resistance levelsA) I, IV, and VB) I, II, and IIIC) II, III, and IVD) II, IV, and VE) All of the items are used by fundamental analysts.Answer: C Difficulty: ModerateRationale: Analysts look at fundamental factors such as earnings, dividend prospects, expectation of future interest rates,and risk of the firm. The information is used to determine the present value of future cash flows to stockholders. Technical analysts use trendlines and resistance levels.41. According to proponents of the efficient market hypothesis, the best strategy for a smallinvestor with a portfolio worth $40,000 is probably toA) perform fundamental analysis.B) exploit market anomalies.C) invest in Treasury securities.D) invest in derivative securities.E) invest in mutual funds.Answer: E Difficulty: ModerateRationale: Individual investors tend to have relatively small portfolios and are usually unable to realize economies of size. The best strategy is to pool funds with other small investors and allow professional managers to invest the funds.42. Which of the following are investment superstars who have consistently shown superiorperformance?I)Warren BuffetII)Phoebe BuffetIII)Peter LynchIV)Merrill LynchV)Jimmy BuffetA) I, III, and IVB) II, III, and IVC) I and IIID) III and IVE) I, III, IV, and VAnswer: C Difficulty: ModerateRationale: Warren Buffet manages Berkshire Hathaway and Peter Lynch managedFidelity's Magellan Fund. Phoebe Buffet is a character on NBC's and Jimmy Buffet is Away in Margaritaville. Merrill Lynch isn't a person.43. Google has a beta of 1.0. The annualized market return yesterday was 11%, and therisk-free rate is currently 5%. You observe that Google had an annualized returnyesterday of 14%. Assuming that markets are efficient, this suggests thatA) bad news about Google was announced yesterday.B) good news about Google was announced yesterday.C) no news about Google was announced yesterday.D) interest rates rose yesterday.E) interest rates fell yesterday.Answer: B Difficulty: ModerateRationale: AR = 14% - (5% + 1.0 (6%)) = +3.0%. A positive abnormal return suggests that there was firm-specific good news.44. Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%,and the risk-free rate is currently 4%. You observe that Music Doctors had anannualized return yesterday of 15%. Assuming that markets are efficient, this suggests thatA) bad news about Music Doctors was announced yesterday.B) good news about Music Doctors was announced yesterday.C) no news about Music Doctors was announced yesterday.D) interest rates rose yesterday.E) interest rates fell yesterday.Answer: A Difficulty: ModerateRationale: AR = 15% - (4% + 2.25 (8%)) = -7.0%. A negative abnormal return suggests that there was firm-specific bad news.45. QQAG has a beta of 1.7. The annualized market return yesterday was 13%, and therisk-free rate is currently 3%. You observe that QQAG had an annualized returnyesterday of 20%. Assuming that markets are efficient, this suggests thatA) bad news about QQAG was announced yesterday.B) good news about QQAG was announced yesterday.C) no significant news about QQAG was announced yesterday.D) interest rates rose yesterday.E) interest rates fell yesterday.Answer: C Difficulty: ModerateRationale: AR = 20% - (3% + 1.7 (10%)) = 0.0%. A positive abnormal return suggests that there was firm-specific good news and a negative abnormal return suggests that there was firm-specific bad news.46. QQAG just announced yesterday that its 4th quarter earnings will be 35% higher thanlast year's 4th quarter. You observe that QQAG had an abnormal return of -1.7%yesterday. This suggests thatA) the market is not efficient.B) QQAG stock will probably rise in value tomorrow.C) investors expected the earnings increase to be larger than what was actuallyannounced.D) investors expected the earnings increase to be smaller than what was actuallyannounced.E) earnings are expected to decrease next quarter.Answer: C Difficulty: ModerateRationale: Anticipated earnings changes are impounded into a security's price as soon as expectations are formed. Therefore a negative market response indicates that the earnings surprise was negative, that is, the increase was less than anticipated.47. LJP Corporation just announced yesterday that it would undertake an international jointventure. You observe that LJP had an abnormal return of 3% yesterday. This suggests thatA) the market is not efficient.B) LJP stock will probably rise in value again tomorrow.C) investors view the international joint venture as bad news.D) investors view the international joint venture as good news.E) earnings are expected to decrease next quarter.Answer: D Difficulty: Moderate48. Music Doctors just announced yesterday that its 1st quarter sales were 35% higher thanlast year's 1st quarter. You observe that Music Doctors had an abnormal return of -2% yesterday. This suggests thatA) the market is not efficient.B) Music Doctors stock will probably rise in value tomorrow.C) investors expected the sales increase to be larger than what was actually announced.D) investors expected the sales increase to be smaller thanwhat was actuallyannounced.E) earnings are expected to decrease next quarter.Answer: C Difficulty: Moderate49. The Food and Drug Administration (FDA) just announced yesterday that they wouldapprove a new cancer-fighting drug from King. You observe that King had an abnormal return of 0% yesterday. This suggests thatA) the market is not efficient.B) King stock will probably rise in value tomorrow.C) King stock will probably fall in value tomorrow.D) the approval was already anticipated by the marketE) none of the above.Answer: D Difficulty: Moderate50. Your professor finds a stock-trading rule that generates excess risk-adjusted returns.Instead of publishing the results, she keeps the trading rule to herself. This is mostclosely associated with ________.A) regret avoidanceB) selection biasC) framingD) insider tradingE) none of the aboveAnswer: B Difficulty: Moderate51. At freshman orientation, 1,500 students are asked to flipa coin 20 times. One student iscrowned the winner (tossed 20 heads). This is most closely associated with ________.A) regret avoidanceB) selection biasC) overconfidenceD) the lucky event issueE) none of the aboveAnswer: D Difficulty: Moderate52. Sehun (1986) finds that the practice of monitoring insider trade disclosures, and tradingon that information, would be ________.A) extremely profitable for long-term tradersB) extremely profitable for short-term tradersC) marginally profitable for long-term tradersD) marginally profitable for short-term tradersE) not sufficiently profitable to cover trading costsAnswer: E53. If you believe in the reversal effect, you shouldA) sell bonds in this period if you held stocks in the last period.B) sell stocks in this period if you held bonds in the last period.C) sell stocks this period that performed well last period.D) go long.E) C and DAnswer: C Difficulty: EasyRationale: The reversal effect states that stocks that do well in one period tend toperform poorly in the subsequent period, and vice versa.54. Patell and Woflson (1984) report that most of the stock price response to corporatedividend or earnings announcements occurs within。

投资学第7版testbank答案09Multiple Choice Questions1. In the context of the Capital Asset Pricing Model (CAPM) the relevantmeasure of risk isA) unique risk.B) beta.C) standard deviation of returns.D) variance of returns.E) none of the above.Answer: B Difficulty: EasyRationale: Once, a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.2. According to the Capital Asset Pricing Model (CAPM) a well diversifiedportfolio's rate of return is a function ofA) market riskB) unsystematic riskC) unique risk.D) reinvestment risk.E) none of the above.Answer: A Difficulty: EasyRationale: With a diversified portfolio, the only risk remaining is market, or systematic, risk. This is the only risk that influences return according to the CAPM.3. The market portfolio has a beta ofA) 0.B) 1.C) -1.D) .E) none of the aboveAnswer: B Difficulty: EasyRationale: By definition, the beta of the market portfolio is 1.4. The risk-free rate and the expected market rate of return are and ,respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of is equal toA) .B) .C) .D)E)Answer: D Difficulty: EasyRationale: E(R) = 6% + (12 - 6) = %.5. The risk-free rate and the expected market rate of return are and ,respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of is equal toA)B) .C) .D)E)Answer: A Difficulty: EasyRationale: E(R) = % + - = %.6. Which statement is not true regarding the market portfolioA) It includes all publicly traded financial assets.B) It lies on the efficient frontier.C) All securities in the market portfolio are held in proportion to theirmarket values.D) It is the tangency point between the capital market line and theindifference curve.E) All of the above are true.Answer: D Difficulty: ModerateRationale: The tangency point between the capital market line and the indifference curve is the optimal portfolio for a particular investor.7. Which statement is not true regarding the Capital Market Line (CML)A) The CML is the line from the risk-free rate through the marketportfolio.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.Answer: C Difficulty: ModerateRationale: Both the Capital Market Line and the Security Market Line depict risk/return relationships. However, the risk measure for the CML is standard deviation and the risk measure for the SML is beta (thus C is not true; the other statements are true).8. The market risk, beta, of a security is equal toA) the covariance between the security's return and the market returndivided by the variance of the market's returns.B) the covariance between the security and market returns divided by thestandard deviation of the market's returns.C) the variance of the security's returns divided by the covariancebetween the security and market returns.D) the variance of the security's returns divided by the variance of themarket's returns.E) none of the above.Answer: A Difficulty: ModerateRationale: Beta is a measure of how a security's return covaries with the market returns, normalized by the market variance.9. According to the Capital Asset Pricing Model (CAPM), the expected rateof return on any security is equal toA) R f+ β [E(R M)].B) R f + β [E(R M) - R f].C) β [E(R M) - R f].D) E(R M) + R f.E) none of the above.Answer: B Difficulty: ModerateRationale: The expected rate of return on any security is equal to the risk free rate plus the systematic risk of the security (beta) times themarket risk premium, E(RM - Rf).10. The Security Market Line (SML) isA) the line that describes the expected return-beta relationship forwell-diversified portfolios only.B) also called the Capital Allocation Line.C) the line that is tangent to the efficient frontier of all risky assets.D) the line that represents the expected return-beta relationship.E) the line that represents the relationship between an individualsecurity's return and the market's return.Answer: D Difficulty: ModerateRationale: The SML is a measure of expected return per unit of risk, where risk is defined as beta (systematic risk).11. According to the Capital Asset Pricing Model (CAPM), fairly pricedsecuritiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: B Difficulty: ModerateRationale: A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).12. According to the Capital Asset Pricing Model (CAPM), under pricedsecuritiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: D Difficulty: Moderate13. According to the Capital Asset Pricing Model (CAPM), over pricedsecuritiesA) have positive betas.B) have zero alphas.C) have negative betas.D) have positive alphas.E) none of the above.Answer: C Difficulty: ModerateRationale: A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).14. According to the Capital Asset Pricing Model (CAPM),A) a security with a positive alpha is considered overpriced.B) a security with a zero alpha is considered to be a good buy.C) a security with a negative alpha is considered to be a good buy.D) a security with a positive alpha is considered to be underpriced.E) none of the above.Answer: D Difficulty: ModerateRationale: A security with a positive alpha is one that is expected to yield an abnormal positive rate of return, based on the perceived risk of the security, and thus is underpriced.15. According to the Capital Asset Pricing Model (CAPM),which one of thefollowing statements is falseA) The expected rate of return on a security decreases in directproportion to a decrease in the risk-free rate.B) The expected rate of return on a security increases as its betaincreases.C) A fairly priced security has an alpha of zero.D) In equilibrium, all securities lie on the security market line.E) All of the above statements are true.Answer: A Difficulty: ModerateRationale: Statements B, C, and D are true, but statement A is false.16. In a well diversified portfolioA) market risk is negligible.B) systematic risk is negligible.C) unsystematic risk is negligible.D) nondiversifiable risk is negligible.E) none of the above.Answer: C Difficulty: ModerateRationale: Market, or systematic, or nondiversifiable, risk is present in a diversified portfolio; the unsystematic risk has been eliminated.17. Empirical results regarding betas estimated from historical data indicatethatA) betas are constant over time.B) betas of all securities are always greater than one.C) betas are always near zero.D) betas appear to regress toward one over time.E) betas are always positive.Answer: D Difficulty: ModerateRationale: Betas vary over time, betas may be negative or less than one, betas are not always near zero; however, betas do appear to regress toward one over time.18. Your personal opinion is that a security has an expected rate of returnof . It has a beta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: 11% = 5% + (9% - 5%) = %; therefore, the security is fairly priced.19. The risk-free rate is 7 percent. The expected market rate of return is15 percent. If you expect a stock with a beta of to offer a rate of returnof 12 percent, you shouldA) buy the stock because it is overpriced.B) sell short the stock because it is overpriced.C) sell the stock short because it is underpriced.D) buy the stock because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 12% < 7% + (15% - 7%) = %; therefore, stock is overpriced and should be shorted.20. You invest $600 in a security with a beta of and $400 in another securitywith a beta of . The beta of the resulting portfolio isA)B)C)D)E)Answer: D Difficulty: ModerateRationale: + = .21. A security has an expected rate of return of and a beta of . The marketexpected rate of return is and the risk-free rate is . The alpha of the stock isA) %.B) %.C) %.D) %.E) none of the above.Answer: A Difficulty: ModerateRationale: 10% - [5% +(8% - 5%)] = %.22. Your opinion is that CSCO has an expected rate of return of . It has abeta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: B Difficulty: ModerateRationale: % - 4% + % - 4%) = %; therefore, the security is overpriced.23. Your opinion is that CSCO has an expected rate of return of . It has abeta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: % - 4% + % - 4%) = %; therefore, the security is fairly priced.24. Your opinion is that CSCO has an expected rate of return of . It has abeta of . The risk-free rate is and the market expected rate of return is . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: 15% - 4% + % - 4%) = %; therefore, the security is under priced.25. Your opinion is that Boeing has an expected rate of return of . It hasa beta of . The risk-free rate is and the market expected rate of returnis . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: A Difficulty: ModerateRationale: % - 4% + (10% - 4%) = %; therefore, the security is under priced.26. Your opinion is that Boeing has an expected rate of return of . It hasa beta of . The risk-free rate is and the market expected rate of returnis . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: % - 4% + (10% - 4%) = %; therefore, the security is fairly priced.27. Your opinion is that Boeing has an expected rate of return of . It hasa beta of . The risk-free rate is and the market expected rate of returnis . According to the Capital Asset Pricing Model, this security isA) underpriced.B) overpriced.C) fairly priced.D) cannot be determined from data provided.E) none of the above.Answer: C Difficulty: ModerateRationale: % - 4% + (10% - 4%) = %; therefore, the security is overpriced.28. The risk-free rate is 4 percent. The expected market rate of return is11 percent. If you expect CAT with a beta of to offer a rate of returnof 10 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: B Difficulty: ModerateRationale: 10% < 4% + (11% - 4%) = %; therefore, stock is overpriced and should be shorted.29. The risk-free rate is 4 percent. The expected market rate of return is11 percent. If you expect CAT with a beta of to offer a rate ofreturnof 11 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: E Difficulty: ModerateRationale: 11% = 4% + (11% - 4%) = %; therefore, stock is fairly priced.30. The risk-free rate is 4 percent. The expected market rate of return is11 percent. If you expect CAT with a beta of to offer a rate of returnof 13 percent, you shouldA) buy stock X because it is overpriced.B) sell short stock X because it is overpriced.C) sell stock short X because it is underpriced.D) buy stock X because it is underpriced.E) none of the above, as the stock is fairly priced.Answer: D Difficulty: ModerateRationale: 13% > 4% + (11% - 4%) = %; therefore, stock is under priced.31. You invest 55% of your money in security A with a beta of and the restof your money in security B with a beta of . The beta of the resulting。

Multiple Choice Questions1. In 2005, ____________ was the most significant real asset of U. S. nonfinancialbusinesses in terms of total value.A) equipment and softwareB) inventoryC) real estateD) trade creditE) marketable securitiesAnswer: C Difficulty: EasyRationale: See Table 1.4.2. In 2005, ____________ was the least significant real asset of U. S. nonfinancialbusinesses in terms of total value.A) equipment and softwareB) inventoryC) real estateD) trade creditE) marketable securitiesAnswer: B Difficulty: EasyRationale: See Table 1.4.3. In 2005, ____________ was the least significant liability of U. S. nonfinancialbusinesses in terms of total value.A) bonds and mortgatgesB) bank loansC) inventoriesD) trade debtE) marketable securitiesAnswer: B Difficulty: EasyRationale: See Table 1.4.4. In 2005, ____________ was the most significant financial asset of U. S. nonfinancialbusinesses in terms of total value.A) cashB) trade creditC) trade debtD) inventoryE) marketable securitiesAnswer: B Difficulty: EasyRationale: See Table 1.4.5. The material wealth of a society is equal to the sum of _________.A) all financial assetsB) all real assetsC) all financial and real assetsD) all physical assetsE) none of the aboveAnswer: B Difficulty: EasyRationale: Financial assets do not directly contribute the productive capacity of the economy.6. ____________ of an investment bank.A) Citigroup is an exampleB) Merrill Lynch is an exampleC) Goldman is an exampleD) B and C are each examplesE) Each of the above is an exampleAnswer: E Difficulty: Easy7. _______ are financial assets.A) BondsB) MachinesC) StocksD) A and CE) A, B and CAnswer: D Difficulty: EasyRationale: Machines are real assets; stocks and bonds are financial assets.8. An example of a derivative security is ______.A) a common share of General MotorsB) a call option on Mobil stockC) a commodity futures contractD) B and CE) A and BAnswer: D Difficulty: EasyRationale: The values of B and C are derived from that of an underlying financial asset;the value of A is based on the value of the firm only.9. _______ was the first to introduce mortgage pass-through securities.A) Chase ManhattanB) CiticorpC) FNMAD) GNMAE) None of the aboveAnswer: D Difficulty: Easy10. A bond issue is broken up so that some investors will receive only interest paymentswhile others will receive only principal payments, which is an example of ________.A) bundlingB) credit enhancementC) unbundlingD) financial engineeringE) C and DAnswer: E Difficulty: EasyRationale: Unbundling is one of many examples of financial engineering that offer more alternatives to the investor.11. An example of a primitive security is __________.A) a common share of General MotorsB) a call option on Mobil stockC) a call option on a stock of a firm based in a Third World countryD) a U. S. government bondE) A and DAnswer: E Difficulty: EasyRationale: A primitive security's return is based only upon the earning power of the issuing agency, such as stock in General Motors and the U. S. government.12. The ____________ refers to the potential conflict between management andshareholders due to management's control of pecuniary rewards as well as thepossibility of incompetent performance by managers.A) agency problemB) diversification problemC) liquidity problemD) solvency problemE) regulatory problemAnswer: A Difficulty: EasyRationale: The agency problem describes potential conflict between management and shareholders. The other problems are those of firm management only.13. _________ financial asset(s).A) Buildings areB) Land is aC) Derivatives areD) U. S. Agency bonds areE) C and DAnswer: E Difficulty: EasyRationale: A and B are real assets.14. The value of a derivative security _______.A) depends on the value of the related primitive securityB) can only cause increased risk.C) is unrelated to the value of the related primitive securityD) has been enhanced due the recent misuse and negative publicity regarding theseinstrumentsE) is worthless todayAnswer: A Difficulty: EasyRationale: Of the factors cited above, only A affects the value of the derivative and/or isa true statement.15. In terms of total value, the most significant liability of U. S. nonfinancial businesses in2005 was _______.A) bank loansB) bonds and mortgagesC) trade debtD) other loansE) marketable securities.Answer: B Difficulty: EasyRationale: See Table 1.4.16. Money market funds were a financial innovation partly inspired to circumvent _______.A) Regulation B, which is still in existenceB) Regulation DC) DIDMCAD) Regulation ME) Regulation Q, which is no longer in existenceAnswer: E Difficulty: EasyRationale: Regulation Q limited the amount of interest that banks could pay todepositors; money market funds were not covered by Regulation Q and thus could pay a higher rate of interest. Although Regulation Q no longer exists, money market funds continue to be popular. See page 18.17. __________ are a way U. S. investor can invest in foreign companies.A) ADRsB) IRAsC) SDRsD) GNMAsE) KrugerrandsAnswer: A Difficulty: EasyRationale: Only ADRs represent an indirect investment in a foreign company.18. _______ are examples of financial intermediaries.A) Commercial banksB) Insurance companiesC) Investment companiesD) Credit unionsE) All of the aboveAnswer: E Difficulty: EasyRationale: All are institutions that bring borrowers and lenders together.19. Financial intermediaries exist because small investors cannot efficiently ________.A) diversify their portfoliosB) gather all relevant informationC) assess credit risk of borrowersD) advertise for needed investmentsE) all of the above.Answer: E Difficulty: EasyRationale: The individual investor cannot efficiently and effectively perform any of the tasks above without more time and knowledge than that available to most individual investors.20. Firms that specialize in helping companies raise capital by selling securities are called________.A) commercial banksB) investment banksC) savings banksD) credit unionsE) all of the above.Answer: B Difficulty: EasyRationale: An important role of investment banks is to act as middlemen in helping firms place new issues in the market.21. Financial assets ______.A) directly contribute to the country's productive capacityB) indirectly contribute to the country's productive capacityC) contribute to the country's productive capacity both directly and indirectlyD) do not contribute to the country's productive capacity either directly or indirectlyE) are of no value to anyoneAnswer: B Difficulty: EasyRationale: Financial assets indirectly contribute to the country's productive capacity because these assets permit individuals to invest in firms and governments. This in turn allows firms and governments to increase productive capacity.22. The sale of a mortgage portfolio by setting up mortgage pass-through securities is anexample of ________.A) credit enhancementB) securitizationC) unbundlingD) derivativesE) none of the aboveAnswer: B Difficulty: EasyRationale: The financial asset is secured by the mortgages backing the instrument.23. Corporate shareholders are best protected from incompetent management decisions byA) the ability to engage in proxy fights.B) management's control of pecuniary rewards.C) the ability to call shareholder meetings.D) the threat of takeover by other firms.E) one-share / one-vote election rules.Answer: D Difficulty: ModerateRationale: Proxy fights are expensive and seldom successful, and management may often control the board or own significant shares. It is the threat of takeover ofunderperforming firms that has the strongest ability to keep management on their toes.24. The national net worth of the U. S. in 2005 was _________.A) $15.411 trillionB) $26.431 trillionC) $42.669 trillionD) $55.651 trillionE) $70.983 trillionAnswer: C Difficulty: ModerateRationale: See Table 1.2.25. In 2005, _______ of the assets of U. S. households were financial assets as opposed totangible assets.A) 20.4%B) 34.2%C) 60.7%D) 71.7%E) 82.5%Answer: C Difficulty: ModerateRationale: See Table 1.1.26. Investment bankers perform the following role(s) ___________.A) market new stock and bond issues for firmsB) provide advice to the firms as to market conditions, price, etcC) design securities with desirable propertiesD) all of the aboveE) none of the aboveAnswer: D Difficulty: EasyRationale: Investment bankers perform all of the roles described above for their clients.27. Theoretically, takeovers should result in ___________.A) improved managementB) increased stock priceC) increased benefits to existing management of taken over firmD) A and BE) A, B, and CAnswer: D Difficulty: EasyRationale: Theoretically, when firms are taken over, better managers come in and thus increase the price of the stock; existing management often must either leave the firm, be demoted, or suffer a loss of existing benefits.28. Important trends changing the contemporary investment environment areA) globalization.B) securitization.C) information and computer networks.D) financial engineering.E) all of the aboveAnswer: E Difficulty: EasyRationale: All of these are examples of important trends in the contemporary investment environment.29. The means by which individuals hold their claims on real assets in a well-developedeconomy areA) investment assets.B) depository assets.C) derivative assetsD) financial assets.E) exchange-driven assetsAnswer: D Difficulty: EasyRationale: Financial assets allocate the wealth of the economy. Book example: it is easier for an individual to own shares of an auto company than to own an auto company directly.30. Which of the following financial assets makes up the greatest proportion of the financialassets held by U.S. households?A) pension reservesB) life insurance reservesC) mutual fund sharesD) debt securitiesE) personal trustsAnswer: A Difficulty: ModerateRationale: See Table 1.1.31. Which of the following are mechanisms that have evolved to mitigate potential agencyproblems?I)compensation in the form of the firm's stock optionsII)hiring bickering family members as corporate spiesIII)underperforming management teams being forced out by boards of directorsIV)security analysts monitoring the firm closelyV)takeover threatsA) II and VB) I, III, and IVC) I, III, IV, and VD) III, IV, and VE) I, III, and VAnswer: C Difficulty: ModerateRationale: All but the second option have been used to try to limit agency problems.32. Commercial banks differ from other businesses in that both their assets and theirliabilities are mostlyA) illiquid.B) financial.C) real.D) owned by the government.E) regulated.Answer: B Difficulty: EasyRationale: See Table 1.3.33. Which of the following is true about GNMA pass-throughs?I)They aggregate individual home mortgages into heterogeneous pools.II)The purchaser of a GNMA receives monthly interest and principal payments received from payments made on the pool.III)The banks that originated the mortgages maintain ownership of them.IV)The banks that originated the mortgages continue to service them.A) II, III, and IVB) I, II, and IVC) II and IVD) I, III, and IVE) I, II, III, and IVAnswer: B Difficulty: ModerateRationale: III is not correct because the bank no longer owns the mortgage investments.34. Although derivatives can be used as speculative instruments, businesses most often usethem toA) attract customers.B) appease stockholders.C) offset debt.D) hedge.E) enhance their balance sheets.Answer: D Difficulty: EasyRationale: Firms may use forward contracts and futures to protect against currency fluctuations or changes in commodity prices. Interest-rate options help companiescontrol financing costs.35. A WEBS securityA) limits the diversification potential of investors who hold it.B) may be traded only in the primary market.C) is linked directly to the value of a composite index of futures contracts.D) must be earned as a performance bonus within a corporation rather than purchased.E) tracks the performance of an index of share returns for a particular country.Answer: E Difficulty: ModerateRationale: WEBS (World Equity Benchmark Shares) allow investors to trade portfolios of foreign stocks in a selected country. They can be traded by investors in secondary markets (Amex) and allow U.S. investors to diversify their portfolios of foreign stocks.36. During the period between 2000 and 2002, a large number of scandals were uncovered.Most of these scandals were related toI)Manipulation of financial data to misrepresent the actual condition of the firm.II)Misleading and overly optimistic research reports produced by analysts.III)Allocating IPOs to executives as a quid pro quo for personal favors.IV)Greenmail.A) II, III, and IVB) I, II, and IVC) II and IVD) I, III, and IVE) I, II, and IIIAnswer: E Difficulty: ModerateRationale: I, II, and III are all mentioned as causes of recent scandals.37. A disadvantage of using stock options to compensate managers is thatA) it encourages mangers to undertake projects that will increase stock price.B) it encourages managers to engage in empire building.C) it can create an incentive for mangers to manipulate information to prop up a stockprice temporarily, giving them a chance to cash out before the price returns to alevel reflective of the firms true prospects.D) all of the above.E) none of the above.Answer: CRationale: A is a desired characteristic. B is not necessarily a good or bad thing in and of itself. C creates an agency problem.38. In 2005, ____________ was the most significant real asset of U. S. households in termsof total value.A) consumer durablesB) automobilesC) real estateD) mutual fund sharesE) bank loansAnswer: C Difficulty: EasyRationale: See Table 1.1.39. The largest component of domestic net worth in 2005 was ____________.A) non-residential real estateB) residential real estateC) inventoriesD) consumer durablesE) equipment and softwareAnswer: B Difficulty: ModerateRationale: See Table 1.2.40. A fixed-income security pays ____________.A) a fixed level of income for the life of the ownerB) a fixed level of income for the life of the securityC) a variable level of income for owners on a fixed incomeD) a fixed or variable income stream at the option of the ownerE) none of the aboveAnswer: B Difficulty: EasyRationale: Only answer B is correct.41. Money market securities ____________.A) are short termB) pay a fixed incomeC) are highly marketableD) generally very low riskE) all of the aboveAnswer: E Difficulty: EasyRationale: All answers are correct.42. Financial assets permit all of the following except ____________.A) consumption timingB) allocation of riskC) separation of ownership and controlD) elimination of riskE) all of the aboveAnswer: D Difficulty: ModerateRationale: Financial assets do not allow risk to be eliminated. However, they do permit allocation of risk, consumption timing, and separation of ownership and control.43. The Sarbanes-Oxley Act ____________.A) requires corporations to have more independent directorsB) requires the firm's CFO to personally vouch for the firm's accounting statementsC) prohibits auditing firms from providing other services to clientsD) A and B are correct.E) A, B, and C are correct.Answer: E Difficulty: ModerateRationale: The Sarbanes-Oxley Act does all of the above.44. Asset allocation refers to ____________.A) choosing which securities to hold based on their valuationB) investing only in “safe” securitiesC) the allocation of assets into broad asset classesD) bottom-up analysisE) all of the aboveAnswer: C Difficulty: ModerateRationale: Asset allocation refers to the allocation of assets into broad asset classes.45. Which of the following portfolio construction methods starts with security analysis?A) Top-downB) Bottom-upC) Middle-outD) Buy and holdE) Asset allocationAnswer: B Difficulty: ModerateRationale: Bottom-up refers to using security analysis to find securities that areattractively priced. Top-down refers to using asset allocation as a starting point.46. Which of the following portfolio construction methods starts with asset allocation?A) Top-downB) Bottom-upC) Middle-outD) Buy and holdE) Asset allocationAnswer: A Difficulty: ModerateRationale: Bottom-up refers to using security analysis to find securities that areattractively priced.Essay Questions47. Discuss the agency problem in detail.Difficulty: ModerateAnswer:Managers are the agents of the shareholders, and should act on their behalf to maximize shareholder wealth (the value of the stock). A conflict (the agency conflict) arises when managers take self-interested actions to the detriment of shareholders. The roles of the board of directors selected by the shareholders are to oversee management and tominimize agency problems. However, often these boards are figureheads, andindividual shareholders do not own large enough blocks of the shares to overridemanagement actions. One potential resolution of an agency problem occurs wheninefficient management actions cause the price of the stock to be depressed. The firm may then become a takeover target. If the acquisition is successful, managers may be replaced and potentially, stockholders benefit.The question is designed to ascertain that the student understands the corporaterelationship between shareholders, management, and the board of directors. In addition, this problem has been addressed extensively in recent years, both in the popularfinancial press during the mergers and acquisitions mania of the 1980s, and in theacademic literature as agency theory.48. Discuss the similarities and differences between real and financial assets.Difficulty: ModerateAnswer:Real assets represent the productive capacity of the firm, and appear as assets on the firm's balance sheet. Financial assets are claims against the firm, and thus appear as liabilities on the firm's balance sheet. On the other hand, financial assets are listed on the asset side of the balance sheet of the individuals who own them. Thus, whenfinancial statements are aggregated across the economy, the financial assets cancel out, leaving only the real assets, which directly contribute to the productive capacity of the economy. Financial assets contribute indirectly only.The purpose of this question is to ascertain if the student understands the difference between real and financial assets, both in the aggregate balance sheet context and the relative contribution of the two types of assets to the productive capacity of theeconomy.49. Discuss the euro in relation to its impact on globalization. How is it currently used andwhat are the plans for its future use?Difficulty: ModerateAnswer:The euro was introduced in 1999 as a new currency and has replaced the currencies of twelve participating countries so there will be one common European currency in the participating countries. A common currency is expected to facilitate global trade and encourage the integration of markets across national boundaries.50. Discuss the following ongoing trends as they relate to the field of investments:globalization, financial engineering, securitization, and computer networksDifficulty: ModerateAnswer:Globalization offers a wider array of investment choices than what would be available to investors who could only choose domestic securities. As efficient communication technology has become available, globalization of markets has been significantlyenhanced. There are many mechanisms by which one country's investors can holdforeign companies' securities. Some examples are ADRs, WEBS, and direct purchase of foreign securities.Securitization refers to aggregating underlying financial assets, such as mortgages, into pools and then offering a security that represents a claim on these underlying assets.Examples are GNMAs. Securitization allows investors to hold partial ownership in financial assets that would otherwise be beyond their reach (e.g., mortgages).Financial engineering involves bundling or unbundling. Bundling involves combining separate securities together into one composite security. Examples are combiningprimitive and derivative securities, and combining three primitive securities such as common stock, preferred stock, and bonds. Unbundling is the opposite - two or more security classes are created by separating a composite security into parts.Computer networks have permitted online trading, online information dissemination and automated trade crossing. Each of these major breakthroughs has significantimplications for investments.。

Multiple Choice Questions1. ________ is equal to the total market value of the firm's common stock divided by (thereplacement cost of the firm's assets less liabilities).A) Book value per shareB) Liquidation value per shareC) Market value per shareD) Tobin's QE) None of the above.Answer: D Difficulty: EasyRationale: Book value per share is assets minus liabilities divided by number of shares.Liquidation value per share is the amount a shareholder would receive in the event ofbankruptcy. Market value per share is the market price of the stock.2. High P/E ratios tend to indicate that a company will _______, ceteris paribus.A) grow quicklyB) grow at the same speed as the average companyC) grow slowlyD) not growE) none of the aboveAnswer: A Difficulty: EasyRationale: Investors pay for growth; hence the high P/E ratio for growth firms; however, the investor should be sure that he or she is paying for expected, not historic, growth.3. _________ is equal to (common shareholders' equity/common shares outstanding).A) Book value per shareB) Liquidation value per shareC) Market value per shareD) Tobin's QE) none of the aboveAnswer: A Difficulty: EasyRationale: See rationale for test bank question 18.14. ________ are analysts who use information concerning current and prospectiveprofitability of a firms to assess the firm's fair market value.A) Credit analystsB) Fundamental analystsC) Systems analystsD) Technical analystsE) SpecialistsAnswer: B Difficulty: EasyRationale: Fundamentalists use all public information in an attempt to value stock (while hoping to identify undervalued securities).5. The _______ is defined as the present value of all cash proceeds to the investor in thestock.A) dividend payout ratioB) intrinsic valueC) market capitalization rateD) plowback ratioE) none of the aboveAnswer: B Difficulty: EasyRationale: The cash flows from the stock discounted at the appropriate rate, based on the perceived riskiness of the stock, the market risk premium and the risk free rate, determine the intrinsic value of the stock.6. _______ is the amount of money per common share that could be realized by breakingup the firm, selling the assets, repaying the debt, and distributing the remainder to shareholders.A) Book value per shareB) Liquidation value per shareC) Market value per shareD) Tobin's QE) None of the aboveAnswer: B Difficulty: EasyRationale: See explanation for test bank question 18.1.7. Since 1955, Treasury bond yields and earnings yields on stocks were_______.A) identicalB) negatively correlatedC) positively correlatedD) uncorrelatedAnswer: C Difficulty: EasyRationale: The earnings yield on stocks equals the expected real rate of return on the stock market, which should be equal to the yield to maturity on Treasury bonds plus a risk premium, which may change slowly over time. The yields are plotted in Figure18.8.8. Historically, P/E ratios have tended to be _________.A) higher when inflation has been highB) lower when inflation has been highC) uncorrelated with inflation rates but correlated with other macroeconomic variablesD) uncorrelated with any macroeconomic variables including inflation ratesE) none of the aboveAnswer: B Difficulty: EasyRationale: P/E ratios have tended to be lower when inflation has been high, reflecting the market's assessment that earnings in these periods are of "lower quality", i.e.,artificially distorted by inflation, and warranting lower P/E ratios.9. The ______ is a common term for the market consensus value of the required return ona stock.A) dividend payout ratioB) intrinsic valueC) market capitalization rateD) plowback rateE) none of the aboveAnswer: C Difficulty: EasyRationale: The market capitalization rate, which consists of the risk-free rate, thesystematic risk of the stock and the market risk premium, is the rate at which a stock's cash flows are discounted in order to determine intrinsic value.10. The _________ is the fraction of earnings reinvested in the firm.A) dividend payout ratioB) retention rateC) plowback ratioD) A and CE) B and CAnswer: E Difficulty: EasyRationale: Retention rate, or plowback ratio, represents the earnings reinvested in the firm. The retention rate, or (1 - plowback) = dividend payout.11. The Gordon modelA) is a generalization of the perpetuity formula to cover the case of a growingperpetuity.B) is valid only when g is less than k.C) is valid only when k is less than g.D) A and B.E) A and C.Answer: D Difficulty: EasyRationale: The Gordon model assumes constant growth indefinitely. Mathematically, g must be less than k; otherwise, the intrinsic value is undefined.12. You wish to earn a return of 13% on each of two stocks, X and Y. Stock X is expectedto pay a dividend of $3 in the upcoming year while Stock Y is expected to pay adividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock X ______.A) cannot be calculated without knowing the market rate of returnB) will be greater than the intrinsic value of stock YC) will be the same as the intrinsic value of stock YD) will be less than the intrinsic value of stock YE) none of the above is a correct answer.Answer: D Difficulty: EasyRationale: PV0 = D1/(k-g); given k and g are equal, the stock with the larger dividend will have the higher value.13. You wish to earn a return of 11% on each of two stocks, C and D. Stock C is expected topay a dividend of $3 in the upcoming year while Stock D is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock C ______.A) will be greater than the intrinsic value of stock DB) will be the same as the intrinsic value of stock DC) will be less than the intrinsic value of stock DD) cannot be calculated without knowing the market rate of returnE) none of the above is a correct answer.Answer: C Difficulty: EasyRationale: PV0 = D1/(k-g); given k and g are equal, the stock with the larger dividend will have the higher value.14. You wish to earn a return of 12% on each of two stocks, A and B. Each of the stocks isexpected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock A and 10% for stock B. The intrinsic value of stock A _____.A) will be greater than the intrinsic value of stock BB) will be the same as the intrinsic value of stock BC) will be less than the intrinsic value of stock BD) cannot be calculated without knowing the rate of return on the market portfolio.E) none of the above is a correct statement.Answer: C Difficulty: EasyRationale: PV0 = D1/(k-g); given that dividends are equal, the stock with the higher growth rate will have the higher value.15. You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks isexpected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C _____.A) will be greater than the intrinsic value of stock DB) will be the same as the intrinsic value of stock DC) will be less than the intrinsic value of stock DD) cannot be calculated without knowing the rate of return on the market portfolio.E) none of the above is a correct statement.Answer: C Difficulty: EasyRationale: PV0 = D1/(k-g); given that dividends are equal, the stock with the higher growth rate will have the higher value.16. Each of two stocks, A and B, are expected to pay a dividend of $5 in the upcoming year.The expected growth rate of dividends is 10% for both stocks. You require a rate of return of 11% on stock A and a return of 20% on stock B. The intrinsic value of stock A _____.A) will be greater than the intrinsic value of stock BB) will be the same as the intrinsic value of stock BC) will be less than the intrinsic value of stock BD) cannot be calculated without knowing the market rate of return.E) none of the above is true.Answer: A Difficulty: EasyRationale: PV0 = D1/(k-g); given that dividends are equal, the stock with the larger required return will have the lower value.17. Each of two stocks, C and D, are expected to pay a dividend of $3 in the upcoming year.The expected growth rate of dividends is 9% for both stocks. You require a rate ofreturn of 10% on stock C and a return of 13% on stock D. The intrinsic value of stock C _____.A) will be greater than the intrinsic value of stock DB) will be the same as the intrinsic value of stock DC) will be less than the intrinsic value of stock DD) cannot be calculated without knowing the market rate of return.E) none of the above is true.Answer: A Difficulty: EasyRationale: PV0 = D1/(k-g); given that dividends are equal, the stock with the larger required return will have the lower value.18. If the expected ROE on reinvested earnings is equal to k, the multistage DDM reducestoA) V0 = (Expected Dividend Per Share in Year 1)/kB) V0 = (Expected EPS in Year 1)/kC) V0 = (Treasury Bond Yield in Year 1)/kD) V0 = (Market return in Year 1)/kE) none of the aboveAnswer: B Difficulty: ModerateRationale: If ROE = k, no growth is occurring; b = 0; EPS = DPS19. Low Tech Company has an expected ROE of 10%. The dividend growth rate will be________ if the firm follows a policy of paying 40% of earnings in the form ofdividends.A) 6.0%B) 4.8%C) 7.2%D) 3.0%E) none of the aboveAnswer: A Difficulty: EasyRationale: 10% X 0.60 = 6.0%.20. Music Doctors Company has an expected ROE of 14%. The dividend growth rate willbe ________ if the firm follows a policy of paying 60% of earnings in the form ofdividends.A) 4.8%B) 5.6%C) 7.2%D) 6.0%E) none of the aboveAnswer: B Difficulty: EasyRationale: 14% X 0.40 = 5.6%.21. Medtronic Company has an expected ROE of 16%. The dividend growth rate will be________ if the firm follows a policy of paying 70% of earnings in the form ofdividends.A) 3.0%B) 6.0%C) 7.2%D) 4.8%E) none of the aboveAnswer: D Difficulty: EasyRationale: 16% X 0.30 = 4.8%.22. High Speed Company has an expected ROE of 15%. The dividend growth rate will be________ if the firm follows a policy of paying 50% of earnings in the form ofdividends.A) 3.0%B) 4.8%C) 7.5%D) 6.0%E) none of the aboveAnswer: C Difficulty: EasyRationale: 15% X 0.50 = 7.5%.23. Light Construction Machinery Company has an expected ROE of 11%. The dividendgrowth rate will be _______ if the firm follows a policy of paying 25% of earnings in the form of dividends.A) 3.0%B) 4.8%C) 8.25%D) 9.0%E) none of the aboveAnswer: C Difficulty: EasyRationale: 11% X 0.75 = 8.25%.24. Xlink Company has an expected ROE of 15%. The dividend growth rate will be_______ if the firm follows a policy of plowing back 75% of earnings.A) 3.75%B) 11.25%C) 8.25%D) 15.0%E) none of the aboveAnswer: B Difficulty: EasyRationale: 15% X 0.75 = 11.25%.25. Think Tank Company has an expected ROE of 26%. The dividend growth rate will be_______ if the firm follows a policy of plowing back 90% of earnings.A) 2.6%B) 10%C) 23.4%D) 90%E) none of the aboveAnswer: C Difficulty: EasyRationale: 26% X 0.90 = 23.4%.26. Bubba Gumm Company has an expected ROE of 9%. The dividend growth rate will be_______ if the firm follows a policy of plowing back 10% of earnings.A) 90%B) 10%C) 9%D) 0.9%E) none of the aboveAnswer: D Difficulty: EasyRationale: 9% X 0.10 = 0.9%.27. A preferred stock will pay a dividend of $2.75 in the upcoming year, and every yearthereafter, i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.A) $0.275B) $27.50C) $31.82D) $56.25E) none of the aboveAnswer: B Difficulty: ModerateRationale: 2.75 / .10 = 27.5028. A preferred stock will pay a dividend of $3.00in the upcoming year, and every yearthereafter, i.e., dividends are not expected to grow. You require a return of 9% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.A) $33.33B) $0..27C) $31.82D) $56.25E) none of the aboveAnswer: A Difficulty: ModerateRationale: 3.00 / .09 = 33.3329. A preferred stock will pay a dividend of $1.25 in the upcoming year, and every yearthereafter, i.e., dividends are not expected to grow. You require a return of 12% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.A) $11.56B) $9.65C) $11.82D) $10.42E) none of the aboveAnswer: D Difficulty: ModerateRationale: 1.25 / .12 = 10.4230. A preferred stock will pay a dividend of $3.50 in the upcoming year, and every yearthereafter, i.e., dividends are not expected to grow. You require a return of 11% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.A) $0.39B) $0.56C) $31.82D) $56.25E) none of the aboveAnswer: C Difficulty: ModerateRationale: 3.50 / .11 = 31.8231. A preferred stock will pay a dividend of $7.50 in the upcoming year, and every yearthereafter, i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.A) $0.75B) $7.50C) $64.12D) $56.25E) none of the aboveAnswer: E Difficulty: ModerateRationale: 7.50 / .10 = 75.0032. A preferred stock will pay a dividend of $6.00 in the upcoming year, and every yearthereafter, i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.A) $0.60B) $6.00C) $600D) $5.40E) none of the aboveAnswer: E Difficulty: ModerateRationale: 6.00 / .10 = 60.0033. You are considering acquiring a common stock that you would like to hold for one year.You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.A) $30.23B) $24.11C) $26.52D) $27.50E) none of the aboveAnswer: A Difficulty: ModerateRationale: .10 = (32 - P + 1.25) / P; .10P = 32 - P + 1.25; 1.10P = 33.25; P = 30.23.34. You are considering acquiring a common stock that you would like to hold for one year.You expect to receive both $0.75 in dividends and $16 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 12% return.A) $23.91B) $14.96C) $26.52D) $27.50E) none of the aboveAnswer: B Difficulty: ModerateRationale: .12 = (16 - P + 0.75) / P; .12P = 16 - P + 0.75; 1.12P = 16.75; P = 14.96. 35. You are considering acquiring a common stock that you would like to hold for one year.You expect to receive both $2.50 in dividends and $28 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 15% return.A) $23.91B) $24.11C) $26.52D) $27.50E) none of the aboveAnswer: C Difficulty: ModerateRationale: .15 = (28 - P + 2.50) / P; .15P = 28 - P + 2.50; 1.15P = 30.50; P = 26.52. 36. You are considering acquiring a common stock that you would like to hold for one year.You expect to receive both $3.50 in dividends and $42 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.A) $23.91B) $24.11C) $26.52D) $27.50E) none of the aboveAnswer: E Difficulty: ModerateRationale: .10 = (42 - P + 3.50) / P; .10P = 42 - P + 3.50; 1.1P = 45.50; P = 41.36.Use the following to answer questions 37-40:Paper Express Company has a balance sheet which lists $85 million in assets, $40 million in liabilities and $45 million in common shareholders' equity. It has 1,400,000 common shares outstanding. The replacement cost of the assets is $115 million. The market share price is $90.37. What is Paper Express's book value per share?A) $1.68B) $2.60C) $32.14D) $60.71E) none of the aboveAnswer: C Difficulty: ModerateRationale: $45M/1.4M = $32.14.38. What is Paper Express's market value per share?A) $1.68B) $2.60C) $32.14D) $60.71E) none of the aboveAnswer: E Difficulty: Easy39. What is Paper Express's replacement cost per share?A) $1.68B) $2.60C) $53.57D) $60.71E) none of the aboveAnswer: C Difficulty: ModerateRationale: $115M - 40M/1.4M = $53.57.40. What is Paper Express's Tobin's q?A) 1.68B) 2.60C) 53.57D) 60.71E) none of the aboveAnswer: A Difficulty: ModerateRationale: $90/ 53.57 = 1.6841. One of the problems with attempting to forecast stock market values is thatA) there are no variables that seem to predict market return.B) the earnings multiplier approach can only be used at the firm level.C) the level of uncertainty surrounding the forecast will always be quite high.D) dividend payout ratios are highly variable.E) none of the above.Answer: C Difficulty: EasyRationale: Although some variables such as market dividend yield appear to be strongly related to market return, the market has great variability and so the level of uncertainty in any forecast will be high.42. The most popular approach to forecasting the overall stock market is to useA) the dividend multiplier.B) the aggregate return on assets.C) the historical ratio of book value to market value.D) the aggregate earnings multiplier.E) Tobin's Q.Answer: D Difficulty: EasyRationale: The earnings multiplier approach is the most popular approach to forecasting the overall stock market.Use the following to answer questions 43-44:Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4% and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25.43. The market's required rate of return on Sure's stock is _____.A) 14.0%B) 17.5%C) 16.5%D) 15.25%E) none of the aboveAnswer: C Difficulty: ModerateRationale: 4% + 1.25(14% - 4%) = 16.5%.44. What is the intrinsic value of Sure's stock today?A) $20.60B) $20.00C) $12.12D) $22.00E) none of the aboveAnswer: A Difficulty: DifficultRationale: k = .04 + 1.25 (.14 - .04); k = .165; .165 = (22 - P + 2) / P; .165P = 24 - P;1.165P = 24 ; P = 20.60.45. If Sure's intrinsic value is $21.00 today, what must be its growth rate?A) 0.0%B) 10%C) 4%D) 6%E) 7%Answer: E Difficulty: DifficultRationale: k = .04 + 1.25 (.14 - .04); k = .165; .165 = 2/21 + g; g = .07Use the following to answer questions 46-47:Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2.46. What is the return you should require on Torque's stock?A) 12.0%B) 14.6%C) 15.6%D) 20%E) none of the aboveAnswer: B Difficulty: ModerateRationale: 5% + 1.2(13% - 5%) = 14.6%.47. What is the intrinsic value of Torque's stock?A) $14.29B) $14.60C) $12.33D) $11.62E) none of the aboveAnswer: D Difficulty: DifficultRationale: k = 5% + 1.2(13% - 5%) = 14.6%; P = 1 / (.146 - .06) = $11.62.48. Midwest Airline is expected to pay a dividend of $7 in the coming year. Dividends areexpected to grow at the rate of 15% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Midwest Airline has a beta of 3.00. The return you should require on the stock is ________.A) 10%B) 18%C) 30%D) 42%E) none of the aboveAnswer: C Difficulty: ModerateRationale: 6% + 3(14% - 6%) = 30%.49. Fools Gold Mining Company is expected to pay a dividend of $8 in the upcoming year.Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Fools Gold Mining Company has a beta of -0.25. The return you should require on the stock is ________.A) 2%B) 4%C) 6%D) 8%E) none of the aboveAnswer: B Difficulty: ModerateRationale: 6% + [-0.25(14% - 6%)] = 4%.50. High Tech Chip Company is expected to have EPS in the coming year of $2.50. Theexpected ROE is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 70%, the growth rate of dividends should beA) 5.00%B) 6.25%C) 6.60%D) 7.50%E) 8.75%Answer: E Difficulty: EasyRationale: 12.5% X 0.7 = 8.75%.51. A company paid a dividend last year of $1.75. The expected ROE for next year is14.5%. An appropriate required return on the stock is 10%. If the firm has a plowbackratio of 75%, the dividend in the coming year should beA) $1.80B) $2.12C) $1.77D) $1.94E) none of the aboveAnswer: D Difficulty: ModerateRationale: g = .155 X .75 = 10.875%; $1.75(1.10875) = $1.9452. High Tech Chip Company paid a dividend last year of $2.50. The expected ROE fornext year is 12.5%. An appropriate required return on the stock is 11%. If the firm hasa plowback ratio of 60%, the dividend in the coming year should beA) $1.00B) $2.50C) $2.69D) $2.81E) none of the aboveAnswer: C Difficulty: ModerateRationale: g = .125 X .6 = 7.5%; $2.50(1.075) = $2.6953. Suppose that the average P/E multiple in the oil industry is 20. Dominion Oil isexpected to have an EPS of $3.00 in the coming year. The intrinsic value of Dominion Oil stock should be _____.A) $28.12B) $35.55C) $60.00D) $72.00E) none of the aboveAnswer: C Difficulty: EasyRationale: 20 X $3.00 = $60.00.54. Suppose that the average P/E multiple in the oil industry is 22. Exxon Oil is expected tohave an EPS of $1.50 in the coming year. The intrinsic value of Exxon Oil stock should be _____.A) $33.00B) $35.55C) $63.00D) $72.00E) none of the aboveAnswer: A Difficulty: EasyRationale: 22 X $1.50 = $33.00.55. Suppose that the average P/E multiple in the oil industry is 16. Mobil Oil is expected tohave an EPS of $4.50 in the coming year. The intrinsic value of Mobil Oil stock should be _____.A) $28.12B) $35.55C) $63.00D) $72.00E) none of the aboveAnswer: D Difficulty: EasyRationale: 16 X $4.50 = $72.00.56. Suppose that the average P/E multiple in the gas industry is 17. KMP is expected tohave an EPS of $5.50 in the coming year. The intrinsic value of KMP stock should be _____.A) $28.12B) $93.50C) $63.00D) $72.00E) none of the aboveAnswer: B Difficulty: EasyRationale: 17 X $5.50 = $93.50.57. An analyst has determined that the intrinsic value of HPQ stock is $20 per share usingthe capitalized earnings model. If the typical P/E ratio in the computer industry is 25, then it would be reasonable to assume the expected EPS of HPQ in the coming year is ______.A) $3.63B) $4.44C) $0.80D) $22.50E) none of the aboveAnswer: C Difficulty: EasyRationale: $20(1/25) = $0.80.58. An analyst has determined that the intrinsic value of Dell stock is $34 per share usingthe capitalized earnings model. If the typical P/E ratio in the computer industry is 27, then it would be reasonable to assume the expected EPS of Dell in the coming year is ______.A) $3.63B) $4.44C) $14.40D) $1.26E) none of the aboveAnswer: D Difficulty: EasyRationale: $34(1/27) = $1.26.59. An analyst has determined that the intrinsic value of IBM stock is $80 per share usingthe capitalized earnings model. If the typical P/E ratio in the computer industry is 22, then it would be reasonable to assume the expected EPS of IBM in the coming year is ______.A) $3.64B) $4.44C) $14.40D) $22.50E) none of the aboveAnswer: A Difficulty: EasyRationale: $80(1/22) = $3.64.60. Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the comingyear. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Old Quartz Gold Mining Company has a beta of -0.25. The intrinsic value of the stock is ______.A) $80.00B) 133.33C) $200.00D) $400.00E) none of the aboveAnswer: B Difficulty: DifficultRationale: k = 6% + [-0.25(14% - 6%)] = 4%; P = 8 / [.04 - (-.02)] = $133.33.61. Low Fly Airline is expected to pay a dividend of $7 in the coming year. Dividends areexpected to grow at the rate of 15% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of low Fly Airline has a beta of 3.00. The intrinsic value of the stock is ______.A) $46.67B) $50.00C) $56.00D) $62.50E) none of the aboveAnswer: A Difficulty: ModerateRationale: 6% + 3(14% - 6%) = 30%; P = 7 / (.30 - .15) = $46.67.62. Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year.Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Sunshine Corporation has a beta of 0.75. The intrinsic value of the stock is _______.A) $10.71B) $15.00C) $17.75D) $25.00E) none of the aboveAnswer: D Difficulty: ModerateRationale: 6% + 0.75(14% - 6%) = 12%; P = 1.50 / (.12 - .06) = $25.63. Low Tech Chip Company is expected to have EPS in the coming year of $2.50. Theexpected ROE is 14%. An appropriate required return on the stock is 11%. If the firm has a dividend payout ratio of 40%, the intrinsic value of the stock should beA) $22.73B) $27.50C) $28.57D) $38.46E) none of the aboveAnswer: D Difficulty: DifficultRationale: g = 14% X 0.6 = 8.4%; Expected DPS = $2.50(0.4) = $1.00; P = 1 / (.11 - .084) = $38.46.Use the following to answer questions 64-65:Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year. Dividends are expected to grow at a rate of 10% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The stock is trading in the market today at a price of $90.00.64. What is the market capitalization rate for Risk Metrics?A) 13.6%B) 13.9%C) 15.6%D) 16.9%E) none of the aboveAnswer: B Difficulty: ModerateRationale: k = 3.50 / 90 + .10; k = 13.9%65. What is the approximate beta of Risk Metrics's stock?A) 0.8B) 1.0C) 1.1D) 1.4E) none of the aboveAnswer: C Difficulty: DifficultRationale: k = 13.9% from 18.64; 13.9 = 5% + b(13% - 5%) = 1.11.66. The market capitalization rate on the stock of Flexsteel Company is 12%. The expectedROE is 13% and the expected EPS are $3.60. If the firm's plowback ratio is 50%, the P/E ratio will be _________.A) 7.69B) 8.33C) 9.09D) 11.11E) none of the aboveAnswer: C Difficulty: DifficultRationale: g = 13% X 0.5 = 6.5%; .5/(.12-.065) = 9.09。

Multiple Choice Questions1. ___________ a relationship between expected return and risk.A) APT stipulatesB) CAPM stipulatesC) Both CAPM and APT stipulateD) Neither CAPM nor APT stipulateE) No pricing model has foundAnswer: C Difficulty: EasyRationale: Both models attempt to explain asset pricing based on risk/returnrelationships.2. Which pricing model provides no guidance concerning the determination of the riskpremium on factor portfolios?A) The CAPMB) The multifactor APTC) Both the CAPM and the multifactor APTD) Neither the CAPM nor the multifactor APTE) None of the above is a true statement.Answer: B Difficulty: ModerateRationale: The multifactor APT provides no guidance as to the determination of the risk premium on the various factors. The CAPM assumes that the excess market return over the risk-free rate is the market premium in the single factor CAPM.3. An arbitrage opportunity exists if an investor can construct a __________ investmentportfolio that will yield a sure profit.A) positiveB) negativeC) zeroD) all of the aboveE) none of the aboveAnswer: C Difficulty: EasyRationale: If the investor can construct a portfolio without the use of the investor's own funds and the portfolio yields a positive profit, arbitrage opportunities exist.4. The APT was developed in 1976 by ____________.A) LintnerB) Modigliani and MillerC) RossD) SharpeE) none of the aboveAnswer: C Difficulty: EasyRationale: Ross developed this model in 1976.5. A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 onone of the factors and a beta of 0 on any other factor.A) factorB) marketC) indexD) A and BE) A, B, and CAnswer: A Difficulty: EasyRationale: A factor model portfolio has a beta of 1 one factor, with zero betas on other factors.6. The exploitation of security mispricing in such a way that risk-free economic profitsmay be earned is called ___________.A) arbitrageB) capital asset pricingC) factoringD) fundamental analysisE) none of the aboveAnswer: A Difficulty: EasyRationale: Arbitrage is earning of positive profits with a zero (risk-free) investment.7. In developing the APT, Ross assumed that uncertainty in asset returns was a result ofA) a common macroeconomic factorB) firm-specific factorsC) pricing errorD) neither A nor BE) both A and BAnswer: E Difficulty: ModerateRationale: Total risk (uncertainty) is assumed to be composed of both macroeconomic and firm-specific factors.8. The ____________ provides an unequivocal statement on the expected return-betarelationship for all assets, whereas the _____________ implies that this relationship holds for all but perhaps a small number of securities.A) APT, CAPMB) APT, OPMC) CAPM, APTD) CAPM, OPME) none of the aboveAnswer: C Difficulty: ModerateRationale: The CAPM is an asset-pricing model based on the risk/return relationship of all assets. The APT implies that this relationship holds for all well-diversified portfolios, and for all but perhaps a few individual securities.9. Consider a single factor APT. Portfolio A has a beta of 1.0 and an expected return of16%. Portfolio B has a beta of 0.8 and an expected return of 12%. The risk-free rate of return is 6%. 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, AB) A, BC) B, AD) B, BE) A, the riskless assetAnswer: C Difficulty: ModerateRationale: A: 16% = 1.0F + 6%; F = 10%; B: 12% = 0.8F + 6%: F = 7.5%; thus, short B and take a long position in A.10. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of13%. 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, AB) A, BC) B, AD) B, BE) none of the aboveAnswer: C Difficulty: ModerateRationale: A: 13% = 10% + 0.2F; F = 15%; B: 15% = 10% + 0.4F; F = 12.5%; therefore, short B and take a long position in A.11. Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. Thebeta of a well-diversified portfolio on the factor is 1.1. The variance of returns on the well-diversified portfolio is approximately __________.A) 3.6%B) 6.0%C) 7.3%D) 10.1%E) none of the aboveAnswer: C Difficulty: ModerateRationale: s2P = (1.1)2(6%) = 7.26%.12. Consider the one-factor APT. The standard deviation of returns on a well-diversifiedportfolio is 18%. The standard deviation on the factor portfolio is 16%. The beta of the well-diversified portfolio is approximately __________.A) 0.80B) 1.13C) 1.25D) 1.56E) none of the aboveAnswer: B Difficulty: ModerateRationale: (18%)2 = (16%)2 b2; b = 1.125.13. Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%,respectively. The risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has a beta of __________.A) 0.67B) 1.00C) 1.30D) 1.69E) none of the aboveAnswer: E Difficulty: ModerateRationale: A: 15% = 6% + bF; B: 8% = 6% + 1.0F; F = 12%; thus, beta of A = 9/12 =0.75.14. Consider the multifactor APT with two factors. Stock A has an expected return of16.4%, a beta of 1.4 on factor 1 and a beta of .8 on factor 2. The risk premium on thefactor 1 portfolio is 3%. The risk-free rate of return is 6%. What is the risk-premium on factor 2 if no arbitrage opportunities exit?A) 2%B) 3%C) 4%D) 7.75%E) none of the aboveAnswer: D Difficulty: DifficultRationale: 16.4% = 1.4(3%) + .8x + 6%; x = 7.75.15. Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 onfactor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and factor 2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________if no arbitrage opportunities exist.A) 13.5%B) 15.0%C) 16.5%D) 23.0%E) none of the aboveAnswer: C Difficulty: ModerateRationale: 7% + 0.75(1%) + 1.25(7%) = 16.5%.16. Consider the multifactor APT with two factors. The risk premiums on the factor 1 andfactor 2 portfolios are 5% and 6%, respectively. Stock A has a beta of 1.2 on factor 1, and a beta of 0.7 on factor 2. The expected return on stock A is 17%. If no arbitrage opportunities exist, the risk-free rate of return is ___________.A) 6.0%B) 6.5%C) 6.8%D) 7.4%E) none of the aboveAnswer: C Difficulty: ModerateRationale: 17% = x% + 1.2(5%) + 0.7(6%); x = 6.8%.17. Consider a one-factor economy. Portfolio A has a beta of 1.0 on the factor and portfolioB has a beta of 2.0 on the factor. The expected returns on portfolios A and B are 11%and 17%, respectively. Assume that the risk-free rate is 6% and that arbitrageopportunities exist. Suppose you invested $100,000 in the risk-free asset, $100,000 in portfolio B, and sold short $200,000 of portfolio A. Your expected profit from this strategy would be ______________.A) -$1,000B) $0C) $1,000D) $2,000E) none of the aboveAnswer: C Difficulty: ModerateRationale: $100,000(0.06) = $6,000 (risk-free position); $100,000(0.17) = $17,000(portfolio B); -$200,000(0.11) = -$22,000 (short position, portfolio A); 1,000 profit. 18. Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified.The betas of portfolios A and B are 1.0 and 1.5, respectively. The expected returns on portfolios A and B are 19% and 24%, respectively. Assuming no arbitrageopportunities exist, the risk-free rate of return must be ____________.A) 4.0%B) 9.0%C) 14.0%D) 16.5%E) none of the aboveAnswer: B Difficulty: ModerateRationale: A: 19% = r f + 1(F); B:24% = r f + 1.5(F); 5% = .5(F); F = 10%; 24% = r f +1.5(10); ff = 9%.19. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfoliosare 5% and 3%, respectively. The risk-free rate of return is 10%. Stock A has anexpected return of 19% and a beta on factor 1 of 0.8. Stock A has a beta on factor 2 of ________.A) 1.33B) 1.50C) 1.67D) 2.00E) none of the aboveAnswer: C Difficulty: ModerateRationale: 19% = 10% + 5%(0.8) + 3%(x); x = 1.67.20. Consider the single factor APT. Portfolios A and B have expected returns of 14% and18%, respectively. The risk-free rate of return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities are ruled out, portfolio B must have a beta of __________.A) 0.45B) 1.00C) 1.10D) 1.22E) none of the aboveAnswer: C Difficulty: ModerateRationale: A: 14% = 7% + 0.7F; F = 10; B: 18% = 7% + 10b; b = 1.10.Use the following to answer questions 21-24:There are three stocks, A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature for economic growth in the upcoming year; economic growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below:21. If you invested in an equally weighted portfolio of stocks A and B, your portfolio returnwould be ___________ if economic growth were moderate.A) 3.0%B) 14.5%C) 15.5%D) 16.0%E) none of the aboveAnswer: D Difficulty: EasyRationale: E(Rp) = 0.5(17%) + 0.5(15%) = 16%.22. If you invested in an equally weighted portfolio of stocks A and C, your portfolio returnwould be ____________ if economic growth was strong.A) 17.0%B) 22.5%C) 30.0%D) 30.5%E) none of the aboveAnswer: B Difficulty: EasyRationale: 0.5(39%) + 0.5(6%) = 22.5%.23. If you invested in an equally weighted portfolio of stocks B and C, your portfolio returnwould be _____________ if economic growth was weak.A) -2.5%B) 0.5%C) 3.0%D) 11.0%E) none of the aboveAnswer: D Difficulty: EasyRationale: 0.5(0%) + 0.5(22%) = 11%.24. If you wanted to take advantage of a risk-free arbitrage opportunity, you should take ashort position in _________ and a long position in an equally weighted portfolio of_______.A) A, B and CB) B, A and CC) C, A and BD) A and B, CE) none of the above, none of the aboveAnswer: C Difficulty: DifficultRationale: E(R A) = (39% + 17% - 5%)/3 = 17%; E(R B) = (30% + 15% + 0%)/3 = 15%;E(R C) = (22% + 14% + 6%)/3 = 14%; E(R P) = -0.5(14%) + 0.5[(17% + 15%)/2]; -7.0% + 8.0% = 1.0%.Use the following to answer questions 25-26:Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The following information is available about two well-diversified portfolios:25. Assuming no arbitrage opportunities exist, the risk premium on the factor F1 portfolioshould be __________.A) 3%B) 4%C) 5%D) 6%E) none of the aboveAnswer: A Difficulty: DifficultRationale: 2A: 38% = 12% + 2.0(RP1) + 4.0(RP2); B: 12% = 6% + 2.0(RP1) +0.0(RP2); 26% = 6% + 4.0(RP2); RP2 = 5; A: 19% = 6% + RP1 + 2.0(5); RP1 = 3%.26. Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolioshould be ___________.A) 3%B) 4%C) 5%D) 6%E) none of the aboveAnswer: C Difficulty: DifficultRationale: See solution to previous problem.27. A zero-investment portfolio with a positive expected return arises when _________.A) an investor has downside risk onlyB) the law of prices is not violatedC) the opportunity set is not tangent to the capital allocation lineD) a risk-free arbitrage opportunity existsE) none of the aboveAnswer: D Difficulty: EasyRationale: When an investor can create a zero-investment portfolio (by using none of the investor's own funds) with a possibility of a positive profit, a risk-free arbitrage opportunity exists.28. An investor will take as large a position as possible when an equilibrium pricerelationship is violated. This is an example of _________.A) a dominance argumentB) the mean-variance efficiency frontierC) a risk-free arbitrageD) the capital asset pricing modelE) none of the aboveAnswer: C Difficulty: ModerateRationale: When the equilibrium price is violated, the investor will buy the lower priced asset and simultaneously place an order to sell the higher priced asset. Suchtransactions result in risk-free arbitrage. The larger the positions, the greater therisk-free arbitrage profits.29. The APT differs from the CAPM because the APT _________.A) places more emphasis on market riskB) minimizes the importance of diversificationC) recognizes multiple unsystematic risk factorsD) recognizes multiple systematic risk factorsE) none of the aboveAnswer: D Difficulty: ModerateRationale: The CAPM assumes that market returns represent systematic risk. The APT recognizes that other macroeconomic factors may be systematic risk factors.30. The feature of the APT that offers the greatest potential advantage over the CAPM is the______________.A) use of several factors instead of a single market index to explain the risk-returnrelationshipB) identification of anticipated changes in production, inflation and term structure askey factors in explaining the risk-return relationshipC) superior measurement of the risk-free rate of return over historical time periodsD) variability of coefficients of sensitivity to the APT factors for a given asset overtimeE) none of the aboveAnswer: A Difficulty: EasyRationale: The advantage of the APT is the use of multiple factors, rather than a single market index, to explain the risk-return relationship. However, APT does not identify the specific factors.31. In terms of the risk/return relationshipA) only factor risk commands a risk premium in market equilibrium.B) only systematic risk is related to expected returns.C) only nonsystematic risk is related to expected returns.D) A and B.E) A and C.Answer: D Difficulty: EasyRationale: Nonfactor risk may be diversified away; thus, only factor risk commands a risk premium in market equilibrium. Nonsystematic risk across firms cancels out in well-diversified portfolios; thus, only systematic risk is related to expected returns.32. The following factors might affect stock returns:A) the business cycle.B) interest rate fluctuations.C) inflation rates.D) all of the above.E) none of the above.Answer: D Difficulty: EasyRationale: A, B, and C all are likely to affect stock returns.33. Advantage(s) of the APT is(are)A) that the model provides specific guidance concerning the determination of the riskpremiums on the factor portfolios.B) that the model does not require a specific benchmark market portfolio.C) that risk need not be considered.D) A and B.E) B and C.Answer: B Difficulty: EasyRationale: The APT provides no guidance concerning the determination of the risk premiums on the factor portfolios. Risk must considered in both the CAPM and APT.A major advantage of APT over the CAPM is that a specific benchmark marketportfolio is not required.34. Portfolio A has expected return of 10% and standard deviation of 19%. Portfolio B hasexpected return of 12% and standard deviation of 17%. Rational investors willA) Borrow at the risk free rate and buy A.B) Sell A short and buy B.C) Sell B short and buy A.D) Borrow at the risk free rate and buy B.E) Lend at the risk free rate and buy B.Answer: B Difficulty: EasyRationale: Rational investors will arbitrage by selling A and buying B.35. An important difference between CAPM and APT isA) CAPM depends on risk-return dominance; APT depends on a no arbitragecondition.B) CAPM assumes many small changes are required to bring the market back toequilibrium; APT assumes a few large changes are required to bring the marketback to equilibrium.C) implications for prices derived from CAPM arguments are stronger than pricesderived from APT arguments.D) all of the above are true.E) both A and B are true.Answer: E Difficulty: DifficultRationale: Under the risk-return dominance argument of CAPM, when an equilibrium price is violated many investors will make small portfolio changes, depending on their risk tolerance, until equilibrium is restored. Under the no-arbitrage argument of APT, each investor will take as large a position as possible so only a few investors must act to restore equilibrium. Implications derived from APT are much stronger than thosederived from CAPM, making C an incorrect statement.36. A professional who searches for mispriced securities in specific areas such asmerger-target stocks, rather than one who seeks strict (risk-free) arbitrage opportunities is engaged inA) pure arbitrage.B) risk arbitrage.C) option arbitrage.D) equilibrium arbitrage.E) none of the above.Answer: B Difficulty: ModerateRationale: Risk arbitrage involves searching for mispricings based on speculativeinformation that may or may not materialize.37. In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomeslarger its nonsystematic risk approachesA) one.B) infinity.C) zero.D) negative one.E) none of the above.Answer: C Difficulty: EasyRationale: As the number of securities, n, increases, the nonsystematic risk of awell-diversified portfolio approaches zero.38. A well-diversified portfolio is defined asA) one that is diversified over a large enough number of securities that thenonsystematic variance is essentially zero.B) one that contains securities from at least three different industry sectors.C) a portfolio whose factor beta equals 1.0.D) a portfolio that is equally weighted.E) all of the above.Answer: A Difficulty: ModerateRationale: A well-diversified portfolio is one that contains a large number of securities, each having a small (but not necessarily equal) weight, so that nonsystematic variance is negligible.39. The APT requires a benchmark portfolioA) that is equal to the true market portfolio.B) that contains all securities in proportion to their market values.C) that need not be well-diversified.D) that is well-diversified and lies on the SML.E) that is unobservable.Answer: D Difficulty: ModerateRationale: Any well-diversified portfolio lying on the SML can serve as the benchmark portfolio for the APT. The true (and unobservable) market portfolio is only arequirement for the CAPM.40. Imposing the no-arbitrage condition on a single-factor security market implies which ofthe following statements?I)the expected return-beta relationship is maintained for all but a small number ofwell-diversified portfolios.II)the expected return-beta relationship is maintained for all well-diversified portfolios.III)the expected return-beta relationship is maintained for all but a small number of individual securities.IV)the expected return-beta relationship is maintained for all individual securities.A) I and III are correct.B) I and IV are correct.C) II and III are correct.D) II and IV are correct.E) Only I is correct.Answer: C Difficulty: ModerateRationale: The expected return-beta relationship must hold for all well-diversifiedportfolios and for all but a few individual securities; otherwise arbitrage opportunities will be available.41. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is6%, the risk premium on the first factor portfolio is 4% and the risk premium on the second factor portfolio is 3%. If portfolio A has a beta of 1.2 on the first factor and .8 on the second factor, what is its expected return?A) 7.0%B) 8.0%C) 9.2%D) 13.0%E) 13.2%Answer: E Difficulty: ModerateRationale: .06 + 1.2 (.04) + .8 (.03) = .13242. The term “arbitrage” refers toA) buying low and selling high.B) short selling high and buying low.C) earning risk-free economic profits.D) negotiating for favorable brokerage fees.E) hedging your portfolio through the use of options.Answer: C Difficulty: EasyRationale: Arbitrage is exploiting security mispricings by the simultaneous purchase and sale to gain economic profits without taking any risk. A capital market inequilibrium rules out arbitrage opportunities.43. To take advantage of an arbitrage opportunity, an investor wouldI)construct a zero investment portfolio that will yield a sure profit.II)construct a zero beta investment portfolio that will yield a sure profit.III)make simultaneous trades in two markets without any net investment.IV)short sell the asset in the low-priced market and buy it in the high-priced market.A) I and IVB) I and IIIC) II and IIID) I, III, and IVE) II, III, and IVAnswer: B Difficulty: DifficultRationale: Only I and III are correct. II is incorrect because the beta of the portfolio does not need to be zero. IV is incorrect because the opposite is true.44. The factor F in the APT model representsA) firm-specific risk.B) the sensitivity of the firm to that factor.C) a factor that affects all security returns.D) the deviation from its expected value of a factor that affects all security returns.E) a random amount of return attributable to firm events.Answer: D Difficulty: ModerateRationale: F measures the unanticipated portion of a factor that is common to allsecurity returns.45. In the APT model, what is the nonsystematic standard deviation of an equally-weightedportfolio that has an average value of ó(e i ) equal to 25% and 50 securities?A) 12.5%B) 625%C) 0.5%D) 3.54%E) 14.59%Answer: D Difficulty: ModerateRationale: ()%54.35.12)(,5.1225501)(1)(222=====p i p e e n e σσσ46. Which of the following is true about the security market line (SML) derived from theAPT?A) The SML has a downward slope.B) The SML for the APT shows expected return in relation to portfolio standarddeviation.C) The SML for the APT has an intercept equal to the expected return on the marketportfolio.D) The benchmark portfolio for the SML may be any well-diversified portfolio. E) The SML is not relevant for the APT.Answer: D Difficulty: ModerateRationale: The benchmark portfolio does not need to be the (unobservable) marketportfolio under the APT, but can be any well-diversified portfolio. The intercept still equals the risk-free rate.47. If arbitrage opportunities are to be ruled out, each well-diversified portfolio's expectedexcess return must beA) inversely proportional to the risk-free rate.B) inversely proportional to its standard deviation.C) proportional to its weight in the market portfolio.D) proportional to its standard deviation.E) proportional to its beta coefficient.Answer: E Difficulty: ModerateRationale: For each well-diversified portfolio (P and Q, for example), it must be true that [E(r p )-r f ]/βp = [E(r Q )-r f ]/ βQ.48. Suppose you are working with two factor portfolios, Portfolio 1 and Portfolio 2. Theportfolios have expected returns of 15% and 6%, respectively. Based on thisinformation, what would be the expected return on well-diversified portfolio A, if A hasa beta of 0.80 on the first factor and 0.50 on the second factor? The risk-free rate is 3%.A) 15.2%B) 14.1%C) 13.3%D) 10.7%E) 8.4%Answer: B Difficulty: ModerateRationale: E(R A) = 3 +0.8*(15-3) + 0.5*(6-3) = 14.1.49. Which of the following is (are) true regarding the APT?I)The Security Market Line does not apply to the APT.II)More than one factor can be important in determining returns.III)Almost all individual securities satisfy the APT relationship.IV)It doesn't rely on the market portfolio that contains all assets.A) II, III, and IVB) II and IVC) II and IIID) I, II, and IVE) I, II, III, and IVAnswer: A Difficulty: ModerateRationale: All except the first item are true. There is a Security Market Line associated with the APT.50. In a factor model, the return on a stock in a particular period will be related toA) factor risk.B) non-factor risk.C) standard deviation of returns.D) both A and B are true.E) none of the above is true.Answer: D Difficulty: ModerateRationale: Factor models explain firm returns based on both factor risk and non-factor risk.51. Which of the following factors did Chen, Roll and Ross not include in their multifactormodel?A) Change in industrial productionB) Change in expected inflationC) Change in unanticipated inflationD) Excess return of long-term government bonds over T-billsE) All of the above factors were included in their model.Answer: E Difficulty: ModerateRationale: Chen, Roll and Ross included the four listed factors as well as the excess return of long-term corporate bonds over long-term government bonds in their model.52. Which of the following factors were used by Fama and French in their multi-factormodel?A) Return on the market indexB) Excess return of small stocks over large stocks.C) Excess return of high book-to-market stocks over low book-to-market stocks.D) All of the above factors were included in their model.E) None of the above factors was included in their model.Answer: D Difficulty: ModerateRationale: Fama and French included all three of the factors listed.53. Which of the following factors did Merton not suggest as a likely source of uncertaintythat might affect security returns?A) uncertainties in labor income.B) prices of important consumption goods.C) book-to-market ratios.D) changes in future investment opportunities.E) All of the above are sources of uncertainty affecting security returns.Answer: C Difficulty: ModerateRationale: Merton did not suggest book-to-market ratios as an ICAPM pricing factor;the other three were suggested.54. Black argues that past risk premiums on firm-characteristic variables, such as thosedescribed by Fama and French, are problematic because.A) they may result from data snooping.B) they are sources of systematic risk.C) they can be explained by security characteristic lines.D) they are more appropriate for a single-factor model.E) they are macroeconomic factors.Answer: A Difficulty: Moderate55. Multifactor models seek to improve the performance of the single-index model byA) modeling the systematic component of firm returns in greater detail.B) incorporating firm-specific components into the pricing model.C) allowing for multiple economic factors to have differential effectsD) all of the above are true.E) none of the above is true.Answer: D Difficulty: Easy56. Multifactor models such as the one constructed by Chen, Roll, and Ross, can betterdescribe assets' returns byA) expanding beyond one factor to represent sources of systematic risk.B) using variables that are easier to forecast ex ante.C) calculating beta coefficients by an alternative method.D) using only stocks with relatively stable returns.E) ignoring firm-specific risk.Answer: A Difficulty: ModerateRationale: The study used five different factors to explain security returns, allowing for several sources of risk to affect the returns.。

Multiple Choice Questions1. Which of the following is not a characteristic of a money market instrument?A) liquidityB) marketabilityC) long maturityD) liquidity premiumE) C and DAnswer: E Difficulty: EasyRationale: Money market instruments are short-term instruments with high liquidityand marketability; they do not have long maturities nor pay liquidity premiums.2. Which one of the following is not a money market instrument?A) a Treasury billB) a negotiable certificate of depositC) commercial paperD) a Treasury bondE) a Eurodollar accountAnswer: D Difficulty: EasyRationale: Money market instruments are instruments with maturities of one year or less, which applies to all of the above except Treasury bonds. See Table 2.1.3. T-bills are financial instruments initially sold by ________ to raise funds.A) commercial banksB) the U. S. governmentC) state and local governmentsD) agencies of the federal governmentE) B and DAnswer: B Difficulty: EasyRationale: Only the U. S. government sells T-bills in the primary market.4. The bid price of a T-bill in the secondary market isA) the price at which the dealer in T-bills is willing to sell the bill.B) the price at which the dealer in T-bills is willing to buy the bill.C) greater than the asked price of the T-bill.D) the price at which the investor can buy the T-bill.E) never quoted in the financial press.Answer: B Difficulty: EasyRationale: T-bills are sold in the secondary market via dealers; the bid price quoted in the financial press is the price at which the dealer is willing to buy the bill.5. Commercial paper is a short-term security issued by ________ to raise funds.A) the Federal Reserve BankB) commercial banksC) large, well-known companiesD) the New York Stock ExchangeE) state and local governmentsAnswer: C Difficulty: EasyRationale: Commercial paper is short-term unsecured financing issued directly by large, presumably safe corporations.6. Which one of the following terms best describes Eurodollars:A) dollar-denominated deposits in European banks.B) dollar-denominated deposits at branches of foreign banks in the U. S.C) dollar-denominated deposits at foreign banks and branches of American banksoutside the U. S.D) dollar-denominated deposits at American banks in the U. S.E) dollars that have been exchanged for European currency.Answer: C Difficulty: ModerateRationale: Although originally Eurodollars were used to describe dollar-denominated deposits in European banks, today the term has been extended to apply to anydollar-denominated deposit outside the U. S.7. Deposits of commercial banks at the Federal Reserve Bank are called __________.A) bankers' acceptancesB) repurchase agreementsC) time depositsD) federal fundsE) reserve requirementsAnswer: D Difficulty: EasyRationale: The federal funds are required for the bank to meet reserve requirements, which is a way of influencing the money supply. No substitutes for fed funds arepermitted.8. The interest rate charged by banks with excess reserves at a Federal Reserve Bank tobanks needing overnight loans to meet reserve requirements is called the_________.A) prime rateB) discount rateC) federal funds rateD) call money rateE) money market rateAnswer: C Difficulty: Easy9. Which of the following statements is (are) true regarding municipal bonds?I) A municipal bond is a debt obligation issued by state or local governments.II) A municipal bond is a debt obligation issued by the federal government.III)The interest income from a municipal bond is exempt from federal income taxation.IV)The interest income from a municipal bond is exempt from state and local taxation in the issuing state.A) I and II onlyB) I and III onlyC) I, II, and III onlyD) I, III, and IV onlyE) I and IV onlyAnswer: D Difficulty: ModerateRationale: State and local governments and agencies thereof issue municipal bonds on which the interest income is free from all federal taxes and is exempt from state and local taxation in the issuing state.10. Which of the following statements is true regarding a corporate bond?A) A corporate callable bond gives the holder the right to exchange it for a specifiednumber of the company's common shares.B) A corporate debenture is a secured bond.C) A corporate indenture is a secured bond.D) A corporate convertible bond gives the holder the right to exchange the bond for aspecified number of the company's common shares.E) Holders of corporate bonds have voting rights in the company.Answer: D Difficulty: EasyRationale: Statement D is the only true statement; all other statements describesomething other than the term specified.11. In the event of the firm's bankruptcyA) the most shareholders can lose is their original investment in the firm's stock.B) common shareholders are the first in line to receive their claims on the firm's assets.C) bondholders have claim to what is left from the liquidation of the firm's assets afterpaying the shareholders.D) the claims of preferred shareholders are honored before those of the commonshareholders.E) A and D.Answer: E Difficulty: ModerateRationale: Shareholders have limited liability and have residual claims on assets.Bondholders have a priority claim on assets, and preferred shareholders have priority over common shareholders.12. Which of the following is true regarding a firm's securities?A) Common dividends are paid before preferred dividends.B) Preferred stockholders have voting rights.C) Preferred dividends are usually cumulative.D) Preferred dividends are contractual obligations.E) Common dividends usually can be paid if preferred dividends have been skipped.Answer: C Difficulty: EasyRationale: The only advantages of preferred dividends over common dividends are that preferred dividends must be paid first and any skipped preferred dividends must be paid before common dividends may be paid.13. Which of the following is true of the Dow Jones Industrial Average?A) It is a value-weighted average of 30 large industrial stocks.B) It is a price-weighted average of 30 large industrial stocks.C) The divisor must be adjusted for stock splits.D) A and C.E) B and C.Answer: E Difficulty: EasyRationale: The Dow Jones Industrial Average is a price-weighted index of 30 large industrial firms and the divisor must be adjusted when any of the stocks on the index split.14. Which of the following indices is (are) market-value weighted?I)The New York Stock Exchange Composite IndexII)The Standard and Poor's 500 Stock IndexIII)The Dow Jones Industrial AverageA) I onlyB) I and II onlyC) I and III onlyD) I, II, and IIIE) II and III onlyAnswer: B Difficulty: ModerateRationale: The Dow Jones Industrial Average is a price-weighted index.15. The Dow Jones Industrial Average (DJIA) is computed by:A) adding the prices of 30 large "blue-chip" stocks and dividing by 30.B) calculating the total market value of the 30 firms in the index and dividing by 30.C) adding the prices of the 30 stocks in the index and dividing by a divisor.D) adding the prices of the 500 stocks in the index and dividing by a divisor.E) adding the prices of the 30 stocks in the index and dividing by the value of thesestocks as of some base date period.Answer: C Difficulty: EasyRationale: When the DJIA became a 30-stock index, response A was true; however, as stocks on the index have split and been replaced, the divisor has been adjusted. In 2006 the divisor was 0.125.Use the following to answer questions 16-18:Consider the following three stocks:16. The price-weighted index constructed with the three stocks isA) 30B) 40C) 50D) 60E) 70Answer: B Difficulty: EasyRationale: ($40 + $70 + $10)/3 = $40.17. The value-weighted index constructed with the three stocks using a divisor of 100 isA) 1.2B) 1200C) 490D) 4900E) 49Answer: C Difficulty: ModerateRationale: The sum of the value of the three stocks divided by 100 is 490: [($40 x 200) + ($70 x 500) + ($10 x 600)] /100 = 490.18. Assume at these prices the value-weighted index constructed with the three stocks is490. What would the index be if stock B is split 2 for 1 and stock C 4 for 1?A) 265B) 430C) 355D) 490E) 1000Answer: D Difficulty: ModerateRationale: Value-weighted indexes are not affected by stock splits.19. The price quotations of Treasury bonds in the Wall Street Journal show an ask price of104:08 and a bid price of 104:04. As a buyer of the bond what is the dollar price you expect to pay?A) $10,480.00B) $10,425.00C) $10,440.00D) $10,412.50E) $10,404.00Answer: B Difficulty: ModerateRationale: You pay the asking price of the dealer, 104 8/32, or 104.25% of $10,000, or $10,425.00.20. An investor purchases one municipal and one corporate bond that pay rates of return of8% and 10%, respectively. If the investor is in the 20% marginal tax bracket, his or her after tax rates of return on the municipal and corporate bonds would be ________ and ______, respectively.A) 8% and 10%B) 8% and 8%C) 6.4% and 8%D) 6.4% and 10%E) 10% and 10%Answer: B Difficulty: ModerateRationale: r c = 0.10(1 - 0.20) = 0.08, or 8%; r m = 0.08(1 - 0) = 8%.21. If a Treasury note has a bid price of $975, the quoted bid price in the Wall Street Journalwould beA) 97:50.B) 97:16.C) 97:80.D) 94:24.E) 97:75.Answer: B Difficulty: EasyRationale: Treasuries are quoted as a percent of $1,000 and in 1/32s.22. In calculating the Standard and Poor's stock price indices, the adjustment for stock splitoccurs:A) by adjusting the divisor.B) automatically.C) by adjusting the numerator.D) quarterly, on the last trading day of each quarter.E) none of the above.Answer: B Difficulty: EasyRationale: The calculation of the value-weighted S&P indices includes both price and number of shares of each of the stocks in the index. Thus, the effects of stock splits are automatically incorporated into the calculation.23. Which of the following statements regarding the Dow Jones Industrial Average (DJIA)is false?A) The DJIA is not very representative of the market as a whole.B) The DJIA consists of 30 blue chip stocks.C) The DJIA is affected equally by changes in low and high priced stocks.D) The DJIA divisor needs to be adjusted for stock splits.E) The value of the DJIA is much higher than individual stock prices.Answer: C Difficulty: EasyRationale: The high priced stocks have much more impact on the DJIA than do the lower priced stocks.24. The index that includes the largest number of actively traded stock is:A) the NASDAQ Composite Index.B) the NYSE Composite Index.C) the Wilshire 5000 Index.D) the Value Line Composite Index.E) the Russell Index.Answer: C Difficulty: EasyRationale: The Wilshire 5000 is the largest readily available stock index, consisting of the stocks traded on the organized exchanges and the OTC stocks.25. A 5.5% 20-year municipal bond is currently priced to yield 7.2%. For a taxpayer in the33% marginal tax bracket, this bond would offer an equivalent taxable yield of:A) 8.20%.B) 10.75%.C) 11.40%.D) 4.82%.E) none of the above.Answer: B Difficulty: ModerateRationale: 0.072 = r m (1-t); 0.072 = r m / (0.67); r m = 0.1075 = 10.75%.26. If the market prices of each of the 30 stocks in the Dow Jones Industrial Average (DJIA)all change by the same percentage amount during a given day, which stock will have the greatest impact on the DJIA?A) The stock trading at the highest dollar price per share.B) The stock with total equity has the higher market value.C) The stock having the greatest amount of equity in its capital structure.D) The stock having the lowest volatility.E) None of the above.Answer: A Difficulty: ModerateRationale: Higher priced stocks affect the DJIA more than lower priced stocks; other choices are not relevant.27. The stocks on the Dow Jones Industrial AverageA) have remained unchanged since the creation of the index.B) include most of the stocks traded on the NYSE.C) are changed occasionally as circumstances dictate.D) consist of stocks on which the investor cannot lose money.E) B and C.Answer: C Difficulty: EasyRationale: The stocks on the DJIA are only a small sample of the entire market, have been changed occasionally since the creation of the index, and one can lose money on any stock. See text box on page 50 for a list of DJIA stock changes.28. Federally sponsored agency debtA) is legally insured by the U. S. Treasury.B) would probably be backed by the U. S. Treasury in the event of a near-default.C) has a small positive yield spread relative to U. S. Treasuries.D) B and C.E) A and C.Answer: D Difficulty: EasyRationale: Federally sponsored agencies, such as the FHLB, are not government owned.These agencies' debt is not insured by the U.S. Treasury, but probably would be backed by the Treasury in the event of an agency near-default. As a result, the issues are very safe and carry a yield only slightly higher than that of U. S. Treasuries.29. Brokers' callsA) are funds used by individuals who wish to buy stocks on margin.B) are funds borrowed by the broker from the bank, with the agreement to repay thebank immediately if requested to do so.C) carry a rate that is usually about one percentage point lower than the rate on U.S.T-bills.D) A and B.E) A and C.Answer: D Difficulty: EasyRationale: Brokers' calls are funds borrowed from banks by brokers and loaned toinvestors in margin accounts.30. A form of short-term borrowing by dealers in government securities isA) reserve requirements.B) repurchase agreements.C) banker's acceptances.D) commercial paper.E) brokers' calls.Answer: B Difficulty: EasyRationale: Repurchase agreements are a form of short-term borrowing where a dealer sells government securities to an investor with an agreement to buy back those same securities at a slightly higher price.31. Which of the following securities is a money market instrument?A) Treasury noteB) Treasury bond.C) municipal bond.D) commercial paper.E) mortgage security.Answer: D Difficulty: EasyRationale: Only commercial paper is a money market security. The others are capital market instruments.32. The yield to maturity reported in the financial pages for Treasury securitiesA) is calculated by compounding the semiannual yield.B) is calculated by doubling the semiannual yield.C) is also called the bond equivalent yield.D) is calculated as the yield-to-call for premium bonds.E) Both B and C are true.Answer: E Difficulty: EasyRationale: The yield to maturity shown in the financial pages is an APR calculated by doubling the semi-annual yield.33. Which of the following is not a mortgage-related government or government sponsoredagency?A) The Federal Home Loan BankB) The Federal National Mortgage AssociationC) The U.S. TreasuryD) Freddie MacE) Ginnie MaeAnswer: C Difficulty: EasyRationale: Only the U.S. Treasury issues securities that are not mortgage-backed.34. In order for you to be indifferent between the after tax returns on a corporate bondpaying 8.5% and a tax-exempt municipal bond paying 6.12%, what would your taxbracket need to be?A) 33%B) 72%C) 15%D) 28%E) Cannot tell from the information givenAnswer: D Difficulty: ModerateRationale: .0612 = .085(1-t); (1-t) = 0.72; t = .2835. What does the term “negotiable” mean with regard to negotia ble certificates of deposit?A) The CD can be sold to another investor if the owner needs to cash it in before itsmaturity date.B) The rate of interest on the CD is subject to negotiation.C) The CD is automatically reinvested at its maturity date.D) The CD has staggered maturity dates built in.E) The interest rate paid on the CD will vary with a designated market rate.Answer: A Difficulty: Easy36. Freddie Mac and Ginnie Mae were organized to provideA) a primary market for mortgage transactions.B) liquidity for the mortgage market.C) a primary market for farm loan transactions.D) liquidity for the farm loan market.E) a source of funds for government agencies.Answer: B Difficulty: Easy37. The type of municipal bond that is used to finance commercial enterprises such as theconstruction of a new building for a corporation is calledA) a corporate courtesy bond.B) a revenue bond.C) a general obligation bond.D) a tax anticipation note.E) an industrial development bond.Answer: E Difficulty: Easy38. Suppose an investor is considering a corporate bond with a 7.17% before-tax yield and amunicipal bond with a 5.93% before-tax yield. At what marginal tax rate would the investor be indifferent between investing in the corporate and investing in the muni?A) 15.4%B) 23.7%C) 39.5%D) 17.3%E) 12.4%Answer: D Difficulty: ModerateRationale: t m = 1-(5.93%/7.17%) = 17.29%39. Which of the following are characteristics of preferred stock?I)It pays its holder a fixed amount of income each year, at the discretion of itsmanagers.II)It gives its holder voting power in the firm.III)Its dividends are usually cumulative.IV)Failure to pay dividends may result in bankruptcy proceedings.A) I, III, and IVB) I, II, and IIIC) I and IIID) I, II, and IVE) I, II, III, and IVAnswer: C Difficulty: Moderate40. Bond market indexes can be difficult to construct becauseA) they cannot be based on firms' market values.B) bonds tend to trade infrequently, making price information difficult to obtain.C) there are so many different kinds of bonds.D) prices cannot be obtained for companies that operate in emerging markets.E) corporations are not required to disclose the details of their bond issues.Answer: B Difficulty: Moderate41. With regard to a futures contract, the long position is held byA) the trader who bought the contract at the largest discount.B) the trader who has to travel the farthest distance to deliver the commodity.C) the trader who plans to hold the contract open for the lengthiest time period.D) the trader who commits to purchasing the commodity on the delivery date.E) the trader who commits to delivering the commodity on the delivery date.Answer: D Difficulty: EasyUse the following to answer questions 42-43:42. Based on the information given, for a price-weighted index of the three stocks calculate:A) the rate of return for the first period (t=0 to t=1).B) the value of the divisor in the second period (t=2). Assume that Stock A had a 2-1split during this period.C) the rate of return for the second period (t=1 to t=2).Answer: A Difficulty: DifficultRationale:A.The price-weighted index at time 0 is (70+85+105)/3 = 86.67. The price-weightedindex at time 1 is (72+81+98)/3 = 83.67. The return on the index is 83.67/86.67 1 =-3.46%.B.The divisor must change to reflect the stock split. Because nothing elsefundamentally changed, the value of the index should remain 83.67. So the newdivisor is (36+81+98)/83.67 = 2.57. The index value is (36+81+98)/2.57 = 83.67.C.The rate of return for the second period is 83.67/83.67-1 = 0.00%43. Based on the information given for the three stocks, calculate the first-period rates ofreturn (from t=0 to t=1) onA) a market-value-weighted index.B) an equally-weighted index.C) a geometric index.Answer: A Difficulty: DifficultRationale:A.The total market value at time 0 is $70*200 + $85*500 + $105*300 = $88,000. Thetotal market value at time 1 is $72*200 + $81*500 + $98*300 = $84,300. The return is $84,300/$88,000 1 = -4.20%.B.The return on Stock A for the first period is $72/$70-1 = 2.86%. The return onStock B for the first period is $81/$85-1 = -4.71%. The return on Stock C for thefirst period is $98/$105-1 = -6.67%. The return on an equally weighted index of the three stocks is (2.86%-4.71%-6.67%)/3 = -2.84%.C.The geometric average return is [(1+.0286)(1-.0471)(1-.0667)](1/3)-1 =[(1.0286)(0.9529)(0.9333)]0.3333 -1 = -2.92%44. In order for you to be indifferent between the after tax returns on a corporate bondpaying 9% and a tax-exempt municipal bond paying 7%, what would your tax bracket need to be?A) 17.6%B) 27%C) 22.2%D) 19.8%E) Cannot tell from the information givenAnswer: C Difficulty: ModerateRationale: .07 = .09(1-t); (1-t) = 0.777; t = .22245. In order for you to be indifferent between the after tax returns on a corporate bondpaying 7% and a tax-exempt municipal bond paying 5.5%, what would your tax bracket need to be?A) 22.6%B) 21.4%C) 26.2%D) 19.8%E) Cannot tell from the information givenAnswer: B Difficulty: ModerateRationale: .055 = .07(1-t); (1-t) = 0.786; t = .21446. An investor purchases one municipal and one corporate bond that pay rates of return of6% and 8%, respectively. If the investor is in the 25% marginal tax bracket, his or her after tax rates of return on the municipal and corporate bonds would be ________ and ______, respectively.A) 6% and 8%B) 4.5% and 6%C) 4.5% and 8%D) 6% and 6%E) None of the aboveAnswer: D Difficulty: ModerateRationale: r c = 0.08(1 - 0.25) = 0.06, or 6%; r m = 0.06(1 - 0) = 6%.47. An investor purchases one municipal and one corporate bond that pay rates of return of7.2% and 9.1%, respectively. If the investor is in the 15% marginal tax bracket, his orher after tax rates of return on the municipal and corporate bonds would be ________ and ______, respectively.A) 7.2% and 9.1%B) 7.2% and 7.735%C) 6.12% and 7.735%D) 8.471% and 9.1%E) None of the aboveAnswer: B Difficulty: ModerateRationale: r c = 0.091(1 - 0.15) = 0.07735, or 7.735%; r m = 0.072(1 - 0) = 7.2%.48. For a taxpayer in the 25% marginal tax bracket, a 20-year municipal bond currentlyyielding 5.5% would offer an equivalent taxable yield of:A) 7.33%.B) 10.75%.C) 5.5%.D) 4.125%.E) none of the above.Answer: A Difficulty: ModerateRationale: 0.055= r m(1-t); 0.0733 = r m / 0.75).49. For a taxpayer in the 15% marginal tax bracket, a 15-year municipal bond currentlyyielding 6.2% would offer an equivalent taxable yield of:A) 6.2%.B) 5.27%.C) 8.32%.D) 7.29%.E) none of the above.Answer: D Difficulty: ModerateRationale: 0.062= r m(1-t); 0.062 = r m / (0.85); r m = 0.0729 = 7.29%.50. With regard to a futures contract, the short position is held byA) the trader who bought the contract at the largest discount.B) the trader who has to travel the farthest distance to deliver the commodity.C) the trader who plans to hold the contract open for the lengthiest time period.D) the trader who commits to purchasing the commodity on the delivery date.E) the trader who commits to delivering the commodity on the delivery date.Answer: E Difficulty: Easy51. A call option allows the buyer toA) sell the underlying asset at the exercise price on or before the expiration date.B) buy the underlying asset at the exercise price on or before the expiration date.C) sell the option in the open market prior to expiration.D) A and C.E) B and C.Answer: E Difficulty: EasyRationale: A call option may be exercised (allowing the holder to buy the underlying asset) on or before expiration; the option contract also may be sold prior to expiration.52. A put option allows the holder toA) buy the underlying asset at the striking price on or before the expiration date.B) sell the underlying asset at the striking price on or before the expiration date.C) sell the option in the open market prior to expiration.D) B and C.E) A and C.Answer: D Difficulty: EasyRationale: A put option allows the buyer to sell the underlying asset at the striking price on or before the expiration date; the option contract also may be sold prior to expiration.53. The ____ index represents the performance of the German stock market.A) DAXB) FTSEC) NikkeiD) Hang SengE) None of the aboveAnswer: A Difficulty: Easy54. The ____ index represents the performance of the Japanese stock market.A) DAXB) FTSEC) NikkeiD) Hang SengE) None of the aboveAnswer: C Difficulty: Easy55. The ____ index represents the performance of the U.K. stock market.A) DAXB) FTSEC) NikkeiD) Hang SengE) None of the aboveAnswer: B Difficulty: Easy56. The ____ index represents the performance of the Hong Kong stock market.A) DAXB) FTSEC) NikkeiD) Hang SengE) None of the aboveAnswer: D Difficulty: Easy57. The ultimate stock index in the U.S. is theA) Wilshire 5000.B) DJIA.C) S&P 500.D) Russell 2000.E) None of the above.Answer: A Difficulty: Easy58. The ____ is an example of a U.S. index of large firms.A) Wilshire 5000B) DJIAC) DAXD) Russell 2000E) All of the aboveAnswer: B Difficulty: Easy59. The ____ is an example of a U.S. index of small firms.A) S&P 500B) DJIAC) DAXD) Russell 2000E) All of the aboveAnswer: D Difficulty: Easy60. The largest component of the money market is ____________.A) repurchase agreementsB) money market mutual fundsC) T-billsD) EurodollarsE) savings depositsAnswer: E Difficulty: Easy61. Certificates of deposit are insured by the ____________.A) SPICB) CFTCC) Lloyds of LondonD) FDICE) all of the aboveAnswer: D Difficulty: Easy62. Certificates of deposit are insured for up to ____________ in the event of bankinsolvency.A) $10,000B) $100,000C) $50,000D) $500,000E) none of the aboveAnswer: B Difficulty: Easy63. The maximum maturity of commercial paper that can be issued without SECregistration is ____________.A) 270 daysB) 180 daysC) 90 daysD) 30 daysE) none of the aboveAnswer: A Difficulty: Easy64. Which of the following is used extensively in foreign trade when the creditworthiness ofone trader is unknown to the trading partner?A) reposB) bankers acceptancesC) EurodollarsD) federal fundsE) none of the aboveAnswer: B Difficulty: Easy65. A US dollar denominated bond that is sold in Singapore is a ____________.A) EurobondB) Yankee bondC) Samurai bondD) Bulldog bondE) none of the aboveAnswer: A Difficulty: Easy66. A municipal bond issued to finance an airport, hospital, turnpike, or port authority istypically a ____________.A) revenue bondB) general obligation bondC) industrial development bondD) A and B are equally likelyE) B and C are equally likelyAnswer: A Difficulty: Easy67. Unsecured bonds are called ____________.A) junk bondsB) debenturesC) indenturesD) subordinated debenturesE) either A or DAnswer: E Difficulty: Easy68. A bond that can be retired prior to maturity by the issuer is a ____________ bond.A) convertibleB) securedC) unsecuredD) callableE) YankeeAnswer: D Difficulty: Easy。