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Given a normal distribution, assume you want to earn a rate of return that plots more than three standard deviations above the mean. What is your probability of earning such a return in any one year?
Less than .5 percent
Between .5 and 1 percent Between 1 and 2 percent
More than 2 percent
Assume stocks A and B have had identical stock prices every day for the past three years. Stock A pays a dividend but Stock B does not. Which one of these statements applies to these stocks for the last three years?
Their annual total rates of return are equal.
Stock A's total return has been higher than Stock B's every year. Stock B's capital gain has exceeded Stock A's every year.
Stock A's total return had to be positive every year.
Stock B's holding period return exceeded that of Stock A.
Suppose a portfolio had an arithmetic average return of 8 percent for a 4-year period. Which one of these statements must be true regarding this portfolio for the period?
At least one of the four years produced an annual rate of return of 8 percent.
If the standard deviation of the portfolio is greater than zero, then the geometric average portfolio return is less than 8 percent.
The standard deviation of the portfolio must be lower than the standard deviation of a comparable portfolio that had an arithmetic average return of 9 percent.
If the standard deviation of the portfolio is zero, then the geometric average return must also be zero. The holding period return must be less than 8 percent.
You are comparing the returns on two portfolios for a 10-year period. Portfolio I has a lower dispersion of returns and a higher average rate of return than Portfolio II. Given this, what do you know with certainty?
Portfolio I has a lower standard deviation than Portfolio II. Portfolio I consists of more dividend-paying stocks than Portfolio II. Portfolio II has less total risk than Portfolio I.
Portfolio I will outperform Portfolio II over the next 10 years.
Portfolio II consists of more individual stocks than Portfolio I.
Over the period 1925-2012, stocks outperformed bonds by a wide margin. What conclusion should you draw from this performance?
Stocks will have a higher rate of return than bonds in any given year.
Investors should only purchase stocks.
Any stock you select will outperform a bond over the long-term.
On an annual basis, stock returns will exceed the rate of inflation but bond returns may or may not. Stocks are riskier than bonds.
Which one of these statements must be correct?
Long-term expected rates of return are inversely related to risk premium.
The lower the risk premium the higher a security's average rate of return.
Risk premium is defined as the nominal rate of return minus the rate of inflation.
One security can have both a higher standard deviation and a lower risk premium than another security for the same historical period.
A security with a standard deviation of 9.9 percent for a stated historical period will have a higher average rate of return for that period than a security with a standard deviation of 9.6 percent.
positive square root of the variance.
positive square root of the average return.
average return divided by N minus one, where N is the number of returns.
average squared difference between the actual return and the average return.
A symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard deviation is the _____ distribution.
The average compound return earned per year over a multi-year period is called the _____ average return.
The return earned in an average year over a multi-year period is called the _____ average return.
The excess return you earn by moving from a relatively risk-free investment to a risky investment is called the:
geometric average return. inflation premium.
arithmetic average return.
The capital gains yield plus the dividend yield on a security is called the:
average period return.
variance of returns.
Based on the period of 1926 through 2012, which category of securities has outperformed all of the other categories?
Long-term corporate bonds
U.S. Treasury bills
Long-term government bonds
Which one of the following types of securities has tended to produce the lowest real rate of return for the period 1926 through 2012?
Long-term corporate bonds
Long-term government bonds Small-company stocks
U.S. Treasury bills
Which one of the following is a correct ranking of securities based on their volatility over the period of 1926 to 2012? Rank from highest volatility to lowest volatility.
Small-company stocks, large-company stocks, long-term government bonds
Large-company stocks, U.S. Treasury bills, long-term government bonds
Small-company stocks, long-term government bonds, large-company stocks
Long-term corporate bonds, large-company stocks, U.S. Treasury bills Small-company stocks, long-term corporate bonds, large-company stocks
Over the long-term, which one of the following is a correct statement concerning risk premium?
The lower the volatility of returns, the greater the risk premium. Stocks tend to have a higher risk premium than bonds.
The lower the rate of return, the greater the risk premium.
The risk premium does not affect the rate of return.
The risk premium varies by the same percentage rate as the inflation rate.
The risk premium is computed by ______ the average rate of return for an investment.
subtracting the inflation rate from adding the inflation rate to subtracting the average return on U.S. Treasury bills from
adding the average return on U.S. Treasury bills to
subtracting the average return on long-term government bonds from
The variance of returns is computed by dividing the sum of the:
squared deviations by the number of returns minus one.
average returns by the number of returns minus one.
average returns by the number of returns plus one.
squared deviations by the average rate of return.
squared deviations by the number of returns plus one.
When forecasting the future, the arithmetic average historical return is probably too ____ of an estimate for longer periods and the geometric average historical return is:
high; probably too low.
high: probably accurate.
low: probably too high.
low: probably also too low.
high; probably also too high.
The principle of diversification tells us that: concentrating an investment in three companies all within the same industry will greatly reduce the overall risk of a portfolio.
concentrating an investment in two or three large stocks will eliminate all of a portfolio's risk.
spreading an investment across many diverse assets will eliminate all of a portfolio's risk.
spreading an investment across many diverse assets will lower a portfolio's level of risk.
spreading an investment across five diverse companies will not lower a portfolio's level of risk.
Which one of these measures the interrelationship between two securities?
The beta of a security is calculated by dividing the:
variance of the market by the covariance of the security with the market.
correlation of the security with the market by the variance of the security.
variance of the market by the correlation of the security with the market.
covariance of the security with the market by the variance of the market.
covariance of the security with the market by the variance of the security.
Which one of the following is an example of a nondiversifiable risk?
A poorly managed firm suddenly goes out of business due to lack of sales
A well managed firm reduces its work force and automates several jobs
A key employee of a firm suddenly resigns and accepts employment with a key competitor
A well respected chairman of the Federal Reserve suddenly resigns A well respected president of a firm suddenly resigns
The risk premium for an individual security is computed by:
adding the risk-free rate to the security's expected return. multiplying the security's beta by the market risk premium. multiplying the security's beta by the risk-free rate of return. dividing the market risk premium by the beta of the security. dividing the market risk premium by the quantity (1 - beta).
Standard deviation measures _____ risk.
When computing the expected return on a portfolio of stocks the portfolio weights are based on the:
number of shares owned in each stock.
price per share of each stock. market value of the total shares held in each stock.
original amount invested in each stock.
cost per share of each stock held.
The expected return on a portfolio:
can be greater than the expected return on the best performing security in the portfolio.
can be less than the expected return on the worst performing security in the portfolio.
is independent of the performance of the overall economy.
is limited by the returns on the individual securities within the portfolio.
is an arithmetic average of the returns of the individual securities when the weights of those securities are unequal.
If a stock portfolio is well diversified, then the portfolio variance:
must be equal to or greater than the variance of the least risky stock in the portfolio.
will be a weighted average of the variances of the individual securities in the portfolio.
will equal the variance of the most volatile stock in the portfolio. will be an arithmetic average of the variances of the individual securities in the portfolio.
may be less than the variance of the least risky stock in the portfolio.
Which one of the following statements is correct concerning the standard deviation of a portfolio?
Standard deviation is used to determine the amount of risk premium that should apply to a portfolio.
The greater the diversification of a portfolio, the greater the standard deviation of that portfolio. Standard deviation measures only the systematic risk of a portfolio. The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio.
The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the individual securities held within the portfolio.
The standard deviation of a portfolio will tend to increase when:
the portfolio concentration in a single cyclical industry increases.
one of two stocks related to the airline industry is replaced with a third stock that is unrelated to the airline industry.
a risky asset in the portfolio is replaced with U.S. Treasury bills. the weights of the various diverse securities become more evenly distributed.
short-term bonds are replaced with Treasury Bills.
Systematic risk is measured by:
the arithmetic average.
the geometric average.
the standard deviation.
The systematic risk of the market is assigned a:
beta of 1.
beta of 0.
standard deviation of 1.
standard deviation of 0.
variance of 1.
can be effectively eliminated through portfolio diversification. is measured by beta.
is compensated for by the risk premium.
is related to the overall economy.
The primary purpose of portfolio diversification is to:
increase returns and risks. eliminate all risks.
eliminate asset-specific risk. lower both returns and risks. eliminate systematic risk.
Which one of the following would tend to indicate that a portfolio is being effectively diversified?
A decrease in the portfolio standard deviation
An increase in the portfolio rate of return
An increase in the portfolio beta An increase in the portfolio standard deviation
A constant portfolio beta
A security that is fairly priced will have a return that lies _____ the security market line.
on or below
on or above
The intercept point of the security market line is the rate of return that corresponds to:
the market rate of return.
the beta of the market.
a value of one.
a value of zero.
the risk-free rate of return.
A stock with an actual return that lies above the security market line:
has less systematic risk than the overall market.
has more risk than warranted based on the realized rate of return.
has yielded a return equivalent to the level of risk assumed.
has more systematic risk than the overall market.
has yielded a higher return than expected for the level of risk assumed.
The market risk premium is computed by:
adding the risk-free rate of return to the inflation rate.
adding the risk-free rate of return to the market rate of return. subtracting the risk-free rate of return from the inflation rate. subtracting the risk-free rate of return from the market rate of return.
multiplying the risk-free rate of return by a beta of one.
Well-diversified portfolios have negligible:
A stock with a beta of zero would be expected to have a rate of return equal to:
the prime rate. the average AAA bond. the market rate. the risk-free rate. zero.
According to the capital asset pricing model, the expected return on a security is:
negatively and linearly related to the security's beta.
positively and linearly related to the security's beta.
positively and non-linearly related to the security's beta.
positively and linearly related to the security's variance. negatively and non-linearly related to the security's beta.
Amy has a portfolio with a beta of 1.26. She has decided to lower her investment risk. Adding which one of the following securities to her portfolio is most assuredly going to lower the risk of the portfolio?
A stock that has a covariance with the market of .89
A security that has a standard deviation of 11 percent
A security with a beta of 1.58
U.S. Treasury bills
A mix of small-company and large-company stocks
A portfolio is comprised of five securities that have individual betas of 1.38, .87, 1.02, 1.49, and .67. You do not know the portfolio weight of each security. What do you know with certainty?
The portfolio beta will not be affected by any change in the portfolio weights.
The portfolio beta will not change if an additional security with a beta of 1 is added to the portfolio.
The portfolio beta will be greater than the market beta.
The portfolio beta will be less than 1.49 and greater than .67.
The optimal portfolio beta for any investor must be greater than 0 and less than 1.
The correlation between stocks A and B is equal to the:
standard deviation of A divided by the standard deviation of B. covariance of A and B divided by the product of the standard deviation of A multiplied by the standard deviation of B.
standard deviation of B divided by the covariance between A and B. sum of the variances of A and B divided by the covariance of A and B.
product of the standard deviation of A multiplied by the standard deviation of B divided by covariance of AB with the market.
You plotted the monthly rate of return for two securities against time for the past 48 months. If the pattern of the movements of these two sets of returns rose and fell together the majority, but not all of the time, then the securities have:
no correlation at all.
a weak negative correlation.
a strong negative correlation.
a strong positive correlation.
a perfect positive correlation.
You have a portfolio of two risky stocks that has no diversification benefit. The lack of any diversification benefit must be due to the fact that:
the returns on the two stocks move perfectly in sync with one another. the returns on the two stocks move perfectly opposite of one another.
one security must be a risk-free security.
the portfolio is equally weighted between the two stocks.
the two stocks are completely unrelated to one another.
Assume two securities are negatively correlated. If these two securities are combined into an equally weighted portfolio, the portfolio standard deviation must be:
equal to the standard deviation of the overall market.
equal to the arithmetic average of the standard deviations of the individual securities.
equal to zero.
less than the weighted average of the standard deviations of the individual securities.
equal to or greater than the lowest standard deviation of the two securities.
Assume the risk-free rate and the market risk premium are both positive. Trevor currently owns a portfolio comprised of risky and risk-free securities. The portfolio has an expected return of 11.2 percent, a standard deviation of 16.2 percent, and a beta of 1.21. He has decided that he would prefer a higher expected return. Which one of these actions should he take?
Replace a stock in his current portfolio with a beta of 1.34 with a stock that has a 1.02 beta
Sell a portion of the risky assets and use the proceeds to purchase risk-free securities
Lower both the portfolio standard deviation and beta
Increase the portfolio weight of the risky assets without affecting the total portfolio value
Increase the standard deviation of the portfolio without affecting the portfolio beta
The yield to maturity on a bond is the rate:
computed as annual interest divided by the bond's market price. an investor earns if the bond is sold prior to the maturity date.
of annual interest initially offered when the bond was issued.
of return currently required by the market.
of annual interest paid on the bond.
A discount bond has a coupon rate that:
exceeds its current yield.
is less than the bond's yield to maturity.
exceeds both its current yield and its yield to maturity.
equals its current yield.
equals its current yield provided the bond pays interest annually.
A bond with both a face value and a market value of $1,000 is called a _____ bond.
both increases in time to maturity and coupon rates.
increases in time to maturity and decreases in coupon rates.
increases in coupon rates and decreases in market rates. decreases in market rates and increases in time to maturity.
both decreases in coupon rates and market rates.
Which one of these definitions is correct?
Negative covenant: a "thou shalt" agreement within an indenture Premium bond: bond that sells for less than face value
Dirty price: market price, excluding accrued interest
Call provision: issuer's right to repurchase a bond prior to maturity Unfunded debt: long-term corporate debt
The part of an indenture that protect the interests of the lender by limiting certain actions that a company might take during the term of the loan are called:
deferred call provisions.
sinking funds provisions. protective covenants.
Which formula computes the actual real rate of return on an investment?
r = (1 + R) - (1 + h) - 1
r = (1 + R)/(1 + h) - 1
R = (1 + r) × (1 + h) - 1
The relationship between nominal interest rates on default-free, pure discount securities and the time to maturity is called the:
term structure of interest rates. inflation premium.
interest rate risk premium.
The _____ premium is that portion of a nominal interest rate or bond yield that represents compensation for the possibility of nonpayment by the bond issuer.
interest rate risk taxability liquidity inflation default risk
All else constant, a bond will sell at _____ when the yield to maturity is _____ the coupon rate.
at par; less than
a premium; equal to
at par; higher than
a discount; higher than
a premium; higher than
All else constant, a coupon bond that is selling at a premium, must have:
a yield to maturity that is less than the coupon rate.
a coupon rate that is equal to the yield to maturity.
a market price that is less than par value.
semiannual interest payments.
a coupon rate that is less than the yield to maturity.
Assume a discount bond has a few years until maturity and a positive yield. All else constant, the bonds' yield to maturity is:
directly related to the time to maturity.
equal to the coupon rate. inversely related to the bond's market price.
unrelated to the time to maturity. less than its coupon rate.
Which one of the following statements is correct concerning interest rate risk as it relates to bonds, all else equal?
The shorter the time to maturity, the greater the interest rate risk. The higher the coupon, the greater the interest rate risk.
For a bond selling at par, there is no interest rate risk.
The greater the number of semiannual interest payments, the greater the interest rate risk.
The lower the amount of each interest payment, the lower the interest rate risk.
Interest rate risk _____ as the time to maturity increases.
increases at an increasing rate increases at a decreasing rate increases at a constant rate decreases at an increasing rate decreases at a decreasing rate
You own a fixed-rate bond that has a coupon rate of 6.5 percent and matures in 12 years. You purchased this bond at par value when it was originally issued. If the current market rate for this type and quality of bond is 6.8 percent, then you would expect:
the bond issuer to increase the amount of each interest payment. the yield to maturity to remain constant due to the fixed coupon rate.
the current yield today to be less than 6.5 percent.
today's market price to exceed the face value of the bond.
to realize a capital loss if you sold the bond at the market price today.
are primarily designed to protect bondholders from future actions of the bond issuer.
only apply to bonds that have a deferred call provision.
are limited to stating actions that a firm must take.
are consistent for all bonds issued by a corporation within the United States.
are designed to protect the issuer should it default.
Bonds issued by the U.S. government:
are considered to be default-free. are exempt from interest rate risk. provide totally tax-free income. pay interest that is exempt from federal income tax.
are taxed the same as municipal bonds.
Which bond has interest that is taxed only at the federal level?
Corporate, unsecured bond Treasury bond
Corporate, secured bond Corporate, zero coupon bond
What does the spread between the bid and asked bond prices represent?
Difference between the coupon rate and the current yield
Difference between the current yield and the yield to maturity Accrued interest
The increase you realize in buying power as a result of owning a bond is referred to as the _____ rate of return.
The term structure of interest rates reflects the:
pure time value of money for various lengths of time.
actual risk premium being paid for corporate bonds of varying maturities.
pure inflation adjustment applied to bonds of various maturities. interest rate risk premium applicable to bonds of varying maturities.
nominal interest rates applicable to coupon bonds of varying maturities.
Which one of these bonds is subject to the greatest interest rate risk?
5-year, zero coupon bond
5-year bond with a 4.5 percent coupon rate
5-year bond with a 5 percent coupon rate
10-year, zero coupon bond
10-year, 5 percent coupon bond
Two of the primary differences between a corporate bond and a Treasury bond with identical maturity dates are related to:
interest rate risk and time value of money.
time value of money and inflation. taxes and potential default. taxes and inflation.
inflation and interest rate risk.
Which one of these formulas is used to estimate a firm's growth rate?
Annual dividend/Current stock price
(1 - Dividend payout ratio) × g Retention ratio × ROE
Retention ratio × ROA
1 - Dividend payout ratio
Retention ratio x ROE
The total return on a stock is equal to:
the annual dividend divided by the current stock price.
the difference between the capital gains yield and the dividend yield. the capital gains yield plus the dividend yield.
(1 + Dividend yield ) × (1 + Inflation rate).
(1 + Capital gains yield) × (1 + Dividend yield).
According to finance professionals, which one of these factors has the biggest impact on a firm's PE ratio?
Accounting practices of the firm Risk-level of the firm
Size of the firm
Age of the firm
Multiple classes of stock are primarily created to:
allow certain shareholders to retain control of a firm.
replace cash dividends with share repurchases.
allow common stock to have cumulative privileges.
eliminate preemptive rights. ensure all shareholders have equal rights.
The rate at which a stock's price is expected to appreciate (or depreciate) is called the _____ yield.
A _____ is a form of equity security that has a stated liquidating value.
The voting procedure whereby shareholders may cast all of their votes for one member of the board is called _____ voting.
The voting procedure where you must own 50 percent plus one of the outstanding shares of stock to guarantee that you will win a seat on the board of directors is called _____ voting.
The voting procedure where a shareholder grants authority to another individual to vote his/her shares is called _____ voting.
The market in which new securities are originally sold to investors is called the _____ market.
Lew, an individual investor, sold 100 shares of Global Tech stock on Monday. Janice, another individual investor, purchased those shares but never met Lew. You know for certain that this trade occurred in which market?
A market participant who buys and sells securities from inventory is called a:
NASDAQ has which one of these features?
Multiple market maker system Designated market maker system Trading stations called "posts"
Based on the dividend growth model, an increase in investors' overall level of required returns will:
cause the market values of all stocks to decrease, all else held constant.
not affect overall stock market prices.
cause dividend growth rates to increase to offset this change. cause non-dividend paying stocks to decrease in price while dividend-paying stock prices remain constant.
cause some stock prices to rise while others fall.
Which one of these represents the portion of a stock's rate of return that is attributable to the growth rate of the dividends?
Capital gains yield Real rate of return Interest yield Inflation rate Dividend yield
Jack owns shares of stock in Boynton Foods and wants to be elected to the company's board of directors. There are 10,000 shares of stock outstanding and each share is granted one vote for each open position on the board. Presently, the company is voting to elect two new directors. Jack can be assured of his election:
if straight voting applies and he owns at least 25 percent of the shares, plus one additional share. if straight voting applies and he owns at least one-third of the shares, plus one additional share. if cumulative voting applies and he owns 25 percent of the shares, plus one additional share. only if cumulative voting applies and he owns the majority of the shares. if cumulative voting applies and he owns one-third of the shares, plus one additional share.
Greener Grass Co. pays a constant annual dividend of $1 a share and has 1,000 shares of common stock outstanding. The company:
must always show a current liability on its balance sheet of $1,000 for dividends payable. must still declare each dividend before it becomes an actual company liability.
is obligated to continue paying $1 a share each year.
can deduct $1,000 a year as a business expense as a result of its dividend payment.
can be forced into bankruptcy by its shareholders if it fails to pay at least $1 a year in dividends.
are a source of tax-free income for individual investors.
reduce the taxable income of the payer.
are only 70 percent taxable to corporate shareholders.
are paid out of pre-tax income and thus are taxed at the personal level. are taxed at the personal level even though they are paid from aftertax income.
The owner of preferred stock:
owns shares that generally have a stated liquidating value of $1,000 per share.
has the right to veto the outcome of an election held by the common shareholders.
has the right to collect payment on any unpaid dividends as long as the stock is non-cumulative preferred.
is entitled to a distribution of income prior to the common shareholders.
is guaranteed voting rights similar to a common shareholder.
Which one of the following statements concerning preferred stock is correct?
Unpaid preferred dividends are a liability of the firm whether or not they have been declared. Preferred shareholders may be granted voting rights if preferred dividend payments remain unpaid. Any unpaid preferred dividends will accrue interest at a rate equal to the dividend rate.
All unpaid dividends on both cumulative and non-cumulative preferred stock must be paid before any common stock dividends are declared.
Preferred dividends will be paid quarterly only when the firm has current net income that exceeds the amount of the quarterly dividend.
Which one of the following transactions occurs in the primary market?
Repurchase of GHI stock from Tim by GHI
Tax-free gift of DEF stock to Heather by Jennifer
Sale of ABC stock by Fred Jones to Mary Smith
Initial sale of JKL stock by JKL to Jamie
Transfer of MNO stock from Tom to his son, Jon
Which one of the following statements concerning dealers and brokers in the financial markets is correct?
A broker never assumes ownership of the securities being traded.
A dealer pays the ask price when purchasing securities.
A broker earns income in the form of a bid-ask spread.
A dealer in market securities arranges sales between buyers and sellers for a fee.
A broker deals solely in the primary market.
A stock quote shows a last price of 32.13, a P/E of 17, and a net change of -.23. Based on this information, which one of the following statements is correct?
The closing price on the previous trading day was $.23 lower than today's closing price.
A dealer can purchase the stock for $.23 less than an investor can. The earnings per share decreased by $.23 a share this year.
The earnings per share have increased by 17 percent this year. The earnings per share are equal to 1/17th of $32.13.
A stock report contains the following information: P/E 21.4, closing price 28.16, dividend 1.10, net chg .06, and an ask of 28.22 × 300. Which one of the following statements is correct given this information?
The stock price has increased by 6 percent thus far this year.
The closing price on the previous trading day was $28.10.
The earnings per share are approximately $2.
The dividend yield is 21.4 percent. The bid-ask spread is $.300.
In a stock market report, the open price represents the:
price a dealer is willing to pay. price at which a designated market maker will sell.
first trade of the day.
closing price on the previous trading day.
current bid price.
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