Mfin 15 CH1 3 Reviewer

CHAPTER 1—THE INVESTMENT SETTING
TRUE/FALSE
1. The rate of exchange between certain future dollars and certain current dollars is known as the pure
rate of interest.
ANS: True PTS: 1
2. An investment is the current commitment of dollars over time to derive future payments to compensate
the investor for the time funds are committed, the expected rate of inflation and the uncertainty of
future payments.
ANS: True PTS: 1
3. The holding period return (HPR) is equal to the holding period yield (HPY) stated as a percentage.
ANS: False PTS: 1
4. The geometric mean of a series of returns is always larger than the arithmetic mean and the difference
increases with the volatility of the series.
ANS: False PTS: 1
5. The expected return is the average of all possible returns.
ANS: False PTS: 1
6. Two measures of the risk premium are the standard deviation and the variance.
ANS: False PTS: 1
7. The variance of expected returns is equal to the square root of the expected returns.
ANS: False PTS: 1
8. The coefficient of variation is the expected return divided by the standard deviation of the expected
return.
ANS: False PTS: 1
9. Nominal rates are averages of all possible real rates.
ANS: False PTS: 1
10. The risk premium is a function of the volatility of operating earnings, sales volatility and inflation.
ANS: False PTS: 1
11. An individual who selects the investment that offers greater certainty when everything else is the same
is known as a risk averse investor.
ANS: True PTS: 1
12. Investors are willing to forgo current consumption in order to increase future consumption for a
nominal rate of interest.
ANS: False PTS: 1
13. The two most common calculations investors use to measure return performance are arithmetic means
and geometric means.
ANS: True PTS: 1
14. The arithmetic mean is a superior measure of the long-term performance because it indicates the
compound annual rate of return based on the ending value of the investment versus its beginning
value.
ANS: False PTS: 1
MULTIPLE CHOICE
1. The basic trade-off in the investment process is

a. between the anticipated rate of return for a given investment instrument and its degree of
risk.
b. between understanding the nature of a particular investment and having the opportunity to
purchase it.
c. between high returns available on single instruments and the diversification of instruments
into a portfolio.
d. between the desired level of investment and possessing the resources necessary to carry it
out.
e. None of the above.
ANS: A PTS: 1 OBJ: Multiple Choice
2. The rate of exchange between future consumption and current consumption is

a. The nominal risk-free rate.
b. The coefficient of investment exchange.
c. The pure rate of interest.
d. The consumption/investment paradigm.
e. The expected rate of return.
ANS: C PTS: 1 OBJ: Multiple Choice
3. The the variance of returns, everything else remaining constant, the the dispersion of
expectations and the the risk.
a. Larger, greater, lower
b. Larger, smaller, higher
c. Larger, greater, higher
d. Smaller, greater, lower
e. Smaller, greater, greater
4. The coefficient of variation is a measure of

a. Central tendency.
b. Absolute variability.
c. Absolute dispersion.
d. Relative variability.
e. Relative return.
ANS: D PTS: 1 OBJ: Multiple Choice
5. The nominal risk free rate of interest is a function of

a. The real risk free rate and the investment's variance.
b. The prime rate and the rate of inflation.
c. The T-bill rate plus the inflation rate.
d. The tax free rate plus the rate of inflation.
e. The real risk free rate and the rate of inflation.
ANS: E PTS: 1 OBJ: Multiple Choice
6. In the phrase "nominal risk free rate," nominal means

a. Computed.
b. Historical.
c. Market.
d. Average.
e. Risk adverse.
7. If a significant change is noted in the yield of a T-bill, the change is most likely attributable to
a. A downturn in the economy.
b. A static economy.
c. A change in the expected rate of inflation.
d. A change in the real rate of interest.
e. A change in risk aversion.
8. The real risk-free rate is affected by a two factors;

a. The relative ease or tightness in capital markets and the expected rate of inflation.
b. The expected rate of inflation and the set of investment opportunities available in the
economy.
c. The relative ease or tightness in capital markets and the set of investment opportunities
available in the economy.
d. Time preference for income consumption and the relative ease or tightness in capital
markets.
e. Time preference for income consumption and the set of investment opportunities available
in the economy.
9. Which of the following is not a component of the risk premium?

a. Business risk
b. Financial risk
c. Liquidity risk
d. Exchange rate risk
e. Unsystematic market risk
10. The ability to sell an asset quickly at a fair price is associated with
a. Business risk.
b. Liquidity risk.
c. Exchange rate risk.
d. Financial risk.
e. Market risk.
ANS: B PTS: 1 OBJ: Multiple Choice
11. The variability of operating earnings is associated with

a. Business risk.
b. Liquidity risk.
d. Financial risk.
e. Market risk.
12. The uncertainty of investment returns associated with how a firm finances its investments is known as
a. Business risk.
b. Liquidity risk.
d. Financial risk.
e. Market risk.
13. What will happen to the security market line (SML) if the following events occur, other things
constant: (1) inflation expectations increase, and (2) investors become more risk averse?
a. Shift up and keep the same slope
b. Shift up and have less slope
c. Shift up and have a steeper slope
d. Shift down and keep the same slope
e. Shift down and have less slope
14. A decrease in the market risk premium, all other things constant, will cause the security market line to
a. Shift up
b. Shift down
c. Have a steeper slope
d. Have a flatter slope
e. Remain unchanged
15. A decrease in the expected real growth in the economy, all other things constant, will cause the
security market line to
a. Shift up
b. Shift down
c. Have a steeper slope
d. Have a flatter slope
e. Remain unchanged
16. Unsystematic risk refers to risk that is
a. Undiversifiable
b. Diversifiable
c. Due to fundamental risk factors
d. Due to market risk
e. None of the above
17. The security market line (SML) graphs the expected relationship between
a. Business risk and financial risk
b. Systematic risk and unsystematic risk
c. Risk and return
d. Systematic risk and unsystematic return
18. Two factors that influence the nominal risk-free rate are;
a. The relative ease or tightness in capital markets and the expected rate of inflation.
b. The expected rate of inflation and the set of investment opportunities available in the
economy.
c. The relative ease or tightness in capital markets and the set of investment opportunities
available in the economy.
d. Time preference for income consumption and the relative ease or tightness in capital
markets.
e. Time preference for income consumption and the set of investment opportunities available
in the economy.
19. Measures of risk for an investment include

a. Variance of returns and business risk
b. Coefficient of variation of returns and financial risk
c. Business risk and financial risk
d. Variance of returns and coefficient of variation of returns
e. All of the above
20. Sources of risk for an investment include

a. Variance of returns and business risk
b. Coefficient of variation of returns and financial risk
c. Business risk and financial risk
d. Variance of returns and coefficient of variation of returns
e. All of the above
21. Modern portfolio theory assumes that most investors are

a. Risk averse
b. Risk neutral
c. Risk seekers
d. Risk tolerant
22. Which of the following is not a component of the required rate of return?
a. Expected rate of inflation
b. Time value of money
c. Risk
d. Holding period return
e. All of the above are components of the required rate of return
23. All of the following are major sources of uncertainty EXCEPT

a. Business risk
b. Financial risk
c. Default risk
d. Country risk
e. Liquidity risk
24. The total risk for a security can be measured by its

a. Beta with the market portfolio
b. Systematic risk
c. Standard deviation of returns
d. Unsystematic risk
e. Alpha with the market portfolio
25. The increase in yield spreads in late 2008 and early 2009 indicated that
a. Credit risk premiums decreased
b. Market risk premiums increased
c. Investors are more confident of the future cash flows of bonds
d. Non-investment grade bonds are less risky
e. Government bonds are no longer a risk free investment
26. Which of the following is least likely to move a firm's position to the right on the Security Market Line
(SML)?
a. An increase in the firm's beta
b. Adding more financial debt to the firm's balance sheet relative to equity
c. Changing the business strategy to include new product lines with more volatile expected
cash flows
d. Investors perceive the stock as being more risky
e. An increase in the risk-free required rate of return.
Exhibit 1.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume you bought 100 shares of NewTech common stock on January 15, 2003 at $50.00 per share
and sold it on January 15, 2004 for $40.00 per share.
27. Refer to Exhibit 1.1. What was your holding period return?
a. 10%
b. 0.8
c. 25%
d. 0.8
e. 20%
ANS: D
HPR = Ending Value/Beginning Value = 40/50 = 0.8
PTS: 1 OBJ: Multiple Choice Problem
28. Refer to Exhibit 1.1. What was your holding period yield?
a. 10%
b. 0.8
c. 25%
d. 0.8
e. 20%
ANS: E
HPY = HPR  1 = (40/50)  1 = 0.8  1 = 0.2 = 20%
Exhibit 1.2
Suppose you bought a GM corporate bond on January 25, 2001 for $750, on January 25, 2004 sold it
for $650.00.
29. Refer to Exhibit 1.2. What was your annual holding period return?
a. 0.8667
b. 0.1333
c. 0.0333
d. 0.9534
e. 0.0466
ANS: D
HPR = Ending Value/Beginning Value = $650.00/$750 = 0.8667
Annual HPR = (HPR)1/n = (0.8667)1/3 = 0.9534
30. Refer to Exhibit 1.2. What was your annual holding period yield?
a. 0.0466
b. 0.1333
c. 0.0333
d. 0.3534
e. 0.8667
ANS: A
HPR = Ending Value/Beginning Value = $650.00/$750 = 0.8667
Annual HPR = (HPR)1/n = (0.8667)1/3 = 0.9534
Annual HPY = Annual HPR  1 = 0.9534  1 = 0.0466 = 4.66%
Exhibit 1.3
The common stock of XMen Inc. had the following historic prices.
Time Price of X-Tech

3/01/1999 50.00
3/01/2000 47.00
3/01/2001 76.00
3/01/2002 80.00
3/01/2003 85.00
3/01/2004 90.00
31. Refer to Exhibit 1.3. What was your holding period return for the time period 3/1/1999 to 3/1/2004?
a. 0.1247
b. 1.8
c. 0.1462
d. 0.40
e. 0.25
ANS: B
HPR = Ending Value/Beginning Value = 90/50 = 1.8
32. Refer to Exhibit 1.3. What was your annual holding period yield (Annual HPY)?
a. 0.1462
b. 0.1247
c. 1.8
d. 0.40
e. 0.25
ANS: B
Annual HPR = (HPR)1/n = (1.8)1/5 = 1.1247
Annual HPY = Annual HPR  1 = 1.1247  1 = 0.1247 = 12.47%
Time Price of X-Tech Return HPR

3/01/1999 50
3/01/2000 47 0.0600 0.9400
3/01/2001 76 0.6170 1.6170
3/01/2002 80 0.0526 1.0526
3/01/2003 85 0.0625 1.0625
3/01/2004 90 0.0588 1.0588

33. Refer to Exhibit 1.3. What was your arithmetic mean annual yield for the investment in XMen
Industries.
a. 0.1462
b. 0.1247
c. 1.8
d. 0.40
e. 0.25
ANS: A
Arithmetic Mean =
34. Refer to Exhibit 1.3. What was your geometric mean annual yield for the investment in XMen?
a. 0.25
b. 0.40
c. 1.8
d. 0.1247
e. 0.1462
ANS: D
Exhibit 1.4
You have concluded that next year the following relationships are possible:
Economic Status Probability Rate of Return

Weak Economy .15 5%
Static Economy .60 5%
Strong Economy .25 15%
35. Refer to Exhibit 1.4. What is your expected rate of return [E(Ri)] for next year?
a. 4.25%
b. 6.00%
c. 6.25%
d. 7.75%
e. 8.00%
ANS: B
E(Ri) = (0.15)(5) + (0.60)(5) + (0.25)(15) = 6%
36. Refer to Exhibit 1.4. Compute the standard deviation of the rate of return for the one year period.
a. 0.65%
b. 1.45%
c. 4.0%
d. 6.25%
e. 6.4%
ANS: D
= [(0.15)(5  6)2 + (0.60)(5  6)2 + (0.25)(15  6)2]1/2 = 6.25%
37. Refer to Exhibit 1.4. Compute the coefficient of variation for your portfolio.
a. 0.043
b. 0.12
c. 1.40
d. 0.69
e. 1.04
ANS: E
CV = Standard Deviation of Returns/Expected Rate of Return
= 6.25/6 = 1.04
Exhibit 1.5
Assume that during the past year the consumer price index increased by 1.5 percent and the securities
listed below returned the following nominal rates of return.
U.S. Government T-bills 2.75%

U.S. Long-term bonds 4.75%
38. Refer to Exhibit 1.5. What are the real rates of return for each of these securities?
a. 4.29% and 6.32%
b. 1.23% and 4.29%
c. 3.20% and 6.32%
d. 1.23% and 3.20%
e. 3.75% and 5.75%
ANS: D
Real rate on T-bills = (1.0275/1.015)  1 = 0.0123 = 1.23%
Real rate on bonds = (1.0475/1.015)  1 = 0.032 = 3.2%
39. Refer to Exhibit 1.5. If next year the real rates all rise by 10 percent while inflation climbs from 1.5
percent to 2.5 percent, what will be the nominal rate of return on each security?
a. 1.24% and 1.52%
b. 1.35% and 3.52%
c. 3.89% and 6.11%
d. 3.52% and 3.89%
e. 1.17% and 6.11%
ANS: C
The computations for the new real rates are:
Real rate on T-bills = 1.23  1.10 = 1.353%

Real rate on bonds = 3.2  1.10 = 3.52%
Nominal rate on T-bills = (1.01353)(1.025)  1 = .03886 = 3.89%
Nominal rate on corporate bonds = (1.0352)(1.025)  1 = .06108 = 6.11%
40. If over the past 20 years the annual returns on the S&P 500 market index averaged 12% with a
standard deviation of 18%, what was the coefficient of variation?
a. 0.6
b. 0.6%
c. 1.5
d. 1.5%
e. 0.66%
ANS: C
Coefficient of Variation = Standard Deviation of Returns/Expected Rate of Return
= 18%/12% = 1.5
41. Given investments A and B with the following risk return characteristics, which one would you prefer
and why?
Standard Deviation
Investment Expected Return of Expected Returns
A 12.2% 7%
B 8.8% 5%
a. Investment A because it has the highest expected return.

b. Investment A because it has the lowest relative risk.
c. Investment B because it has the lowest absolute risk.
d. Investment B because it has the lowest coefficient of variation.
e. Investment A because it has the highest coefficient of variation.
ANS: D
Coefficient of Variation = Standard Deviation of Returns/Expected Rate of Return
CVA = 7%/12.2% = 0.573
CVB = 5%/8.8% = 0.568
Investment B has the lowest coefficient of variation and would be preferred.
Exhibit 1.6
You are provided with the following information:
Nominal return on risk-free asset = 4.5%

Expected return for asset i = 12.75%
Expected return on the market portfolio = 9.25%
42. Refer to Exhibit 1.6. Calculate the risk premium for asset i.
a. 4.5%
b. 8.25%
c. 4.75%
d. 3.5%
ANS: B
Risk premium for asset i = 12.75  4.5 = 8.25%
43. Refer to Exhibit 1.6. Calculate the risk premium for the market portfolio.
a. 4.5%
b. 8.25%
c. 4.75%
d. 3.5%
ANS: C
Risk premium market portfolio = 9.25  4.5 = 4.75%
Exhibit 1.7
Consider the following information
Nominal annual return on U.S. government T-bills for year 2009 = 3.5%
Nominal annual return on U.S. government long-term bonds for year 2009 = 4.75%
Nominal annual return on U.S. large-cap stocks for year 2009= 8.75%
Consumer price index January 1, 2009 = 165
Consumer price index December 31, 2009 = 169
44. Refer to Exhibit 1.7. Compute the rate of inflation for the year 2009.
a. 2.42%
b. 4.0%
c. 1.69%
d. 1.24%
ANS: A
Rate of inflation = (169/165)  1 = .0242 = 2.42%

45. Refer to Exhibit 1.7. Calculate the annual real rate of return for U.S. T-bills.
a. 2.26%
b. 1.81%
c. 0.5%
d. 1.05%
ANS: D
Real return on U.S. T-bills = (1.035/1.0242)  1 = .0105 = 1.05%
46. Refer to Exhibit 1.7. Calculate the annual real rate of return for U.S. long-term bonds.
a. 3.06%
b. 2.27%
c. 2.51%
d. 3.5%
ANS: B
Real return on U.S. bonds = (1.0475/1.0242)  1 = .0227 = 2.27%
47. Refer to Exhibit 1.7. Calculate the annual real rate of return for U.S. large-cap stocks.
a. 7.06%
b. 6.18%
c. 4.75%
d. 3.75%
ANS: B
Real return on U.S. stocks = (1.0875/1.0242)  1 = .0618 = 6.18%
Exhibit 1.8
Assume that you hold a two stock portfolio. You are provided with the following information on your
holdings:
Stock Shares Price(t) Price(t + 1)

1 15 10 12
2 25 15 16
48. Refer to Exhibit 1.8. Calculate the HPY for stock 1.

a. 10%
b. 20%
c. 15%
d. 12%
e. 7%
ANS: B
MV Price MV Weighted
Stock Shares Price(t) (t) (t+1) (t+1) HPR HPY Weight HPY
1 15 10 150 12 180 1.2 0.2 0.29 0.058
2 25 15 375 16 400 1.07 0.07 0.71 0.048
525 580 0.106
HPY for stock 1 = (180/150)  1 = .2 = 20%
49. Refer to Exhibit 1.8. Calculate the HPY for stock 2.

a. 5%
b. 6%
c. 7%
d. 8%
e. 10%
ANS: C
1 15 10 150 12 180 1.2 0.2 0.29 0.058
2 25 15 375 16 400 1.07 0.07 0.71 0.048
525 580 0.106
HPY for stock 2 = (400/375)  1 = .07 = 7%
50. Refer to Exhibit 1.8. Calculate the market weights for stock 1 and 2 based on period t values.
a. 39% for stock 1 and 61% for stock 2
b. 50% for stock 1 and 50% for stock 2
c. 71% for stock 1 and 29% for stock 2
d. 29% for stock 1 and 71% for stock 2
ANS: D
1 15 10 150 12 180 1.2 0.2 0.29 0.058
2 25 15 375 16 400 1.07 0.07 0.71 0.048
525 580 0.106
Market weight for stock 1 = 150/525 = .29 = 29%
Market weight for stock 2 = 375/525 = .71 = 71%
51. Refer to Exhibit 1.8. Calculate the HPY for the portfolio.
a. 10.6%
b. 6.95%
c. 13.5%
d. 10%
e. 15.7%
ANS: A
1 15 10 150 12 180 1.2 0.2 0.29 0.058
2 25 15 375 16 400 1.07 0.07 0.71 0.048
525 580 0.106
Portfolio HPY = .29(.20) + .71(.07) = .106 = 10.6%
Exhibit 1.9
You purchased 100 shares of GE common stock on January 1, for $29 a share. A year later you
received $1.25 in dividends per share and you sold it for $28 a share.
52. Refer to Exhibit 1.9. Calculate your holding period return (HPR) for this investment in GE stock.
a. 0.9655
b. 1.0086
c. 1.0357
d. 1.0804
e. 1.0973
ANS: B
HPR = (28 + 1.25)/29 = 1.0086
53. Refer to Exhibit 1.9. Calculate your holding period yield (HPY) for this investment in GE stock.
a. 0.0345
b. 0.0090
c. 0.0086
d. 0.0643
e. 0.0804
ANS: C
HPY = (28 + 1.25)/29  1 = 1.0086  1 = 0.0086
Exhibit 1.10
The annual rates of return of Stock Z for the last four years are 0.10, 0.15, 0.05, and 0.20,
respectively.
54. Refer to Exhibit 1.10. Compute the arithmetic mean annual rate of return for Stock Z.
a. 0.03
b. 0.04
c. 0.06
d. 0.10
e. 0.40
ANS: D
AM = (0.10 + 0.15  0.05 + 0.20)/4 = 0.10
55. Refer to Exhibit 1.10. Compute the standard deviation of the annual rate of return for Stock Z.
a. 0.0070
b. 0.0088
c. 0.0837
d. 0.0935
e. 0.1145
ANS: D
56. Refer to Exhibit 1.10. Compute the coefficient of variation for Stock Z.
a. 0.837
b. 0.935
c. 1.070
d. 1.145
e. 1.281
ANS: B
The coefficient of variation is equal to the standard deviation divided by the expected return.
.0935/10 = 0.935
57. Refer to Exhibit 1.10. Compute the geometric mean rate of return for Stock Z.
a. 0.051
b. 0.074
c. 0.096
d. 0.150
e. 1.090
ANS: C
[(1.1)(1.15)(0.95)(1.2)]1/4 = 1.0958  1 = 0.0958
58. Economists project the long-run real growth rate for the next five years to be 2.5 percent and the
average annual rate of inflation over this five year period to be 3 percent. What is the expected
nominal rate of return over the next five years?
a. 0.500 percent
b. 1.056 percent
c. 2.750 percent
d. 5.500 percent
e. 5.575 percent
ANS: E
1  (1.025)(1.03) = 1  1.05575 = 5.575%

CHAPTER 2—THE ASSET ALLOCATION DECISION
TRUE/FALSE
1. Experts suggest life insurance coverage should be seven to ten times an individual's annual salary.
ANS: T PTS: 1
2. Term life insurance provides both a death benefit and a savings plan.
ANS: F PTS: 1
3. Most experts recommend a cash reserve of at least one year's worth of living expenses.
ANS: F PTS: 1
4. The spending phase occurs when investors are relatively young.
ANS: F PTS: 1
5. The gifting phase is similar to, and may be concurrent with, the spending phase.
ANS: T PTS: 1
6. Long-term, high-priority goals include some form of financial independence.
ANS: T PTS: 1
7. It is not a good idea to get too specific when constructing your policy statement.
ANS: F PTS: 1
8. Asset allocation is the process of dividing funds into different classes of assets.
ANS: T PTS: 1
9. The typical investor's goals rarely change during his/her lifetime.
ANS: F PTS: 1
10. Individual security selection is far more important than the asset allocation decision.
ANS: F PTS: 1
11. Return is the only important consideration when establishing investment objectives.
ANS: F PTS: 1
12. In constructing the portfolio, the manager should maximize the investor's risk level.
ANS: F PTS: 1
13. Risk tolerance is exclusively a function of an individual's psychological makeup.
ANS: F PTS: 1
14. An appropriate investment objective for a typical 25-year-old investor is a low-risk strategy, such as
capital preservation or current income.
ANS: F PTS: 1
15. Investment planning is complicated by the tax code.
ANS: T PTS: 1
16. Average tax rate is defined as total tax payment divided by total income.
ANS: T PTS: 1
17. The portfolio mixes of institutional investors around the world are approximately the same.
ANS: F PTS: 1
18. The ability to retire at a certain age is a typical example of a long-term, lower-priority goal.
ANS: F PTS: 1
19. It is essential that both the client and the portfolio manager agree on an appropriate benchmark
portfolio.
ANS: T PTS: 1
20. An example of a unique need in an investment policy statement is related to the legal responsibilities
of a fiduciary or trustee.
ANS: F PTS: 1
21. Equity allocations of pension funds in Japan and Germany are similar to those in the United States.
ANS: F PTS: 1
22. Investing 30 to 40 percent of your retirement funds in the company you work for is reasonable when
they match funds.
ANS: F PTS: 1
23. The majority of a pension fund's return is explained by asset allocation.
ANS: T PTS: 1
MULTIPLE CHOICE
1. The current outlay of money to guard against a potentially large future loss is commonly known as
a. Asset management.
b. Portfolio management.
c. Minimizing risk.
d. Loss control.
e. Insurance.
2. In an investment policy statement the objectives of an investor are expressed in terms of

a. risk and return
b. risk
c. return
d. time horizon
e. liquidity needs
3. phase is the stage when investors in their early-to-middle earning years attempt to accumulate
assets to satisfy near-term needs, e.g., children's education or down payment on a home.
a. Accumulation
b. Spending
c. Gifting
d. Consolidation
e. Divestiture
4. Which of the following is not a life cycle phase?

a. Discovery phase
b. Accumulation phase
c. Consolidation phase
d. Spending phase
e. Gifting phase
5. Which of the following is not a step in the portfolio management process?

a. Develop a policy statement.
b. Study current financial and economic conditions.
c. Construct the portfolio.
d. Monitor investor's needs and market conditions.
e. Sell all assets and reinvestment proceeds at least once a year.
6. The first step in the investment process is the development of a(n)

a. Objective statement.
b. Policy statement.
c. Financial statement.
d. Statement of cash needs.
e. Statement of cash flows.
7. Which of the following is not considered to be an investment objective?

a. Capital preservation
b. Capital appreciation
c. Current income
d. Total return
e. None of the above (that is, all are considered investment objectives)
8. must be stated in terms of expected returns and risk. An investor's tolerance for risk must be
established before returns objectives can be stated.
a. Investment requirements
b. Investment constraints
c. Investment rewards
d. Investment objectives
e. Investment policy
9. is an appropriate objective for investors who want their portfolio to grow in real terms, i.e.,
exceed the rate of inflation.
a. Capital preservation
b. Capital appreciation
c. Portfolio growth
d. Value additivity
e. Nominal preservation
10. refer(s) to the ability to convert assets to cash quickly and at a fair market price and often
increase(s) as one approaches the later stages of the investment life cycle.
a. Liquidity needs
b. Time horizons
c. Liquidation values
d. Liquidation essentials
e. Capital liquidations
11. The policy statement may include a against which a portfolio's or portfolio manager's
performance can be measured.
a. Milestone
b. Benchmark
c. Landmark
d. Reference point
e. Market pair
12. Asset allocation is

a. The process of dividing funds into asset classes.
b. Concerned with returns variability.
c. Concerned with the risk associated with different assets.
d. Concerned with the relationship among investments' returns.
e. All of the above.
13. The asset allocation decision must involve a consideration of

a. Cultural differences.
b. The objectives stated in the investor's policy statement.
c. The types of assets that are appropriate for the investor.
d. The risk associated with different investments.
e. All of the above.
14. Research has shown that the asset allocation decision explains % of the variation in fund returns
across all funds, and % of the variation in returns for a particular fund over time.
a. 90 and 100.
b. 100 and 40.
c. 90 and 40.
d. 40 and 100.
e. 40 and 90.
15. Once the portfolio is constructed, it must be continuously

a. Rebalanced.
b. Recycled
c. Reinvested
d. Monitored.
e. Manipulated.
16. Which of the following statements is false?

a. Unrealized capital gains are taxable.
b. Realized capital gains are taxable.
c. Tax-exempt investments are attractive to individuals with high tax liabilities.
d. Returns comparisons should be made on an equivalent tax basis.
e. Tax exempt investors prefer tax exempt investments.
17. gains are taxable and occur when an asset is sold for more than its basis (the value of the asset
when it was purchased by the original owner, or inherited by the heirs of the original owner).
a. Realized capital
b. Income
c. Portfolio
d. Nominal
e. Real
18. Which of the following statements is true?

a. Except for tax-exempt investors and tax-deferred accounts, annual tax payments increase
investment returns.
b. The only way to maintain purchasing power over time is to invest in bonds.
c. After adjusting for taxes, long-term bonds consistently outperform stocks.
d. An asset allocation decision for a taxable portfolio that does not include a substantial
commitment to common stocks may make it difficult for the portfolio to maintain real
value over time.
19. Important reasons for constructing a policy statement include:
a. Helps investors decide on realistic investment goals
b. Create a standard by which to judge the performance of the portfolio manager
c. Develop an instrument to judge risk
d. Choices a and b
e. All of the above
20. For an investor with a time horizon of 6 to 10 years and lower risk tolerance, an appropriate asset
allocation strategy would be
a. 100% stocks
b. 100% cash
c. 30% cash, 50% bonds, and 20% stocks
d. 10% cash, 30% bonds, and 60% stocks
e. 100% bonds
21. For an investor with a time horizon of 8 years and higher risk tolerance, an appropriate asset allocation
strategy would be
a. 100% stocks
b. 100% cash
e. 100% bonds
22. For an investor with a time horizon of 12 years and higher risk tolerance, an appropriate asset
a. 100% stocks
b. 30% cash, 50% bonds, and 20% stocks
d. 50% bonds and 50% stocks
e. 100% bonds
23. For an investor with a time horizon of 15 years and moderate risk tolerance, an appropriate asset
a. 100% stocks
b. 40% cash and 60% stocks
d. 50% bonds, and 50% stocks
e. 20% bonds, and 80% stocks
24. For an investor with a time horizon of 4 years and higher risk tolerance, an appropriate asset allocation
strategy would be
a. 100% cash
e. 100% bonds
25. For an investor with a time horizon of 5 years and moderate risk tolerance, an appropriate asset
a. 100% cash
e. 100% bonds
26. John is 55 years old has $55,000 outstanding on a mortgage and no other debt. John typically saves
$5,000 in an IRA account and another $10,000 in a company pension. John is most likely in the:
a. Discovery phase
b. Accumulation phase
c. Consolidation phase
d. Spending phase
e. Gifting phase
27. Which of the following is not a typical portfolio constraint?

a. Liquidity needs
b. Risk tolerance
c. Time horizon
d. Tax concerns
e. Legal factors
28. Which of the following strategies seeks to increase the portfolio value by reinvesting current income in
addition to capital gains?
a. Capital appreciation
b. Capital preservation
c. Return preservation
d. Current income
e. Total return
29. Research from the 1970s to the 1990s found that over 90 percent of a fund's returns over time is
explained by:
a. Market timing
b. Stock selection
c. Manager selection
d. Asset allocation
e. All of the above
Exhibit 2.1
USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S)
If Taxable Income Then The Tax is
Is Over But Not Over This Amount Plus This % Of The Excess Over
Single $0 $7,150 0 10% 0
$7,150 $29,050 715 15% $7,150
$29,050 $70,350 $4,000 25% $29,050
$70,350 $146,750 $14,325 28% $70,350
$146,750 $319,100 $35,717 33% $146,750
$319,100 - $92,592.50 35% $319,100
Married $0 $14,300 0 10% 0

Filing $14,300 $58,100 1430 15% $14,300
Jointly $58,100 $117,250 $8,000 25% $58,100
$117,250 $178,650 $22,787.50 28% $117,250
$178,650 $319,100 $39,979.50 33% $178,650
$319,100 - $86,328 35% $319,100
30. Refer to Exhibit 2.1. What is the marginal tax rate for a single individual with taxable income of
$85,000?
a. 15%
b. 25%
c. 28%
d. 33%
e. 35%
ANS: C
Marginal tax rate = 28%
31. Refer to Exhibit 2.1. What is the tax liability for a single individual with taxable income of $85,000?
a. $23,800
b. $18,427
c. $24,958
d. $16,867
e. $19,650
ANS: B
$14,325 + 0.28($85,000 - $70,350) = $18,427 (tax bill)
32. Refer to Exhibit 2.1. What is the average tax for a single individual with taxable income of $85,000?
a. 13.57%
b. 15.68%
c. 21.68%
d. 25.74%
e. 29.55%
ANS: C
$18,427/$85,000 = 21.68% (average tax rate)

33. Refer to Exhibit 2.1. What is the tax liability for a married couple filing jointly with taxable income of
$125,000?
a. $23,800
b. $18,427
c. $24,958
d. $16,867
e. $19,650
ANS: C
$22,787.50 + 0.28($125,000 - $117,250) = $24,958
34. What would the equivalent taxable yield be on an investment that offers a 6 percent tax exempt yield?
Assume a marginal tax rate of 28%.
a. 0.125%
b. 7.20%
c. 6.48%
d. 8.33%
e. 32.14%
ANS: D
Equivalent taxable yield = .06/(1 - .28) = .06/.72 = 8.33%
35. What would the after-tax yield be on an investment that offers a 6 percent fully taxable yield? Assume
a marginal tax rate of 31%.
a. 2.79%
b. 6.48%
c. 4.14%
d. 7.20%
e. 12.50%
ANS: C
After-tax yield = Before-tax yield (1 - Tax Rate) = 6%(1 - .31) = 4.14%
36. The future value of $50,000 invested today, at the end of 10 years assuming an interest rate of 7.5%
per year, with semiannual compounding, is
a. $104,407.60
b. $103,051.58
c. $123,510.52
d. $210,673.43
e. $105,117.46
ANS: A
FV = 50,000(1 + .0375)20 = $104,407.60
37. Assume that you invest $750 at the end of each quarter for the next 20 years in a mutual fund. The
annual rate of interest that you expect to earn in this account is 5.25%. The amount in the account at
the end of 20 years is
a. $60,000.00
b. $105,039.84
c. $37,009.35
d. $123,510.52
e. $115,637.37
ANS: B
38. Assume that you invest $1250 at the end of each of the next 15 years in a mutual fund. You currently
have $10,000 in the mutual fund. The annual rate of interest that you expect to earn in this account is
4.35%. The amount in the account at the end of 15 years is
a. $58,940.30
b. $28,750.00
c. $37,009.35
d. $44,630.81
e. $25,690.50
ANS: D
39. Someone in the 15 percent tax bracket can earn 8 percent annually on his investments in a tax-exempt
IRA account. What will be the value of a $10,000 investment after 5 years (assuming annual
compounding)?
a. $ 6,805
b. $14,693
c. $15,528
d. $20,114
e. $50,000
ANS: B
FV = 10,000(1 + .08)5 = $14,693
40. Suppose the 8 percent investment of the previous problem is taxable rather than tax-deferred. What
will be the after-tax value of his $10,000 investment after 5 years (assuming annual compounding)?
a. $10,680
b. $11,765
c. $13,895
d. $14,693
e. $15,528
ANS: C
After-tax yield = Before-tax yield (1 - Tax rate)
= 8% (1 - .15) = 6.8%
$10,000(1 + 0.068)5 = $13,895
41. An individual in the 36% tax bracket invests $5,000 in a tax-exempt IRA. If the investment earns 10%
annually, what will be the value of the IRA after five years?
a. $6,600
b. $6,818
c. $7,500
d. $8,053
e. $10,879
ANS: D
The total amount is not adjusted for taxes or inflation.
FV = $5,000(1 + 0.10)5 = $8,052.55
42. An individual in the 15% tax bracket has $10,000 invested in a tax-exempt IRA account. If the
individual earns 8% annually before taxes and inflation is 2.5% per year, what is the real value of the
investment in 20 years?
a. $23,211
b. $28,467
c. $29,178
d. $37,276
e. $46,610
ANS: B
The annual real return adjusted for inflation is computed as follows:
(1.08)/(1.025) -1 = 5.37%.
FV = $10,000(1 + 0.0537)20 = $28,466.86
43. An individual in the 36% tax bracket has $20,000 invested in a tax-exempt account. If the individual
earns 10% annually before taxes and inflation is 3.0% per year, what is the real value of the investment
in 10 years?
a. $31,000
b. $33,200
c. $38,614
d. $39,343
e. $47,823
ANS: C
The annual real return adjusted for inflation is computed as follows:
(1.10)/(1.03) - 1 = 6.8%.
FV = $20,000(1 + 0.068)10 = $38,613.80
44. You currently have $150,000 in an IRA designated for retirement. If you save an additional $100 at the
end of every month and expect to earn an annual return of 12%, how much do you expect to have in
the IRA in 10 years?
a. $467,632
b. $518,062
c. $732,546
d. $949,328
e. $1,215,234
ANS: B

CHAPTER 3—SELECTING INVESTMENTS IN A GLOBAL MARKET
TRUE/FALSE
1. The U.S. equity and bond markets have grown in terms of their relative size of the world equity and
bond market.
ANS: F PTS: 1
2. Diversification with foreign securities can help reduce portfolio risk.
ANS: T PTS: 1
3. The total domestic return on German bonds is the return that would be experienced by an U.S. investor
who owned German bonds.
ANS: F PTS: 1
4. If the exchange rate effect for Japanese bonds is negative, it means that the domestic rate of return will
be greater than the U.S. dollar return.
ANS: T PTS: 1
5. A U.S. investor who ignores foreign markets reduces overall number of investment choices.
ANS: T PTS: 1
6. Treasury bills are long-term investments that make regular interest and principal payments.
ANS: F PTS: 1
7. A debenture is an option issued by a corporation that gives the holder the right to acquire common
stock from the issuing firm at a specified price within a designated period of time.
ANS: F PTS: 1
8. Income bonds are considered as safe as debentures because they pay higher rates of interest.
ANS: F PTS: 1
9. A Eurobond is an international bond denominated in a currency other than that of the United States.
ANS: F PTS: 1
10. Warrants are options often issued in connection with the sale of fixed income securities.
ANS: T PTS: 1
11. A call option is usually issued in conjunction with convertible bonds.
ANS: F PTS: 1
12. Yields on money market funds are often lower than yields available to individuals investing in CD's
because of the fees involved.
ANS: F PTS: 1
13. Municipal bond nominal yields are generally below comparable taxable bond yields.
ANS: T PTS: 1
14. REITS are investment companies that invest in high-quality money market instruments such as
Treasury bills, high-grade commercial paper, and large CD's.
ANS: F PTS: 1
15. It is very important when diversifying that the correlation between rates of return for various countries
be high and very stable over time.
ANS: F PTS: 1
16. The decrease in the standard deviation of returns after adding 40 to 50 securities within a country is
known as domestic diversification.
ANS: T PTS: 1
17. Government agency securities are issued by local government entities as either general obligation or
revenue bonds.
ANS: F PTS: 1
18. Subordinated bondholders have claim to the assets of the firm only after the firm has satisfied the
claims of all senior secured and debenture bondholders.
ANS: T PTS: 1
19. The relative size of U.S. financial markets to the total investable assets in the global capital markets
has grown considerably over the last three decades.
ANS: F PTS: 1
20. The correlation of returns between a single pair of countries remains constant over time.
ANS: F PTS: 1
MULTIPLE CHOICE
1. An investor who purchases a put option:

a. Has the right to buy a given stock at a specified price during a designated time period.
b. Has the right to sell a given stock at a specified price during a designated time period.
c. Has the obligation to buy a given stock at a specified price during a designated time
period.
d. Has the obligation to sell a given stock at a specified price during a designated time
period.
2. If you are considering investing in German stocks as a means to reduce the risk of your portfolio, the
initial factor that you should examine is:
a. The average rate of return of the portfolio when you combine U.S. and German stocks.
b. The standard deviation of the German stocks.
c. The standard deviation of the German stocks compared to the standard deviation of U.S.
stocks.
d. The correlation between the rates of return for German stocks and U.S. stocks.
e. The coefficient of variation (CV) of rates of return for German stocks versus the CV of
rates of return for U.S. stocks.
3. All of the following are considered fixed income investments except

a. Corporate bonds.
b. Preferred stock.
c. Treasury bills, notes, and bonds.
d. Money market mutual funds.
e. Certificates of deposit (CDs).
4. Capital market instruments include all of the following except

a. U.S. Treasury notes and bonds.
b. U.S Treasury bills.
c. U.S. government agency securities.
d. Municipal bonds.
e. Corporate bonds.
5. The original maturity of a United States Treasury note is

a. Zero years to five years.
b. Six months to ten years.
c. One year or less.
d. One year to ten years.
e. Over ten years.
6. The original maturity of a United States Treasury bill is

e. Over ten years.
7. The original maturity of a United States Treasury bond is

e. Over ten years.
8. Which of the following is not a U.S. government agency?

a. Federal National Mortgage Association
b. Federal Home Loan Bank
c. Government National Mortgage Association
d. Government Employees Insurance Company
e. Federal Housing Administration
9. The legal document setting forth the obligations of a bond's issuer is called
a. A debenture.
b. A warrant.
c. An indenture.
d. The preemptive right.
e. A trustee deed.
10. All of the following are considered fixed income securities except
a. Debentures.
b. Eurobonds.
c. Preferred stock.
d. Mutual funds.
e. Yankee bonds.
11. The purchase and sale of commodities for current delivery and consumption is known as dealing in the
market.
a. Futures
b. Spot
c. Money
d. Capital
e. Options
12. An investor who purchases a call option:

a. Has the right to buy a given stock at a specified price during a designated time period.
b. Has the right to sell a given stock at a specified price during a designated time period.
c. Has the obligation to buy a given stock at a specified price during a designated time
period.
d. Has the obligation to sell a given stock at a specified price during a designated time
period.
13. If this year is consistent with historical trends you would expect the return for small capitalization
stocks to be
a. Below common stocks and above long-term government bonds.
b. Below common stocks and below long-term government bonds.
c. Above last year's return on the same stocks.
d. Above common stock, long-term government, and corporate bonds.
e. The least variable among long-term bonds and common stocks.
14. The correlation between U.S. equities and U.S. government bonds is
a. Strongly positive.
b. Weakly Positive.
c. Strongly Negative.
d. Weakly Negative.
e. Indeterminate.
15. The best way to directly acquire the shares of a foreign company is through
a. International mutual funds.
b. Global mutual funds.
c. American Depository Receipts.
d. Investment in U.S. companies operating internationally.
e. Eurobonds.
16. Which of the following would be considered a low liquidity investment?

a. Warrants
b. Call options
c. Zero coupon bonds
d. Balanced mutual funds
e. Diamonds
17. An agreement that provides for the future delivery or receipt of an asset at a specified date for a
specified price is a
a. Eurobonds contract.
b. Futures contract.
c. Put option contract.
d. Call option contract.
e. Warrant contract.
18. Which of the following is not a type of investment company?

a. Money market funds
b. Common stock funds
c. Balanced funds
d. Bond funds
19. Antiques, art, coins, stamps, jewelry, etc., are not included in the investment portfolios of financial
institutions because
a. Prices vary substantially.
b. Transaction costs are relatively high.
c. They are illiquid.
d. All of the above.
20. Rank the following four investments in increasing order of historical risk.
a. Art, T-bills, corporate bonds, and common stock
b. T-bills, common stock, corporate bonds, art
c. Corporate bonds, T-bills, common stock, art
d. Common stock, corporate bonds, T-bills, art
e. T-bills, corporate bonds, common stock, art
21. An ETF (exchange traded fund):

a. Is priced once a day at the opening of trading.
b. Is priced once a day at the close of trading.
c. Is priced continuously during the trading day.
d. Is priced at the open and close of trading.
22. A statistic that measures how two variables tend to move together is the
a. Coefficient of variation
b. Correlation coefficient
c. Standard deviation
d. Mean
e. Variance
23. Which of the following statements concerning historical investment risk and return is false?
a. The geometric mean of the rates of return was always lower than the arithmetic mean of
the rates of return.
b. The rates of return on long-term U.S. government bonds were lower than on stocks.
c. Real estate investments consistently provide higher rates of return than those provided by
common stock.
d. Stocks and bonds experienced results in the middle of the art and antiques series.
e. none of the above (that is, all are true statements)
24. Which of the following are reasons that U.S. investors should consider foreign markets when
constructing global portfolios.
a. Ignoring foreign markets reduced their choices of investment opportunities.
b. Foreign markets have low correlations with U.S. markets.
c. Returns on non-U.S. stocks can substantially exceed returns for U.S securities.
d. All of the above.
25. A mutual fund:

a. Is priced once a day at the opening of trading.
b. Is priced once a day at the close of trading.
c. Is priced continuously during the trading day.
d. Is priced at the open and close of trading.
26. For a U.S. based investor, a weaker dollar means that overall dollar based returns on overseas security
investment will be higher because
a. A weaker dollar means that exports will rise.
b. A weaker dollar means that more foreign investors will by U.S. securities.
c. A weaker dollar means that the foreign currency will convert to more dollars.
d. A weaker dollar means that more investors will purchase the foreign security.
27. In order to diversify risk an investor must have investments that have correlations with other
investments in the portfolio that are
a. low positive
b. zero
c. negative
d. any of the above
e. none of the above
28. Correlations between bond markets in different countries have been changing over time because
a. Countries are developing closer trade and economic links.
b. Countries are becoming more segmented.
c. There are fewer barriers to travel.
d. U.S. investors are purchasing more foreign securities.
e. Correlations between bond markets of different countries have been rising.
29. Senior secured bonds are

a. The most senior bonds in a firm's capital structure.
b. Bonds with the lowest risk of default.
c. Bonds that are not backed by specific assets.
d. a and b.
e. a and c.
30. Convertible bonds are bonds

a. That are convertible into more bonds.
b. That are convertible from unsecured to secured status.
c. That are convertible into company stock.
d. That are convertible into specific assets.
e. That have an option attached.
31. A Eurobond is an international bond

a. Sold by an issuer within its own country in that country's currency.
b. Denominated in a currency not native to where it is issued.
c. Also known as a Yankee Bond.
d. Denominated in U.S. dollars but issued by a foreign company.
e. That is sold only to European investors.
32. Foreign equities can be acquired by purchasing all of the following except
a. American Depository Receipts (ADRs)
b. American shares
c. Foreign shares listed on a U.S. or foreign stock exchange
d. Global Exchange-Traded Funds (GETFs)
e. All of the above are ways to purchase foreign equities.
33. Which of the following is not a characteristic of a warrant?

a. The right to buy common stock in a corporation.
b. Issued by the corporation or an individual.
c. Typically valid for longer time periods than options.
d. Similar to a call option with respect to a striking price.
e. All of the above statements are characteristics of a warrant.
34. Certificates of ownership issued by a U.S. bank that represent indirect ownership of a certain number
of shares of a specific foreign firm on deposit in a bank in the firm's home country are known as:
a. American Depository Receipts (ADRs)
b. Exchange Traded Funds (ETFs)
c. Warrants
d. Options
e. Futures
35. All of the following are ways to invest in real estate except
a. Real Estate Investment Trusts (REITs)
b. Raw Land
c. Land Development
d. Rental Properties
e. All of the above are ways to invest in real estate.
36. Which of the following statements regarding real estate investments is false?
a. The large number of transactions and national data sources provide accurate readily
available estimates of historical returns.
b. Real Estate Investment Trusts (REITs) had higher returns than common stocks from 1972
to 1987.
c. Real Estate Investment Trusts (REITs) had lower volatility than common stocks from 1972
to 1987.
d. All of the above statements are true.
e. All of the above statements are false.
37. A bond provision that specifies payments the issuer must make to redeem a given percentage of the
outstanding issue prior to maturity is known as
a. Call provision
b. Indenture
c. Collateralization
d. Sinking fund
e. Collateral trust bond
38. Adding international investments to an all U.S. portfolio will most likely:
a. Increase the overall risk of the portfolio
b. Decrease the overall risk of the portfolio
c. Increase the expected return of the portfolio
d. Decrease the expected return of the portfolio
39. Investments with predetermined contractual payments are known as:

a. Fixed-income
b. Real estate
c. Real assets
d. Equities
e. Low liquidity investments
40. Which of the following investments can be purchased with future contracts?
a. Commodities
b. T-bills
c. Treasury bonds
d. Eurobonds
e. All of the above
41. What type of mutual fund issues "redeemable securities" meaning that the fund stands ready to buy or
sell the shares at their net asset value with a transaction fee?
a. No-load, closed-end fund
b. No-load, open-end fund
c. Load, closed-end fund
d. Load, open-end fund
42. An individual with only $10,000 to invest is most likely better off investing in:
a. Mutual funds to increase the expected return
b. ETFs to increase the diversification
c. Individual equities to increase portfolio efficiency
d. Individual bonds and individual equities to increase efficiency
e. All of the above are rational choices
Exhibit 3.1
Security Annual Percentage Return

U.S. government T-bills 3.04
Long-term government bonds 5.75
Long-term corporate bonds 6.80
Large capitalization common stocks 13.50
Small capitalization common stocks 15.60
The annual rate of inflation is 2%.
43. Refer to Exhibit 3.1. What is the real return on long-term corporate bonds?
a. 1.02%
b. 3.68%
c. 4.71%
d. 11.27%
e. 13.33%
ANS: C
Real return on long term corporate bonds = 4.71% = [(1.068)/(1.02)] - 1
44. Refer to Exhibit 3.1. What is the real return on T-bills?

a. 1.02%
b. 3.68%
c. 4.71%
d. 11.27%
e. 13.33%
ANS: A
Real return on T-bills = 1.02% = [(1.034)/(1.02)] - 1
45. Refer to Exhibit 3.1. What is the real return on small capitalization stocks?
a. 1.02%
b. 3.68%
c. 4.71%
d. 11.27%
e. 13.33%
ANS: E
Real return on small cap stocks = 13.33% = [(1.156)/(1.02)] - 1
46. Refer to Exhibit 3.1. What is the real return on large capitalization stocks?
a. 1.02%
b. 3.68%
c. 4.71%
d. 11.27%
e. 13.33%
ANS: D
Real return on large cap stocks = 11.27% = [(1.135)/(1.02)] - 1
Exhibit 3.2
Real Returns
Investment Real Annual Return
Large company stock 6.50%
Small capitalization stock 8.60%
Long-term corporate bonds 3.60%
Long-term government bonds 2.80%
U.S. Treasury bills 1.03%
The annual rate of inflation is 2.5%
47. Refer to Exhibit 3.2. What is the large company stock nominal return?
a. 3.56%
b. 5.37%
c. 6.19%
d. 9.16%
e. 11.32%
ANS: D
Nominal return on large cap stocks = 9.16% = [(1.065)(1.025)] - 1
48. Refer to Exhibit 3.2. What is the T-bill nominal return?

a. 3.56%
b. 5.37%
c. 6.19%
d. 9.16%
e. 11.32%
ANS: A
Nominal return on T-bills = 3.56% = [(1.0103)(1.025)] - 1
49. Refer to Exhibit 3.2. What is the long term Treasury bond nominal return?
a. 3.56%
b. 5.37%
c. 6.19%
d. 9.16%
e. 11.32%
ANS: B
Nominal return on long term government bonds = 5.37% = [(1.028)(1.025)] - 1

50. Refer to Exhibit 3.2. What is the small capitalization stock nominal return?
a. 3.56%
b. 5.37%
c. 6.19%
d. 9.16%
e. 11.32%
ANS: E
Nominal return on small cap stocks = 11.32% = [(1.086)(1.025)] - 1
51. A return series has an arithmetic mean of 12.8% and standard deviation of 7.8%. Assuming the returns
are normally distributed what is the range of returns that an investor would expect to receive 90% of
the time?
a. 12.8% to 20.6%
b. -10.6% to 36.2%
c. -2.8% to 28.4%
d. -12.8% to 20.6%
e. 10.6% to 36.2%
ANS: C
The range of returns is between 12.8 - 2(7.8) and 12.8 + 2(7.8) = -2.8 and 28.4
52. A return series has an arithmetic mean of 12.8% and standard deviation of 7.8%. Assuming the returns
the time?
a. 12.8% to 20.6%
b. -10.6% to 36.2%
c. -2.8% to 28.4%
d. -12.8% to 20.6%
e. 10.6% to 36.2%
ANS: B
The range of returns is between 12.8 - 3(7.8) and 12.8 + 3(7.8) = -10.6 and 36.2
53. A return series has an arithmetic mean of 10.5% and standard deviation of 13%. Assuming the returns
the time?
a. 10.5% to 13%
b. -2.5% to 23.5%
c. -28.5% to 49.5%
d. -15.5% to 36.5%
e. 0% to 36.5%
ANS: C
The range of returns is between 10.5 - 3(13) and 10.5 + 3(13) = -28.5 and 49.5

54. A return series has an arithmetic mean of 10.5% and standard deviation of 13%. Assuming the returns
the time?
a. 10.5% to 13%
b. -2.5% to 23.5%
c. -28.5 to 49.5%
d. -15.5% to 36.5%
e. 0% to 10.5%
ANS: D
The range of returns is between 10.5 - 2(13) and 10.5 + 2(13) = -15.5 and 36.5.
55. You are trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year
and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors
are the same and you are in the 28% tax bracket, which bond should you choose and why?
a. Corporate bond because the after tax yield is 6.25%.
b. Corporate bond because the after tax yield is 4.5%.
c. Municipal bond because the equivalent taxable yield is 6.3%.
d. Municipal bond because the equivalent taxable yield is 6.6%.
e. You will be indifferent between the two because the after tax yields are the same.
ANS: D
The municipal bond has an equivalent taxable yield of 0.475/(1 - 0.28) = 0.066. This is higher than the
bond yield of .0625.
56. What range of returns would an investor expect to achieve 99% of the time on an investment with an
expected return of 11% and a standard deviation of 16%?
a. 5% to 27%
b. -5% to 27%
c. -21% to 43%
d. -37% to 59%
e. 5% to 21%
ANS: D
Assuming the returns are normally distributed a 99% confidence interval is constructed by 11% plus or
minus three times the standard deviation.
11% - 3(16%) to 11% + 3(16%) = -37% to 59%
57. If the nominal return on an investment of common stocks was 11% and inflation was 2.5% annually,
what was the real return on common stock?
a. 8.3%
b. 8.5%
c. 9.7%
d. 11.0%
e. 12.6%
ANS: A
(1.11)/(1.025) - 1 = 0.0829 or 8.3%
58. If the real return for corporate bonds was 4% and the inflation rate was 2%, what is the nominal return
for corporate bonds?
a. 1.96%
b. 2.00%
c. 4.00%
d. 6.08%
e. 6.42%
ANS: D
(1.04)(1.02) - 1 = 0.068 or 6.08%
59. What is the 95 percent confidence interval for an investment with an expected return of 9 percent and a
standard deviation of 15%?
a. 9% to 15%
b. -6% to 24%
c. -15% to 32%
d. -21% to 39%
e. -36% to 56%
ANS: D
95% confidence interval is 2 standard deviations from the mean
9% - 2(15%) to 9% + 2(15%)
-21% to 39%

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CHAPTER 1—THE INVESTMENT SETTING

ANS: True PTS: 1

ANS: True PTS: 1

ANS: False PTS: 1

ANS: False PTS: 1

5. The expected return is the average of all possible returns.

ANS: False PTS: 1

ANS: False PTS: 1

ANS: False PTS: 1

ANS: False PTS: 1

9. Nominal rates are averages of all possible real rates.

ANS: False PTS: 1

ANS: False PTS: 1

ANS: False PTS: 1

ANS: True PTS: 1

ANS: False PTS: 1

1. The basic trade-off in the investment process is

2. The rate of exchange between future consumption and current consumption is

4. The coefficient of variation is a measure of

5. The nominal risk free rate of interest is a function of

6. In the phrase "nominal risk free rate," nominal means

8. The real risk-free rate is affected by a two factors;

9. Which of the following is not a component of the risk premium?

11. The variability of operating earnings is associated with

19. Measures of risk for an investment include

20. Sources of risk for an investment include

21. Modern portfolio theory assumes that most investors are

23. All of the following are major sources of uncertainty EXCEPT

24. The total risk for a security can be measured by its

PTS: 1 OBJ: Multiple Choice Problem

PTS: 1 OBJ: Multiple Choice Problem

Annual HPR = (HPR)1/n = (0.8667)1/3 = 0.9534

PTS: 1 OBJ: Multiple Choice Problem

Annual HPY = Annual HPR  1 = 0.9534  1 = 0.0466 = 4.66%

PTS: 1 OBJ: Multiple Choice Problem

Time Price of X-Tech

PTS: 1 OBJ: Multiple Choice Problem

Annual HPY = Annual HPR  1 = 1.1247  1 = 0.1247 = 12.47%

Time Price of X-Tech Return HPR

PTS: 1 OBJ: Multiple Choice Problem

PTS: 1 OBJ: Multiple Choice Problem

PTS: 1 OBJ: Multiple Choice Problem

Economic Status Probability Rate of Return

PTS: 1 OBJ: Multiple Choice Problem

PTS: 1 OBJ: Multiple Choice Problem

U.S. Government T-bills 2.75%

Real rate on bonds = (1.0475/1.015)  1 = 0.032 = 3.2%

PTS: 1 OBJ: Multiple Choice Problem

Real rate on T-bills = 1.23  1.10 = 1.353%

PTS: 1 OBJ: Multiple Choice Problem

PTS: 1 OBJ: Multiple Choice Problem

a. Investment A because it has the highest expected return.

CVA = 7%/12.2% = 0.573

CVB = 5%/8.8% = 0.568

Investment B has the lowest coefficient of variation and would be preferred.

PTS: 1 OBJ: Multiple Choice Problem

You are provided with the following information:

Nominal return on risk-free asset = 4.5%