Question: Suppose you observe the investment performance of

> An investor takes as large a position as possible when an equilibrium price relationship is violated. This is an example of: a. A dominance argument. b. The mean-variance efficient frontier. c. Arbitrage activity. d. The capital asset pricing model.

> The general arbitrage pricing theory (APT) differs from the single-factor capital asset pricing model (CAPM) because the APT: a. Places more emphasis on market risk. b. Minimizes the importance of diversification. c. Recognizes multiple unsystematic risk

> According to the theory of arbitrage: a. High-beta stocks are consistently overpriced. b. Low-beta stocks are consistently overpriced. c. Positive alpha investment opportunities will quickly disappear. d. Rational investors will pursue arbitrage opportun

> A zero-investment portfolio with a positive alpha could arise if: a. The expected return of the portfolio equals zero. b. The capital market line is tangent to the opportunity set. c. The Law of One Price remains unviolated. d. A risk-free arbitrage oppo

> Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%. / In this situation you would conclude that portfolios X and Y: a. Are in equilibrium. b. Offer an arbitrage opportunity. c. Are both underpriced. d. Are both fairly

> Jeffrey Bruner, CFA, uses the capital asset pricing model (CAPM) to help identify mispriced securities. A consultant suggests Bruner use arbitrage pricing theory (APT) instead. In comparing CAPM and APT, the consultant makes the following arguments: a. B

> Refer to the following table, which shows risk and return measures for two portfolios. When plotting portfolio R relative to the capital market line, portfolio R lies: a. On the CML. b. Below the CML. c. Above the CML. d. Insufficient data given.

> Refer to the following table, which shows risk and return measures for two portfolios. When plotting portfolio R in the preceding table relative to the SML, portfolio R lies: a. On the SML. b. Below the SML. c. Above the SML. d. Insufficient data given.

> Richard Roll, in an article on using the capital asset pricing model (CAPM) to evaluate portfolio performance, indicated that it may not be possible to evaluate portfolio management ability if there is an error in the benchmark used. a. In evaluating por

> According to CAPM, the expected rate of return of a portfolio with a beta of 1.0 and an alpha of 0 is: a. Between rM and rf . b. The risk-free rate, rf . c. β(rM – rf ). d. The expected return on the market, rM.

> Capital asset pricing theory asserts that portfolio returns are best explained by: a. Economic factors. b. Specific risk. c. Systematic risk. d. Diversification.

> What is the expected return of a zero-beta security? a. Market rate of return. b. Zero rate of return. c. Negative rate of return. d. Risk-free rate of return.

> Within the context of the capital asset pricing model (CAPM), assume: Expected return on the market = 15% Risk-free rate = 8% Expected rate of return on XYZ security = 17% Beta of XYZ security = 1.25 Which one of the following is correct? a. XYZ is overp

> The security market line depicts: a. A security’s expected return as a function of its systematic risk. b. The market portfolio as the optimal portfolio of risky securities. c. The relationship between a security’s return and the return on an index. d. T

> Beta and standard deviation differ as risk measures in that beta measures: a. Only unsystematic risk, while standard deviation measures total risk. b. Only systematic risk, while standard deviation measures total risk. c. Both systematic and unsystematic

> The concept of beta is most closely associated with: a. Correlation coefficients. b. Mean-variance analysis. c. Nonsystematic risk. d. Systematic risk.

> The correlation between the Charlottesville International Fund and the EAFE Market Index of international stocks is 1.0. The expected return on the EAFE Index is 11%, the expected return on Charlottesville International Fund is 9%, and the risk-free retu

> Assume the correlation coefficient between Baker Fund and the market index is .70. What percentage of Baker Fund’s total risk is specific (i.e., nonsystematic)?

> Stocks A, B, and C have the same expected return and standard deviation. The following table shows the correlations between the returns on these stocks. Given these correlations, the portfolio constructed from these stocks having the lowest risk is a por

> Identify and briefly discuss three criticisms of beta as used in the capital asset pricing model.

> Assume that a risk-averse investor owning stock in Miller Corporation decides to add the stock of either Mac or Green Corporation to her portfolio. All three stocks offer the same expected return and total variability. The correlation of return between M

> Portfolio theory as described by Markowitz is most concerned with: a. The elimination of systematic risk. b. The effect of diversification on portfolio risk. c. The identification of unsystematic risk. d. Active portfolio management to enhance return.

> The measure of risk for a security held in a diversified portfolio is: a. Specific risk. b. Standard deviation of returns. c. Reinvestment risk. d. Covariance.

> Which statement about portfolio diversification is correct? a. Efficient diversification can reduce or eliminate systematic risk. b. Diversification reduces the portfolio’s expected return because it reduces a portfolio’s total risk. c. As more securitie

> Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz?

> What is the reward-to-volatility (Sharpe) ratio for the equity fund in CFA Problem 8?

> The change from a straight to a kinked capital allocation line is a result of the: a. Reward-to-volatility (Sharpe) ratio increasing. b. Borrowing rate exceeding the lending rate. c. Investor’s risk tolerance decreasing. d. Increase in the portfolio prop

> Given $100,000 to invest, what is the expected risk premium in dollars of investing in equities versus risk-free T-bills on the basis of the following table?

> Which point designates the optimal portfolio of risky assets?

> Which indifference curve represents the greatest level of utility that can be achieved by the investor?

> Claire Pierce comments on her life circumstances and investment outlook: I must support my parents who live overseas on Pogo Island. The Pogo Island economy has grown rapidly over the past 2 years with minimal inflation, and consensus forecasts call for

> The variable (A) in the utility formula represents the: a. Investor’s return requirement. b. Investor’s aversion to risk. c. Certainty equivalent rate of the portfolio. d. Preference for one unit of return per four uni

> On the basis of the utility formula above, which investment would you select if you were risk neutral?

> On the basis of the utility formula above, which investment would you select if you were risk averse with A = 4?

> Assume that of your $10,000 portfolio, you invest $9,000 in Stock X and $1,000 in Stock Y. What is the expected return on your portfolio?

> What are the standard deviations of returns on Stocks X and Y?

> What are the expected rates of return for Stocks X and Y?

> Based on the scenarios below, what is the expected return for a portfolio with the following return profile? Use the following scenario analysis for Stocks X and Y to answer CFA Problems 3 through 5 (round to the nearest percent).

> Given $100,000 to invest, what is the expected risk premium in dollars of investing in equities versus risk-free T-bills (U.S. Treasury bills) based on the following table?

> An analyst estimates that a stock has the following probabilities of return depending on the state of the economy: What is the expected return of the stock?

> Although we stated that real assets constitute the true productive capacity of an economy, it is hard to conceive of a modern economy without well-developed financial markets and security types. How would the productive capacity of the U.S. economy be af

> During an interview with her investment adviser, a retired investor made the following two statements: a. “I have been very pleased with the returns I’ve earned on Petrie stock over the past two years and I am certain that it will be a superior performer

> What is the relationship between securitization and the role of financial intermediaries in the economy? What happens to financial intermediaries as securitization progresses?

> Why would you expect securitization to take place only in highly developed capital markets?

> Financial engineering has been disparaged as nothing more than paper shuffling. Critics argue that resources used for rearranging wealth (i.e., bundling and unbundling financial assets) might be better spent on creating wealth (i.e., creating real assets

> Consider historical data showing that the average annual rate of return on the S&P 500 portfolio over the past 90 years has averaged roughly 8% more than the Treasury bill return and that the S&P 500 standard deviation has been about 20% per year. Assume

> What are the advantages and disadvantages of exchange-traded funds versus mutual funds?

> Balanced funds, life-cycle funds, and asset allocation funds all invest in both the stock and bond markets. What are the differences among these types of funds?

> Open-end equity mutual funds find it necessary to keep a small fraction of total investments, in very liquid money market assets. Closed-end funds do not have to maintain such a position in “cash-equivalent” securities. What difference between open-end a

> You expect a tax-free municipal bond portfolio to provide a rate of return of 4%. Management fees of the fund are .6%. What fraction of portfolio income is given up to fees? If the management fees for an equity fund also are .6%, but you expect a portfol

> Suppose that every time a fund manager trades stock, transaction costs such as commissions and bid–ask spreads amount to .4% of the value of the trade. If the portfolio turnover rate is 50%, by how much is the total return of the portfolio reduced by tra

> Louise and Christopher Maclin live in the U.K. and currently rent an apartment in London’s metropolitan area. During an initial discussion of the Maclins’ financial plans, Christopher Maclin makes the following statements to the Maclins’ financial advise

> You are considering an investment in a mutual fund with a 4% load and an expense ratio of .5%. You can invest instead in a bank CD paying 6% interest. a. If you plan to invest for 2 years, what annual rate of return must the fund portfolio earn for you t

> The Investments Fund sells Class A shares with a front-end load of 6% and Class B shares with 12b-1 fees of .5% annually as well as back-end load fees that start at 5% and fall by 1% for each full year the investor holds the portfolio (until the fifth ye

> City Street Fund has a portfolio of $450 million and liabilities of $10 million. a. If 44 million shares are outstanding, what is net asset value? b. If a large investor redeems 1 million shares, what happens to the (i) portfolio value, (ii) shares outst

> What are some comparative advantages of investing in the following? a. Unit investment trusts. b. Open-end mutual funds. c. Individual stocks and bonds that you choose for yourself.

> You purchased 1,000 shares of the New Fund at a price of $20 per share at the beginning of the year. You paid a front-end load of 4%. The securities in which the fund invests increase in value by 12% during the year. The fund’s expense ratio is 1.2%. Wha

> a. Impressive Fund had excellent investment performance last year, with portfolio returns that placed it in the top 10% of all funds with the same investment policy. Do you expect it to be a top performer next year? Why or why not? b. Suppose instead tha

> A closed-end fund starts the year with a net asset value of $12.00. By year-end, NAV equals $12.10. At the beginning of the year, the fund was selling at a 2% premium to NAV. By the end of the year, the fund is selling at a 7% discount to NAV. The fund p

> Would you expect a typical open-end fixed-income mutual fund to have higher or lower operating expenses than a fixed-income unit investment trust? Why?

> Consider the following limit-order book for FinTrade stock. The last trade in the stock occurred at a price of $50. a. If a market buy order for 100 shares comes in, at what price will it be filled? b. At what price would the next market buy order be fil

> Old Economy Traders opened an account to short-sell 1,000 shares of Internet Dreams from the previous problem. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $40 to

> Monty Frost’s tax-deferred retirement account is invested entirely in equity securities. Because the international portion of his portfolio has performed poorly in the past, he has reduced his international equity exposure to 2%. Frost’s investment advis

> Dée Trader opens a brokerage account and purchases 300 shares of Internet Dreams at $40 per share. She borrows $4,000 from her broker to help pay for the purchase. The interest rate on the loan is 8%. a. What is the margin in Dée’s account when she fir

> Where would an illiquid security in a developing country most likely trade? a. Broker markets. b. Electronic crossing networks. c. Electronic limit-order markets.

> Are the following statements true or false? If false, correct them. a. An investor who wishes to sell shares immediately should ask his or her broker to enter a limit order. b. The ask price is less than the bid price. c. An issue of additional shares of

> How does buying on margin magnify both the upside potential and the downside risk of an investment position?

> On January 1, you sold short one round lot (i.e., 100 shares) of Four Sisters stock at $21 per share. On March 1, a dividend of $2 per share was paid. On April 1, you covered the short sale by buying the stock at a price of $15 per share. You paid 50 cen

> You’ve borrowed $20,000 on margin to buy shares in Ixnay, which is now selling at $40 per share. Your account starts at the initial margin requirement of 50%. The maintenance margin is 35%. Two days later, the stock price falls to $35 per share. a. Will

> Here is some price information on Marabel, Inc.: You have placed a stop-loss order to sell at $70. What are you telling your broker? Given market prices, will your order be executed?

> Suppose that you sell short 1,000 shares of Xtel, currently selling for $20 per share, and give your broker $15,000 to establish your margin account. a. If you earn no interest on the funds in your margin account, what will be your rate of return after o

> Suppose that Xtel currently is selling at $20 per share. You buy 1,000 shares using $15,000 of your own money, borrowing the remainder of the purchase price from your broker. The rate on the margin loan is 8%. a. What is the percentage increase in the ne

> What are the differences among a limit buy order, a limit sell order, and a market order?

> Don Sampson begins a meeting with his financial adviser by outlining his investment philosophy as shown below: Select the statement from the table above that best illustrates each of the following behavioral finance concepts. Justify your selection. a. M

> If the cost of insuring your house is $1 per $1,000 of value, what will be the certainty equivalent of your end-of-year wealth if you insure your house at: a. ½ its value. b. Its full value. c. 1½ times its value.

> Turn back to Figure 2.3 and look at the Treasury bond maturing in August 2048. a. How much would you have to pay to purchase one of these bonds? b. What is its coupon rate? c. What is the yield to maturity of the bond?

> Why are money market securities sometimes referred to as “cash equivalents”?

> Turn back to Table 2.6 and look at the Microsoft options. Suppose you buy a January expiration call option with exercise price $100. a. Suppose the stock price in January is $103. Will you exercise your call? What is the profit on your position? b. What

> Which security should sell at a greater price? a. A 10-year Treasury bond with a 4% coupon rate versus a 10-year T-bond with a 5% coupon. b. A 3-month expiration call option with an exercise price of $40 versus a 3-month call on the same stock with an ex

> What problems would confront a mutual fund trying to create an index fund tied to an equally weighted index of a broad stock market?

> Using the data in the previous problem, calculate the first-period rates of return on the following indexes of the three stocks: a. A market-value-weighted index. b. An equally weighted index.

> Consider the three stocks in the following table. Pt represents price at time t, and Qt represents shares outstanding at time t. Stock C splits two for one in the last period. a. Calculate the rate of return on a price-weighted index of the three stocks

> Wall Street firms have traditionally compensated their traders with a share of the trading profits that they generated. How might this practice have affected traders’ willingness to assume risk? What agency problem can this practice engender?

> Turn to Figure 2.8 and look at the listing for Herbalife. a. How many shares could you buy for $5,000? b. What would be your annual dividend income from those shares? c. What must be Herbalife’s earnings per share? d. What was the firm&

> You see an advertisement for a book that claims to show how you can make $1 million with no risk and with no money down. Will you buy the book?

> Growth and value can be defined in several ways. “Growth” usually conveys the idea of a portfolio emphasizing or including only issues believed to possess above-average future rates of pershare earnings growth. Low current yield, high price-to-book ratio

> What are some advantages and disadvantages of top-down versus bottom-up investing styles?

> In what ways is preferred stock like long-term debt? In what ways is it like equity?

> Give an example of three financial intermediaries and explain how they act as a bridge between small investors and large capital markets or corporations.

> Oversight by large institutional investors or creditors is one mechanism to reduce agency problems. Why don’t individual investors in the firm have the same incentive to keep an eye on management?

> Discuss the advantages and disadvantages of the following forms of managerial compensation in terms of mitigating agency problems, that is, potential conflicts of interest between managers and shareholders. a. A fixed salary. b. Stock in the firm that mu

> Consider Figure 1A, which describes an issue of American gold certificates. a. Is this issue a primary or secondary market transaction? b. Are the certificates primitive or derivative assets?

> Examine the balance sheet of commercial banks in Table 1.3. a. What is the ratio of real assets to total assets? b. What is the ratio of real assets to total assets for nonfinancial firms (Table 1.4)? c. Why should this difference be expected?

> Reconsider Lanni Products from the previous problem. a. Prepare its balance sheet just after it gets the bank loan. What is the ratio of real assets to total assets? b. Prepare the balance sheet after Lanni spends the $70,000 to develop its software prod

> Lanni Products is a start-up computer software development firm. It currently owns computer equipment worth $30,000 and has cash on hand of $20,000 contributed by Lanni’s owners. For each of the following transactions, identify the real and/or financial

> Suppose housing prices across the world double. a. Is society any richer for the change? b. Are homeowners wealthier? c. Can you reconcile your answers to (a) and (b)? Is anyone worse off as a result of the change?

> a. Briefly explain the concept of the efficient market hypothesis (EMH) and each of its three forms—weak, semistrong, and strong—and briefly discuss the degree to which existing empirical evidence supports each of the three forms of the EMH. b. Briefly d

> Firms raise capital from investors by issuing shares in the primary markets. Does this imply that corporate financial managers can ignore trading of previously issued shares in the secondary market?

> Which of the following is true according to the pure expectations theory? Forward rates: a. Exclusively represent expected future short rates. b. Are biased estimates of market expectations. c. Always overestimate future short rates.

> Use the data from Problem 18. Suppose that you want to construct a 2-year maturity forward loan commencing in 3 years. a. Suppose that you buy today one 3-year maturity zero-coupon bond with face value $1,000. How many 5-year maturity zeros would you hav