Archive for March 2019

Worcester Corporation has a P/E ratio of 15. Natick Corporation is in the same industry as Worcester, but has a P/E ratio of 20. Possible interpretations of this discrepancy include

Worcester Corporation has a P/E ratio of 15. Natick Corporation is in the same industry as Worcester, but has a P/E ratio of 20. Possible interpretations of this discrepancy include




A) Worcester Corporation is overpriced.
B) Natick Corporation has higher earnings per share.
C) Investors expect Natick to grow faster than Worcester.
D) Natick's stock price is higher than Worcester's.


Answer: C

Marco's just reported an EPS of $1.68 on revenues of $440 million. The company has 12 million shares outstanding. Total assets are $280 million, current liabilities equal $48 million, and long-term debt is $112 million. Net fixed assets are worth $230 million. Given this information, which one of the following statements is correct?

Marco's just reported an EPS of $1.68 on revenues of $440 million. The company has 12 million shares outstanding. Total assets are $280 million, current liabilities equal $48 million, and long-term debt is $112 million. Net fixed assets are worth $230 million. Given this information, which one of the following statements is correct?



A) Marco's debt-equity ratio is 0.75.
B) Marco's current ratio is 1.75.
C) Marco's total asset turnover is 3.67.
D) Marco's net working capital is $2 million.


Answer: C

A total asset turnover of 3 means that every

A total asset turnover of 3 means that every



A) $1 in sales is supported by $3 of assets.
B) $3 in assets produces $1 in net earnings.
C) $1 in total assets is replaced on average every 3 years.
D) $1 in assets produces $3 in sales.


Answer: D

The inventory turnover rate for a firm is 14.5 as compared to the relevant industry rate of 13.2. In this case, the firm is

The inventory turnover rate for a firm is 14.5 as compared to the relevant industry rate of 13.2. In this case, the firm is



A) selling its inventory slower than the industry.
B) underperforming the industry.
C) averaging less days of sales in inventory than the industry.
D) generating less sales per dollar of inventory.


Answer: C

Financial ratios

Financial ratios



I. allow comparisons across firms without concern over firm size.
II. can compare a firm's operating and financial status to industry norms.
III. reflect the future outlook for a firm as well as past performance.
IV. look at the liquidity, activity, leverage, profitability and market measures of a firm.


A) II and IV only
B) I and II only
C) I, II and IV only
D) I, II, III and IV


Answer: C

Which of the following are measures of liquidity?

Which of the following are measures of liquidity?



I. net working capital
II. accounts receivable turnover
III. current ratio
IV. times interest earned


A) I and III only
B) I, II and III only
C) I, II and IV only
D) I, III and IV only


Answer: A

The Allied Computer Co. has sales of $300 million, a net profit margin of 9%, and 10 million shares of common stock outstanding. It has no preferred stock outstanding. If Allied stock trades at $50 per share, it has a price/earnings ratio of 20.9.

The Allied Computer Co. has sales of $300 million, a net profit margin of 9%, and 10 million shares of common stock outstanding. It has no preferred stock outstanding. If Allied stock trades at $50 per share, it has a price/earnings ratio of 20.9.



Answer: False

Since the APT does not specify which factors should be used to determine risk premiums, how should we decide which factors to investigate?

Since the APT does not specify which factors should be used to determine risk premiums, how should we decide which factors to investigate? 



a. Researchers should focus on factors that affect firms and industries
b. Researchers should look for the most important unsystematic factors
c. Researchers should concentrate on better defining the market portfolio
D. Researchers should consider factors that correlate highly with uncertainty in consumption and investment opportunities


Answer: D. Researchers should consider factors that correlate highly with uncertainty in consumption and investment opportunities

The two factor model on a stock provides a risk premium for exposure to market risk of 12%, a risk premium for exposure to silver commodity prices of 3.5% and a risk free rate of 4.0%. What is the expected return on the stock?

The two factor model on a stock provides a risk premium for exposure to market risk of 12%, a risk premium for exposure to silver commodity prices of 3.5% and a risk free rate of 4.0%. What is the expected return on the stock? 



a. 11.6%
b. 13.0%
c. 15.3%
D. 19.5%


Answer: D. 19.5%

The risk premium for exposure to exchange rates is 5% and the firm has a beta relative to exchanges rates of 0.4. The risk premium for exposure to the consumer price index is -6% and the firm has a beta relative to the CPI of 0.8. If the risk free rate is 3.0%, what is the expected return on this stock?

The risk premium for exposure to exchange rates is 5% and the firm has a beta relative to exchanges rates of 0.4. The risk premium for exposure to the consumer price index is -6% and the firm has a beta relative to the CPI of 0.8. If the risk free rate is 3.0%, what is the expected return on this stock? 




A. 0.2%
b. 1.5%
c. 3.6%
d. 4.0%


Answer: A. 0.2%

The two factor model on a stock provides a risk premium for exposure to market risk of 8%, a risk premium for exposure to interest rate of (-2.3%), and a risk free rate of 3.0%. What is the expected return on the stock?

The two factor model on a stock provides a risk premium for exposure to market risk of 8%, a risk premium for exposure to interest rate of (-2.3%), and a risk free rate of 3.0%. What is the expected return on the stock? 



A. 8.7%
b. 11.0%
c. 13.3%
d. 15.2%


Answer: A. 8.7%

The two factor model on a stock provides a risk premium for exposure to market risk of 8%, a risk premium for exposure to interest rate of (-2.3%), and a risk free rate of 3.0%. What is the expected return on the stock?

The two factor model on a stock provides a risk premium for exposure to market risk of 8%, a risk premium for exposure to interest rate of (-2.3%), and a risk free rate of 3.0%. What is the expected return on the stock? 



A. 8.7%
b. 11.0%
c. 13.3%
d. 15.2%


Answer: A. 8.7%

The risk premium for exposure to aluminum commodity prices is 4% and the firm has a beta relative to aluminum commodity prices of 0.6. The risk premium for exposure to GDP changes is 6% and the firm has a beta relative to GDP of 1.2. If the risk free rate is 4.0%, what is the expected return on this stock?

The risk premium for exposure to aluminum commodity prices is 4% and the firm has a beta relative to aluminum commodity prices of 0.6. The risk premium for exposure to GDP changes is 6% and the firm has a beta relative to GDP of 1.2. If the risk free rate is 4.0%, what is the expected return on this stock? 



a. 10.0%
b. 11.5%
C. 13.6%
d. 14.0%


Answer: C. 13.6%

There are two independent economic factors M1 and M2. The risk-free rate is 5% and all stocks have independent firm-specific components with a standard deviation of 25%. Portfolios A and B are well diversified. Given the data below which equation provides the correct pricing model?

There are two independent economic factors M1 and M2. The risk-free rate is 5% and all stocks have independent firm-specific components with a standard deviation of 25%. Portfolios A and B are well diversified. Given the data below which equation provides the correct pricing model?



a. E(rP) = 5 + 1.12bP1 + 11.86bP2
b. E(rP) = 5 + 4.96bP1 + 13.26bP2
c. E(rP) = 5 + 3.23bP1 + 8.46bP2
D. E(rP) = 5 + 8.71bP1 + 9.68bP2


Answer: D. E(rP) = 5 + 8.71bP1 + 9.68bP2

Research has identified two systematic factors that affect U.S. stock returns. The factors are growth in industrial production and changes in long term interest rates. Industrial production growth is expected to be 3% and long term interest rates are expected to increase by 1% and based on this data You are analyzing a stock is that has a beta of 1.2 on the industrial production factor and 0.5 on the interest rate factor. It currently has an expected return of 12%. However, if industrial production actually grows 5% and interest rates drop 2% what is your best guess of the stock's return?

Research has identified two systematic factors that affect U.S. stock returns. The factors are growth in industrial production and changes in long term interest rates. Industrial production growth is expected to be 3% and long term interest rates are expected to increase by 1% and based on this data You are analyzing a stock is that has a beta of 1.2 on the industrial production factor and 0.5 on the interest rate factor. It currently has an expected return of 12%. However, if industrial production actually grows 5% and interest rates drop 2% what is your best guess of the stock's return? 



a. 15.9%
B. 12.9%
c. 13.2%
d. 12.0%


Answer: B. 12.9%

You consider buying a share of stock at a price of $25. The stock is expected to pay a dividend of $1.50 next year and your advisory service tells you that you can expect to sell the stock in one year for $28. The stock's beta is 1.1, Rf is 6% and E[rm] = 16%. What is the stock's abnormal return?

You consider buying a share of stock at a price of $25. The stock is expected to pay a dividend of $1.50 next year and your advisory service tells you that you can expect to sell the stock in one year for $28. The stock's beta is 1.1, Rf is 6% and E[rm] = 16%. What is the stock's abnormal return? 



A. 1%
b. 2%
c. -1%
d. -2%


Answer: A. 1%

Two investment advisors are comparing performance. Advisor A averaged a 20% return with a portfolio beta of 1.5 and Advisor B averaged a 15% return with a portfolio beta of 1.2. If the T-bill rate was 5% and the market return during the period was 13%, which advisor was the better stock picker?

Two investment advisors are comparing performance. Advisor A averaged a 20% return with a portfolio beta of 1.5 and Advisor B averaged a 15% return with a portfolio beta of 1.2. If the T-bill rate was 5% and the market return during the period was 13%, which advisor was the better stock picker? 



A. Advisor A was better because he generated a larger alpha
b. Advisor B was better because he generated a larger alpha
c. Advisor A was better because he generated a higher return
d. Advisor B was better because he achieved a good return with a lower beta


Answer: A. Advisor A was better because he generated a larger alpha

Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%. Portfolio X has an expected return of 14% and a beta of 1.00. Portfolio Y has an expected return of 9.5% and a beta of 0.25. In this situation, you would conclude that portfolios X and Y __________.

Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%. Portfolio X has an expected return of 14% and a beta of 1.00. Portfolio Y has an expected return of 9.5% and a beta of 0.25. 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 priced


Answer: A. Are in equilibrium

The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, __________.

The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, __________. 



a. SDA Corp. stock is underpriced
b. SDA Corp. stock is fairly priced
C. SDA Corp. stock's alpha is -0.75%
d. SDA Corp. stock alpha is 0.75%


Answer: C. SDA Corp. stock's alpha is -0.75%

Based on the data you know that the stock

Based on the data you know that the stock 



a. Earned a positive alpha that is statistically significantly different from zero
b. Has a beta precisely equal to 0.890
C. Has a beta that could be anything between 0.6541 and 1.465 inclusive
d. Has no systematic risk


Answer: C. Has a beta that could be anything between 0.6541 and 1.465 inclusive

One of the main problems with the arbitrage pricing theory is

One of the main problems with the arbitrage pricing theory is 





a. Its use of several factors instead of a single market index to explain the risk-return relationship
b. The introduction of non-systematic risk as a key factor in the risk-return relationship
c. That the APT requires an even larger number of unrealistic assumptions than the CAPM
D. The model fails to identify the key macro-economic variables in the risk-return relationship


Answer: D. The model fails to identify the key macro-economic variables in the risk-return relationship

Standard deviation is a measure of ____________.

Standard deviation is a measure of ____________. 



A. Total risk
b. Relative systematic risk
c. Relative non-systematic risk
d. Relative business risk


Answer: A. Total risk

Arbitrage is ___________________________.

Arbitrage is ___________________________. 



a. Is an example of the law of one price
B. The creation of riskless profits made possible by relative mispricing among securities
c. Is a common opportunity in modern markets
d. An example of a risky trading strategy based on market forecasting


Answer: B. The creation of riskless profits made possible by relative mispricing among securities

The most significant conceptual difference between the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is that the CAPM ______________.

The most significant conceptual difference between the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is that the CAPM ______________. 




a. Places less emphasis on market risk
b. Recognizes multiple unsystematic risk factors
C. Recognizes only one systematic risk factor
d. Recognizes multiple systematic risk factors


Answer: C. Recognizes only one systematic risk factor

Beta is a measure of _______________.

Beta is a measure of _______________. 



a. Total risk
B. Relative systematic risk
c. Relative non-systematic risk
d. Relative business risk


Answer: B. Relative systematic risk

Liquidity is a risk factor that ____.

Liquidity is a risk factor that ____. 



A. Has yet to be accurately measured and incorporated into portfolio management
b. Is unaffected by trading mechanisms on various stock exchanges
c. Has no effect on the market value of an asset
d. Affects bond prices but not stock prices


Answer: A. Has yet to be accurately measured and incorporated into portfolio management

The SML is valid for _______________ and the CML is valid for _______________.

The SML is valid for _______________ and the CML is valid for _______________. 



a. Only individual assets; well diversified portfolios only
b. Only well diversified portfolios; only individual assets
c. Both well diversified portfolios and individual assets; both well diversified portfolios and individual assets
D. Both well diversified portfolios and individual assets; well diversified portfolios only


Answer: D. Both well diversified portfolios and individual assets; well diversified portfolios only

In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by ______________.

In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by ______________. 



I. including the unsystematic risk of a stock
II. including human capital in the market portfolio
III. allowing for changes in beta over time


a. I and II only
B. II and III only
c. I and III only
d. I, II and III


Answer: B. II and III only

In his famous critique of the CAPM, Roll argued that the CAPM _______________.

In his famous critique of the CAPM, Roll argued that the CAPM _______________. 



A. Is not testable because the true market portfolio can never be observed
b. Is of limited use because systematic risk can never be entirely eliminated
c. Should be replaced by the APT
d. Should be replaced by the Fama French 3 factor model


Answer: A. Is not testable because the true market portfolio can never be observed

According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is ________________.

According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is ________________. 



a. Directly related to the risk aversion of the particular investor
b. Inversely related to the risk aversion of the particular investor
C. Directly related to the beta of the stock
d. Inversely related to the alpha of the stock


Answer: C. Directly related to the beta of the stock

Consider the following two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.20. Stock B has an expected return of 14% and a beta of 1.80. The expected market rate of return is 9% and the risk-free rate is 5%. Security __________ would be considered a good buy because __________.

Consider the following two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.20. Stock B has an expected return of 14% and a beta of 1.80. The expected market rate of return is 9% and the risk-free rate is 5%. Security __________ would be considered a good buy because __________. 



a. A, it offers an expected excess return of 0.8%
b. A, it offers an expected excess return of 2.2%
C. B, it offers an expected excess return of 1.8%
d. B, it offers an expected return of 2.4%


Answer: C. B, it offers an expected excess return of 1.8%

The risk-free rate and the expected market rate of return are 5% and 15% respectively. According to the capital asset pricing model, the expected rate of return on security X with a beta of 1.2 is equal to __________.

The risk-free rate and the expected market rate of return are 5% and 15% respectively. According to the capital asset pricing model, the expected rate of return on security X with a beta of 1.2 is equal to __________. 



a. 12%
B. 17%
c. 18%
d. 23%


Answer: B. 17%

Consider the one-factor APT. The standard deviation of return on a well-diversified portfolio is 20%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately __________.

Consider the one-factor APT. The standard deviation of return on a well-diversified portfolio is 20%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately __________. 



a. 0.60
b. 1.00
C. 1.67
d. 3.20


Answer: C. 1.67

The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X with a beta of .8 to offer a rate of return of 12 percent, then you should __________.

The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X with a beta of .8 to offer a rate of return of 12 percent, then you should __________. 



a. Buy stock X because it is overpriced
B. Buy stock X because it is underpriced
c. Sell short stock X because it is overpriced
d. Sell short stock X because it is underpriced


Answer: B. Buy stock X because it is underpriced

The variance of the return on the market portfolio is .0400 and the expected return on the market portfolio is 20%. If the risk-free rate of return is 10%, the market degree of risk aversion, A, is __________.

The variance of the return on the market portfolio is .0400 and the expected return on the market portfolio is 20%. If the risk-free rate of return is 10%, the market degree of risk aversion, A, is __________. 




a. 0.5
B. 2.5
c. 3.5
d. 5.0


Answer: B. 2.5

In a single factor market model the beta of a stock

In a single factor market model the beta of a stock 



A. Measures the stock's contribution to the standard deviation of the market portfolio
b. Measures the stock's unsystematic risk
c. Changes with the variance of the residuals
d. Measures the stock's contribution to the standard deviation of the stock


Answer: A. Measures the stock's contribution to the standard deviation of the market portfolio

Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The variance of return on the market portfolio is .0225. If the risk-free rate of return is 4%, the expected return on the market portfolio is __________.

Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The variance of return on the market portfolio is .0225. If the risk-free rate of return is 4%, the expected return on the market portfolio is __________. 



a. 6.75%
b. 9.0%
C. 10.75%
d. 12.0%


Answer: C. 10.75%

An important characteristic of market equilibrium is ________________.

An important characteristic of market equilibrium is ________________. 



a. The presence of many opportunities for creating zero-investment portfolios
b. All investors exhibit the same degree of risk aversion
C. The absence of arbitrage opportunities
d. The a lack of liquidity in the market


Answer: C. The absence of arbitrage opportunities

Building a zero-investment portfolio will always involve _____________

Building a zero-investment portfolio will always involve _____________ 



a. An unknown mixture of short and long positions
b. Only short positions
c. Only long positions
D. Equal investments in a short and a long position


Answer: D. Equal investments in a short and a long position

The possibility of arbitrage arises when _____________.

The possibility of arbitrage arises when _____________. 



a. There is no consensus among investors regarding the future direction of the market, and thus trades are made arbitrarily
B. Mis-pricing among securities creates opportunities for riskless profits
c. Two identically risky securities carry the same expected returns
d. Investors do not diversify


Answer: B. Mis-pricing among securities creates opportunities for riskless profits

Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5% and the market expected rate of return is 15%. According to the capital asset pricing model, security X is __________.

Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5% and the market expected rate of return is 15%. According to the capital asset pricing model, security X is __________. 



a. Fairly priced
B. Overpriced
c. Underpriced
d. None of the above


Answer: B. Overpriced

Consider the one-factor APT. The variance of the return on the factor portfolio is .08. The beta of a well-diversified portfolio on the factor is 1.2. The variance of the return on the well-diversified portfolio is approximately __________.0810.

Consider the one-factor APT. The variance of the return on the factor portfolio is .08. The beta of a well-diversified portfolio on the factor is 1.2. The variance of the return on the well-diversified portfolio is approximately __________.0810. 



A. .1152
b. .1270
c. .1521
d. .1342


Answer: A. .1152

Consider the multi-factor APT with two factors. Portfolio A has a beta of 0. 5 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factors 1 and 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.

Consider the multi-factor APT with two factors. Portfolio A has a beta of 0. 5 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factors 1 and 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. 16.25%
d. 23.0%


Answer: C. 16.25%

Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio __________.

Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio __________. 



a. A, A
b. A, B
C. B, A
d. B, B


Answer: C. B, A

Consider the single factor APT. Portfolio A has a beta of 1.3 and an expected return of 21%. Portfolio B has a beta of 0.7 and an expected return of 17%. The risk-free rate of return is 8%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio __________.

Consider the single factor APT. Portfolio A has a beta of 1.3 and an expected return of 21%. Portfolio B has a beta of 0.7 and an expected return of 17%. The risk-free rate of return is 8%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio __________. 



a. A, A
B. A, B
c. B, A
d. B, B


Answer: B. A, B

In a world where the CAPM holds which one of the following is not a true statement regarding the capital market line?

In a world where the CAPM holds which one of the following is not a true statement regarding the capital market line? 



a. The capital market line always has a positive slope
B. The capital market line is also called the security market line
c. The capital market line is the best attainable capital allocation line
d. The capital market line is the line from the risk-free rate through the market portfolio


Answer: B. The capital market line is also called the security market line

According to the CAPM which of the following is not a true statement regarding the market portfolio.

According to the CAPM which of the following is not a true statement regarding the market portfolio. 



a. All securities in the market portfolio are held in proportion to their market values
b. It includes all risky assets in the world, including human capital
C. It is always the minimum variance portfolio on the efficient frontier
d. It lies on the efficient frontier


Answer: C. It is always the minimum variance portfolio on the efficient frontier

According to the capital asset pricing model, __________.

According to the capital asset pricing model, __________. 



a. All securities' returns must lie on the capital market line
B. All securities' returns must lie on the security market line
c. The slope of the security market line must be less than the market risk premium
d. Any security with a beta of 1 must have an excess return of zero


Answer: B. All securities' returns must lie on the security market line

The beta of a security is equal to __________.

The beta of a security is equal to __________. 



A. The covariance between the security and market returns divided by the variance of the market's returns
b. The covariance between the security and market returns divided by the standard deviation of the market's returns
c. The variance of the security's returns divided by the covariance between the security and market returns
d. The variance of the security's returns divided by the variance of the market's returns


Answer: A. The covariance between the security and market returns divided by the variance of the market's returns

You have a $50,000 portfolio consisting of Intel, GE and Con Edison. You put $20,000 in Intel, $12,000 in GE and the rest in Con Edison. Intel, GE and Con Edison have betas of 1.3, 1.0 and 0.8 respectively. What is your portfolio beta?

You have a $50,000 portfolio consisting of Intel, GE and Con Edison. You put $20,000 in Intel, $12,000 in GE and the rest in Con Edison. Intel, GE and Con Edison have betas of 1.3, 1.0 and 0.8 respectively. What is your portfolio beta? 



A. 1.048
b. 1.033
c. 1.000
d. 1.037


Answer: A. 1.048

Arbitrage is based on the idea that __________.

Arbitrage is based on the idea that __________. 



A. Assets with identical risks must have the same expected rate of return
b. Securities with similar risk should sell at different prices
c. The expected returns from equally risky assets are different
d. Markets are perfectly efficient


Answer: A. Assets with identical risks must have the same expected rate of return

According to the capital asset pricing model, a security with a __________.

According to the capital asset pricing model, a security with a __________. 



a. Negative alpha is considered a good buy
b. Positive alpha is considered overpriced
C. Positive alpha is considered underpriced
d. Zero alpha is considered a good buy


Answer: C. Positive alpha is considered underpriced

If enough investors decide to purchase stocks they are likely to drive up stock prices thereby causing _____________ and ____________.

If enough investors decide to purchase stocks they are likely to drive up stock prices thereby causing _____________ and ____________. 



A. Expected returns to fall; risk premiums to fall
b. Expected returns to rise; risk premiums to fall
c. Expected returns to rise; risk premiums to rise
d. Expected returns to fall; risk premiums to rise


Answer: A. Expected returns to fall; risk premiums to fall

In a simple CAPM world which of the following statements is/are correct?

In a simple CAPM world which of the following statements is/are correct? 



I. All investors will choose to hold the market portfolio, which includes all risky assets in the world
II. Investors' complete portfolio will vary depending on their risk aversion
III. The return per unit of risk will be identical for all individual assets
IV. The market portfolio will be on the efficient frontier and it will be the optimal risky portfolio


a. I, II and III only
b. II, III and IV only
c. I, III and IV only
D. I, II, III and IV


Answer: D. I, II, III and IV

Which of the following are assumptions of the simple CAPM model?

Which of the following are assumptions of the simple CAPM model? 



I. Individual trades of investors do not affect a stock's price
II. All investors plan for one identical holding period
III. All investors analyze securities in the same way and share the same economic view of the world
IV. All investors have the same level of risk aversion



a. I, II and IV only
B. I, II and III only
c. II, III and IV only
d. I, II, III and IV


Answer: B. I, II and III only

Fama and French claim that after controlling for firm size and the ratio of book value to market value, beta is insignificant in explaining stock returns. This claim

Fama and French claim that after controlling for firm size and the ratio of book value to market value, beta is insignificant in explaining stock returns. This claim 



I. is supported by their analysis of historical stock return data
II. is based on a well developed theoretical model
III. implies that unsystematic risk is actually priced


A. I only
b. I and II only
c. II and III only
d. I, II and III


Answer: A. I only

Which of the following arguments supporting passive investment strategies is (are) correct?

Which of the following arguments supporting passive investment strategies is (are) correct?


I. Active trading strategies may not guarantee higher returns but guarantee higher costs.
II. Passive investors can free-ride on the activity of knowledge investors whose trades force prices to reflect currently available information.
III. Passive investors are guaranteed to earn higher rates of return than active investors over sufficiently long time horizons.


A. I only

B. I and II only

C. II and III only

D. I, II, and III


Answer: B. I and II only

The price of a stock is $55 at the beginning of the year and $50 at the end of the year. If the stock paid a $3 dividend and inflation was 3%, what is the real holding-period return for the year?

The price of a stock is $55 at the beginning of the year and $50 at the end of the year. If the stock paid a $3 dividend and inflation was 3%, what is the real holding-period return for the year? 



A. -3.64%

B. -6.36%

C. -6.44%

D. -11.74%


Answer: C. -6.44%


Nominal return on stock: (50 + 3)/55 - 1 = -3.64%
Real return: (1 + R) = (1 + r)(1 + i)
1 + r = (1 - .0364)/(1.03) = .935
R = .935 - 1 = -.0644

A security with normally distributed returns has an annual expected return of 18% and standard deviation of 23%. The probability of getting a return between -28% and 64% in any one year is _____.

A security with normally distributed returns has an annual expected return of 18% and standard deviation of 23%. The probability of getting a return between -28% and 64% in any one year is _____. 



A. 68.26%

B. 95.44%

C. 99.74%

D. 100%


Answer: B. 95.44%


Note that the expected return minus 2 standard deviations is 18% - (2 × 23%) = -28% and the expected return plus 2 standard deviations is 18% + (2 × 23%) = 64%. The probability of a return falling within ± 2 standard deviations is 95.44%.

The annualized (geometric) average return on this investment is _____.

You have the following rates of return for a risky portfolio for several recent years:

2008 - 35.23%
2009 - 18.67%
2010 - -9.87%
2011 - 23.45%


The annualized (geometric) average return on this investment is _____. 



A. 16.15%

B. 16.87%

C. 21.32%

D. 15.60%


Answer: D. 15.60%


(1.17856)1/4 - 1 = 15.60%

If you invested $1,000 at the beginning of 2008, your investment at the end of 2011 would be worth ___________.

You have the following rates of return for a risky portfolio for several recent years:

2008 - 35.23%
2009 - 18.67%
2010 - -9.87%
2011 - 23.45%

If you invested $1,000 at the beginning of 2008, your investment at the end of 2011 would be worth ___________. 



A. $2,176.60

B. $1,785.56

C. $1,645.53

D. $1,247.87


Answer: B. $1,785.56


$1,000(1.3523)(1.1867)(1 + -.0987)(1.2345) = $1,785.56

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. The dollar values of your positions in X, Y, and Treasury bills would be _________, __________, and __________, respectively, if you decide to hold a complete portfolio that has an expected return of 8%.

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. The dollar values of your positions in X, Y, and Treasury bills would be _________, __________, and __________, respectively, if you decide to hold a complete portfolio that has an expected return of 8%. 



A. $162; $595; $243

B. $243; $162; $595

C. $595; $162; $243

D. $595; $243; $162


Answer: B. $243; $162; $595

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. If you decide to hold 25% of your complete portfolio in the risky portfolio and 75% in the Treasury bills, then the dollar values of your positions in X and Y, respectively, would be __________ and _________.

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. If you decide to hold 25% of your complete portfolio in the risky portfolio and 75% in the Treasury bills, then the dollar values of your positions in X and Y, respectively, would be __________ and _________. 



A. $300; $450

B. $150; $100

C. $100; $150

D. $450; $300


Answer: B. $150; $100


X = 1,000(.25)(.6) = 150
Y = 1,000(.25)(.4) = 100

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 8%, you should invest approximately __________ in the risky portfolio. This will mean you will also invest approximately __________ and __________ of your complete portfolio in security X and Y, respectively.

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 8%, you should invest approximately __________ in the risky portfolio. This will mean you will also invest approximately __________ and __________ of your complete portfolio in security X and Y, respectively. 



A. 0%; 60%; 40%

B. 25%; 45%; 30%

C. 40%; 24%; 16%

D. 50%; 30%; 20%


Answer: C. 40%; 24%; 16%



E(rp) = .6(14) + .4(10) = 12.4%
.08 = wrp(.124) + (1 - wrp)(.05)
wrp ˜ 40%
wx in complete portfolio = .40(.60) = 24%
wy in complete portfolio = .40(.40) = 16%

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 11%, you should invest __________ of your complete portfolio in Treasury bills.

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 11%, you should invest __________ of your complete portfolio in Treasury bills. 



A. 19%

B. 25%

C. 36%

D. 50%


Answer: A. 19%

The return on the risky portfolio is 15%. The risk-free rate, as well as the investor's borrowing rate, is 10%. The standard deviation of return on the risky portfolio is 20%. If the standard deviation on the complete portfolio is 25%, the expected return on the complete portfolio is _________.

The return on the risky portfolio is 15%. The risk-free rate, as well as the investor's borrowing rate, is 10%. The standard deviation of return on the risky portfolio is 20%. If the standard deviation on the complete portfolio is 25%, the expected return on the complete portfolio is _________. 



A. 6%

B. 8.75 %

C. 10%

D. 16.25%


Answer: D. 16.25%



sC = y × sp = .25
sC = y × .20 = .25
y = .25/.20 = 1.25
1 - y = -.25
E(rC) = 1.25 × 15% - .25 × 10% = 16.25%

You have $500,000 available to invest. The risk-free rate, as well as your borrowing rate, is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should _________.

You have $500,000 available to invest. The risk-free rate, as well as your borrowing rate, is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should _________. 



A. invest $125,000 in the risk-free asset

B. invest $375,000 in the risk-free asset

C. borrow $125,000

D. borrow $375,000


Answer: D. borrow $375,000

y × .16 + (1 - y) × .08 = .22
.16 y - .08 y + .08 = .22
.08 y = .14
y = 1.75
Put 1.75 × $500,000 = $875,000 in the risky asset by borrowing $375,000.

You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. The slope of the capital allocation line formed with the risky asset and the risk-free asset is approximately _________.

You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. The slope of the capital allocation line formed with the risky asset and the risk-free asset is approximately _________. 



A. 1.040

B. .80

C. .50

D. .25


Answer: C. .50

Slope = (16 - 6)/20 = .50

You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. A portfolio that has an expected value in 1 year of $1,100 could be formed if you _________.

You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. A portfolio that has an expected value in 1 year of $1,100 could be formed if you _________. 



A. place 40% of your money in the risky portfolio and the rest in the risk-free asset

B. place 55% of your money in the risky portfolio and the rest in the risk-free asset

C. place 60% of your money in the risky portfolio and the rest in the risk-free asset

D. place 75% of your money in the risky portfolio and the rest in the risk-free asset


Answer: A. place 40% of your money in the risky portfolio and the rest in the risk-free asset


$1,100 = y × (1,000)(1.16) + (1 - y)1,000(1.06), so y =.4

You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. __________ of your complete portfolio should be invested in the risky portfolio if you want your complete portfolio to have a standard deviation of 9%.

You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. __________ of your complete portfolio should be invested in the risky portfolio if you want your complete portfolio to have a standard deviation of 9%. 



A. 100%

B. 90%

C. 45%

D. 10%


Answer: C. 45%


sC = y × sp
9% = y × 20%
y = 9/20 = 45%

You invest $10,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 15% and a standard deviation of 21% and a Treasury bill with a rate of return of 5%. How much money should be invested in the risky asset to form a portfolio with an expected return of 11%?

You invest $10,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 15% and a standard deviation of 21% and a Treasury bill with a rate of return of 5%. How much money should be invested in the risky asset to form a portfolio with an expected return of 11%? 



A. $6,000

B. $4,000

C. $7,000

D. $3,000


Answer: A. $6,000

15y + 5(1 - y) = 11; y = 60%; .60(10,000) = $6,000

Consider the following two investment alternatives: First, a risky portfolio that pays a 20% rate of return with a probability of 60% or a 5% rate of return with a probability of 40%. Second, a Treasury bill that pays 6%. If you invest $50,000 in the risky portfolio, your expected profit would be _________.

Consider the following two investment alternatives: First, a risky portfolio that pays a 20% rate of return with a probability of 60% or a 5% rate of return with a probability of 40%. Second, a Treasury bill that pays 6%. If you invest $50,000 in the risky portfolio, your expected profit would be _________. 



A. $3,000

B. $7,000

C. $7,500

D. $10,000


Answer: B. $7,000


Ending value = $50,000(1.14) = $57,000
Profit = $57,000 - 50,000 = $7,000

Consider the following two investment alternatives: First, a risky portfolio that pays a 15% rate of return with a probability of 40% or a 5% rate of return with a probability of 60%. Second, a Treasury bill that pays 6%. The risk premium on the risky investment is _________.

Consider the following two investment alternatives: First, a risky portfolio that pays a 15% rate of return with a probability of 40% or a 5% rate of return with a probability of 60%. Second, a Treasury bill that pays 6%. The risk premium on the risky investment is _________. 



A. 1%

B. 3%

C. 6%

D. 9%


Answer: B. 3%

Risk premium = [.4{.15) + .6(.05)] - .06

The holding-period return on a stock was 32%. Its beginning price was $25, and its cash dividend was $1.50. Its ending price must have been _________.

The holding-period return on a stock was 32%. Its beginning price was $25, and its cash dividend was $1.50. Its ending price must have been _________. 



A. $28.50

B. $33.20

C. $31.50

D. $29.75


Answer: C. $31.50

HPR = (P1 + DIV - P0)/P0
HPR × P0 = P1 + DIV - P0
P1 = HPR × P0 - DIV + P0
P1 =.32 × $25 - $1.50 + 25 = $31.50

An investor invests 70% of her wealth in a risky asset with an expected rate of return of 15% and a variance of 5%, and she puts 30% in a Treasury bill that pays 5%. Her portfolio's expected rate of return and standard deviation are __________ and __________ respectively.

An investor invests 70% of her wealth in a risky asset with an expected rate of return of 15% and a variance of 5%, and she puts 30% in a Treasury bill that pays 5%. Her portfolio's expected rate of return and standard deviation are __________ and __________ respectively. 



A. 10%; 6.7%

B. 12%; 22.4%

C. 12%; 15.7%

D. 10%; 35%


Answer: C. 12%; 15.7%
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