# Investment Management Questions

Need help with the following Investment Management Questions:

Question 1.1. The risk of a portfolio consisting of two uncorrelated assets will be (Points : 1)

equal to zero.

greater than the risk of the least risky asset but less than the risk level of the more risky asset.

greater than zero but less than the risk of the more risky asset.

equal to the average of the risk level of the two assets.

Question 2.2. The beta of the market is (Points : 1)

-1.0.

0.0.

1.0.

undefined.

Question 3.3. Portfolio objectives should be established independently of tax considerations. (Points : 1)

True

False

Question 4.4. A stock with a beta of 1.3 is less risky than a stock with a beta of 0.42. (Points : 1)

True

False

Question 5.5. Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible set. (Points : 1)

True

False

Question 6.6. The Capital Asset Pricing Model (CAPM) includes which of the following in its base assumptions?

(Points : 1)

Investors should earn a minimum retun rate equal to the risk-free rate.

Investors in the market should earn a return greater than the return on the overall market.

Investors shoud be awarded for the amount of risk they assume.

Investors should earn a return located above the Security Market Line.

I and III only

II and IV only

I, II and III only

I, III, and IV only

Question 7.7. To obtain the maximum reduction in risk, an investor should combine assets that (Points : 1)

are negatively correlated.

are uncorrelated.

have a correlation coefficient of positive one.

have a correlation coefficient of negative one.

Question 8.8. Standard deviation is a measure that indicates how the price of an individual security responds to market forces. (Points : 1)

True

False

Question 9.9. Traditional portfolio management (Points : 1)

concentrates on only the most recent "hot" sectors of the market.

typically centers on interindustry diversification.

includes only diversified bonds in a laddered portfolio.

is based on statistical measures to develop the portfolio plan.

Question 10.10. Amanda has the following portfolio of assets.

Poporation of

Stock Portfolio Beta

ABC $7,000 .85

DEF $12,000 1.25

GHI $6,000 1.10

What is the beta of Jonathan's portfolio? (Points : 1)

1.06

1.10

1.13

3.02

Question 11.11. A measure of systematic risk (Points : 1)

standard deviation

historical average rate of return

beta

variance

Question 12.12. Diversifiable risk is also called systematic risk. (Points : 1)

True

False

Question 13.13. Studies have shown that investing in different industries as well as different countries reduces portfolio risk. (Points : 1)

True

False

Question 14.14. Which of the following factors comprise the CAPM?

(Points : 1)

I. divendend yield

II. risk-free rate of return

III. the expected rate of return on the market

IV. risk premuim for the firm

I and III only

II and IV only

III and IV only

II, III and IV only

Question 15.15. Security A has a beta of .99, security B has a beta of 1.2, and security C has a beta of -1.0. This information indicates that (Points : 1)

security A has the highest degree of market risk.

security B has 20% more systematic risk than the market.

security C has the highest degree of market risk.

security C would be the best investment if a strong bull market is expected.

Question 16.16. The market rate of return increased by 8% while the rate of return on XYZ stock increased by 4%. The beta of XYZ stock is (Points : 1)

-2.0.

-0.40.

0.50.

2.0.

Question 17.17. A coefficient of determination of 0.6 means that 40% of the variation in a security's return is related to factors other than the security's relationship to the market. (Points : 1)

True

False

Question 18.18. A portfolio that offers the lowest risk for a given level of return is known as an efficient portfolio. (Points : 1)

True

False

Question 19.19. In designing a portfolio, the only relevant risk is (Points : 1)

total risk.

unsystematic risk.

event risk.

nondiversifiable risk.

Question 20.20. The basic theory linking risk and return is the Capital Asset Pricing Model. (Points : 1)

True

False

Question 21.21. A stock's beta value is a measure of (Points : 1)

interest rate risk.

total risk.

systematic risk.

diversifiable risk.

Question 22.22. The investment choice of an individual is affected by

(Points : 1)

I. their tolerance for risk

II. their prior investment experience

III. their marginal tax braket

IV. the stability of their income

II and III only

II, III and IV only

I, III and IV only

I, II, III and IV

Question 23.23. The optimal portfolio for an individual investor is represented by the point that lies on the (Points : 1)

lowest possible utility curve and connects to the efficient frontier.

utility curve which is just tangent to the right side of the feasible set of risk-return options.

utility curve which is just tangent to the efficient frontier.

utility curve which represents the highest possible rate of return within the feasible set of risk-return options.

Question 24.24. Portfolio objectives should be established before beginning to invest. (Points : 1)

True

False

Question 25.25. Market return is the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index. (Points : 1)

True

False

Question 26.26. Risk can be totally eliminated by combining two assets that are perfectly positively correlated. (Points : 1)

True

False

Question 27.27. Historical betas are always reliable predictors of future return fluctuations. (Points : 1)

True

False

Question 28.28. When the Capital Asset Pricing Model is depicted graphically, the result is the (Points : 1)

standard deviation line.

coefficient of variation line.

security market line.

alpha-beta line.

Question 29.29. The best stock to own when the stock market is at a peak and is expected to decline in value is one with a beta of (Points : 1)

+1.5.

+1.0.

-1.0.

-0.5.

Question 30.30. Beta measures diversifiable risk while standard deviation measures systematic risk. (Points : 1)

True

False

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Question 1.1. The risk of a portfolio consisting of two uncorrelated assets will be (Points : 1)

equal to zero.

greater than the risk of the least risky asset but less than the risk level of the more risky asset.

greater than zero but less than the risk of the more risky asset.

equal to the average of the risk level of the two assets.

The risk is determined by the variance of returns of the combined portfolio

Mathematically

Where P represents the portfolio and A & B the individual assets, σ represents the variance of each asset, w represents the weight (% of total investment). in case of uncorrelated assets the covariance is zero hence it can be rephrased as

Hence the risk will be greater than the risk of the least risky asset but less than the risk level of the more risky asset as the standard deviation of the portfolio will lie between the standard deviations of the individual assets

Question 2.2. The beta of the market is (Points : 1)

-1.0.

0.0.

1.0.

undefined.

The beta of the market is 1 by definition as beta is a measure of the protfolio's volatility w.r.t. the market.

Question 3.3. Portfolio objectives should be established independently of tax considerations. (Points : 1)

True

False

True. Portfolio objectives are to be established independently of tax considerations, which are to be condiered in the next step, the investment strategies to achieve the tax considerations.

Question 4.4. A stock with a beta of 1.3 is less risky than a stock with a beta of 0.42. (Points : 1)

True

False

True. Stock with a beta of 0.42 will be less risky as lower beta indicates lower risk

Question 5.5. Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible set. (Points : 1)

True

False

True. Portfolios located on the efficient frontier have the highest return for any given level of risk.

Question 6.6. The Capital Asset Pricing Model (CAPM) includes which of the following in its base assumptions?

(Points : 1)

Investors should earn a minimum retun rate equal to the risk-free rate.

Investors in the market should earn a return greater than the return on the overall market.

Investors shoud be awarded for the amount of risk they assume.

Investors should earn a return located above the Security Market Line.

I and III only

II and IV only

I, II and III only

I, III, and IV only

I and III only are true.

Question 7.7. To obtain the maximum reduction in risk, an ...

#### Solution Summary

The solution provides description for 30 multiple choice questions pertaining to application of capital asset pricing model theory of modern portfolio management.

Investment Fundamentals and Portfolio Management: return on stock, holding-period return on investment, margin account, market price per share, value of stock, expected return of the portfolio, beta of the portfolio, CAPM, value of options at expiration

Whopie, market to book value ratio, earnings multiple, Elvis Alive Corporation,

1. John Smith has been reviewing the stock of ABC. John has estimated that the stock will have the following possible returns and probabilities:

Return Probability

-0.15 0.10

-0.05 0.20

0.05 0.35

0.15 0.25

0.25 0.10

a. Compute the expected return on ABC stock.

b. Compute the standard deviation of returns on ABC.

2. A stock sells for $67 per share and pays a quarterly dividend of $0.50. One year later, the stock sells for $76.

a. Compute the holding-period return on this investment.

b. Compute the holding period return assuming that the investor could buy this stock borrowing half of the purchase price at 12 percent per annum interest.

c. Compute the holding period return (including the information from part b) if the investor pays a commission of $0.40 per share on both the purchase and sale transaction.

3. You open a margin account with a brokerage firm. The initial margin requirement is 50 percent, and the maintenance margin requirement is 25 percent. You purchase 100 shares of a stock selling for $40 per share.

a. How much money do you need to have in your margin account to make this purchase? (Ignore commissions.)

b. What is the amount of your margin loan from the broker?

c. If the stock falls to $32, what is the margin in the account?

d. At what stock price will you receive a margin call?

4. What is the market price per share of Whopie, Inc. if the firm had net income of $200,000, earnings per share of $2.70, total equity of $800,000, and a market to book value ratio of 1.5?

5. The companies in the electrical parts industry have an average earnings multiple of 16. John's Parts, Inc. manufactures electrical parts, and you have forecast that the company will earn $3.60 per share and its stock will sell at the industry average multiple 3 years from now. Estimate the value of John's Parts stock in 3 years. If the required rate of return is 14 percent, what is the present value of John's Parts stock?

6. Tom Jones has identified the following securities for a portfolio:

Security Amount Invested Expected Return Beta

A $25,000 0.05 1.4

B $35,000 0.11 0.1

C $5,000 0.15 0.5

D $35,000 0.01 1.9

Compute the expected return of the portfolio. Compute the beta of the portfolio.

7. The Elvis Alive Corporation, makers of Elvis memorabilia, has a beta of 2.35. The return on the market portfolio is 13%, and the risk-free rate is 7%. According to CAPM, what is the risk premium on a stock with a beta of 1.0?

8. Discuss the 3 forms of market efficiency and the evidence for each form of market efficiency.

9. Compute the value of the following options at expiration:

a. An IBM July 90 call when IBM sells for $98

b. An Eastman Kodak April 25 call with the stock priced at $19

c. A Wall-Mart January 60 put with Wal-Mart stock selling for $48

d. A Pfizer October 35 put with the stock priced at $42.