# Finance-FINC 6399 – Investments (Private Equity, Hedge Funds, Portfolio Theory &

Question

FINC 6399 – Investments

(Private Equity, Hedge Funds, Portfolio Theory & Derivatives)

Quiz 3

Please enter your answers by the due date mentioned in syllabus, unless extended in Blackboard.

1. Which of the following is NOT a recommended step in an individual’s portfolio

management process?

A. A template based investment allocation strategy.

B. Creation of an investment policy statement.

C. Analysis of capital market conditions.

2. All of the following are reasons for creating an investment policy statement (IPS), EXCEPT

A. Identification of specific return goals.

B. Awareness of client’s risk tolerance.

C. Guarantee of maximum return.

3. An IPS can be used for all of the following purposes EXCEPT

A. as a standard or benchmark for performance evaluation.

B. for getting a client the highest possible return irrespective of his disposition and

circumstance.

C. as a basis for communication between the client and the manager.

4. An individual’s risk tolerance is affected by all of the following factors EXCEPT

A. current consumption.

B. age or time horizon.

C. wealth.

5. Someone who is seeking capital preservation

A. would seek high current income.

B. would seek high capital gains.

C. would seek to earn at least as much as the rate of inflation.

6. Which of the following may NOT be a constraint for Mark?

A. Mark’s portfolio is invested in his employer’s stock to the extent of 50%.

B. Mark wants to donate 50,000 to a charity in 3 years.

C. Mark has an aged mother who lives in a nursing home and is his dependent.

7. Which of the following is a liquidity constraint for June who is 45 years old?

A. She needs 20,000 in six months for a down payment on a house.

B. She wants to buy a vacation condo in five years.

C. She wants to leave 100,000 to her alma mater upon her death from her estate if there are

sufficient assets.

8. Christine Phillips is in the 25% tax bracket. She is considering a taxable bond which yields

6.5%. A tax-exempt municipal bond yields 4%. What is the tax-equivalent yield for the muni

and which security should Christina buy?

A. 3.00%, buy the taxable bond.

B. 4.88%, buy the tax-exempt bond.

C. 5.33%, buy the taxable bond.

9. When comparing tax deferred and non-deductible investments

A. an investor may be better off with non-deductible investments as future income may be

tax exempt.

B. an investor is better off with tax deferred investments as future taxes will be lower.

C. an investor should be indifferent between the two.

10. When diversifying a portfolio,

A. an investor may be faced with a myriad of securities that deciding among them is

impossible.

B. an investor may be faced with a large capital gains tax bill on existing securities which

may offset benefits of diversification.

C. an investor would do well to imitate an average investor’s portfolio.

11. For investment purposes, individuals are assumed to be

A. attracted to risk.

B. indifferent to risk.

C. averse to risk.

12. Markowitz assumes all of the following about individuals EXCEPT

A. that they seek to earn the highest rate of return available in the capital market.

B. that they maximize their expected utility.

C. that their utility functions can be represented by risk (variability of return) and return.

13. A portfolio is said to be efficient in Markowitz sense if

A. it offers the same rate of return as other portfolios irrespective of risk.

B. it offers the highest rate of return for a given level of risk.

C. it lies on the negatively sloped segment of the outer envelope of feasible investments.

The following data applies to questions 14 through 16.

The economy is expected to be in a growth phase with a probability of 40%; in a flat mode

with a probability of 25%; and, in a contracting phase with a probability of 35%.

14. If the stock of Giant Motors (GM) is expected to earn 18%, 7% and –12% in the three stares

respectively, what is the expected return on GM stock?

A. 4.33%

B. 13.15%

C. 4.75%

15. What is the variance of the return on GM stock?

A. 461.18

B. 169.61

C. 32.25

16. What is the standard deviation of the return on GM stock?

A. 13.03%

B. 1.12%

C. 5.68%

17. A portfolio contains two stocks, X and Y. Expected return on X is 12.5%, and expected

return on Y is 19.4%. If X and Y represent 30% and 70% of the portfolio respectively, what

is the expected return on the portfolio?

A. 17.33%

B. 16.00%

C. 50.00%

18. The covariance between two stocks – Galvin Skis and Briton Sports Goods – is 234.56. Their

respective standard deviations are 19.55 and 28.94. What is the correlation co-efficient

between them?

A. 0.17

B 2.41

C. 0.41

19. When a portfolio of many assets is created

A. individual asset variances are the most important contributors to portfolio risk.

B. individual asset variances are not as important as covariances when it comes to

contributing to portfolio risk.

C. covariances are irrelevant when it comes to contributing to portfolio risk.

20. The main driver of portfolio diversification is

A. expected return on individual securities.

B. correlation coefficient between securities.

C. variances of securities.

21. Maximum diversification will be achieved with securities that have a correlation coefficient

of

A. 1.

B. 0.

C. –1.

22. Efficient frontier

A. contains portfolios that have the highest return for a given risk.

B. includes the negatively sloped segment of the envelope.

C. excludes feasible portfolios.

23. Investors’ utility functions display

A. diminishing marginal utility property.

B. increasing marginal utility property.

C. constant marginal utility property.

24. Indifference curves

A. are concave to the origin and slope upward toward the northwest direction.

B. intersect each other at least once in the expected return and standard deviation space.

C. represent points of indifference for different risk – return combinations and have a

positive slope.

25. An investor chooses the most preferred portfolio as

A. the one that lies in the interior of the feasible set.

B. the one that is in the efficient set and is tangent to the highest possible indifference curve

of the individual.

C. the one that lies outside the efficient frontier for highest utility.

26. Which of the following statements regarding indifference curves is TRUE?

A. more risk averse investors have flatter indifference curves and have optimal portfolios in

the northeast corner of the efficient frontier.

B. less risk averse investors have flatter indifference curves and have optimal portfolios in

the northeast corner of the efficient frontier.

C. more risk averse investors have steeper indifference curves and have optimal portfolios in

the northeast corner of the efficient frontier.

27. Which of the following is NOT an assumption of the modern portfolio theory?

A. Securities may be over or underpriced.

B. They have a one-period time horizon and have homogeneous expectations about return

and risk of securities.

C. The efficient frontier does not change over the time horizon.

28. Introduction of a risk free asset into an economy

A. does not raise any investor’s utility.

B. does not lower any investor’s utility.

C. raises the utility of some investors and lowers the utility of other investors.

29. Which of the following statements regarding the introduction of a risk free asset into an

economy is FALSE?

A. Some people invest in combinations of the new tangency point and the risk free asset and

others invest along the old efficient frontier only.

B. The new efficient frontier is a straight line.

C. The new efficient frontier is tangent to the old efficient frontier of all risky assets.

30. In the presence of a risk free asset

A. investors will always invest in portfolios offering a return between the market return and

the risk free asset.

B. all investors will invest in portfolios offering returns closer to the risk free asset since the

market portfolio is highly risky.

C. investors will only invest in linear combinations of the risk free asset and the market

portfolio.

31. Since there are no restrictions on borrowing at the risk free rate,

A. some investors may short the market portfolio and invest in the risk free asset.

B. some investors may short the risk free asset and invest in the market portfolio only.

C. many investors will find the market portfolio too risky and they will short both the

market and the risk free asset.

32. Capital market line is

A. the highest sloping capital allocation line.

B. is a flat line joining the risk free asset to all assets to the right.

C. is a straight line with a negative slope.

33. In the modern portfolio theory context, the market prices

A. the non-systematic risk only.

B. both the systematic and non-systematic risk.

C. the systematic risk of a security only.

34. The capital asset pricing model is a relationship between

A. the required rate of return on a security and its diversifiable risk.

B. the required rate of return on a security and its covariance with the market portfolio.

C. the required rate of return on a security and its total risk.

The following data applies to questions 35 through 39.

Covariance of Orion Pharmaceuticals stock with the market portfolio is 0.03754. The market

standard deviation is 0.4075%, the risk free rate in the economy is 5% and the market return

is 11%.

35. What is the slope of the SML when defined in terms of covariance?

A. 66.25

B. 14.72

C. 36.13

36. What is the slope of the SML when expressed in terms of beta?

A. 6%

B. 11%

C. 5%

37. What is the beta of Orion’s stock?

A. 0.00

B. 0.23

C. 1.00

38. What is the required rate of return on Orion’s stock?

A. 5.54%

B. 6.38%

C. 5%

39. If the expected return on Orion’s stock is 7%, is the stock over or underpriced? Does it lie

above or below the SML?

A. Fairly priced, on the SML.

B. Underpriced, above the SML.

C. Overpriced, above the SML.

40. The covariance between a security and the market is 205, and the market’s standard deviation

is 18. If the risk free rate is 5% and the market risk premium 6%, what is the required rate of

return on the security?

A. 11%

B. 8.8%

C. 9.8%

41. The required rate of return on a security is 10%. It is expected to pay $110 in a year’s time. If

the security is selling for $98 in the market, it will plot

A. Above the SML.

B. Below the SML.

C. On the SML.

42. A security or a portfolio that graphs on the SML,

A. has no diversifiable risk.

B. has some diversifiable risk.

C. cannot say.

43. If the lending and borrowing rates were unequal, which of the following statements would be

FALSE?

A. The positive relationship between risk and return would still hold.

B. The SML will still be a straight line.

C. The portfolios of borrowers would not be as profitable as portfolios of lenders.

44. The Sharpe-Linter CAPM does not conclude:

A. the market portfolio is mean-variance efficient.

B. investors are risk averse.

C. excess return is a function of beta or non-diversifiable risk.

45. When short-sales are not allowed

A. beta of a security cannot be calculated.

B. the efficient frontier in the presence of a risk-free asset is not a straight line.

C. the market portfolio is no longer mean-variance efficient.

46. Based on CAPM, if two securities have the same variance but unequal excess returns,

A. the market portfolio will contain a higher dollar value of the security with the lower

excess return.

B. the market portfolio will contain equal dollar values of the two securities.

C. the market portfolio will contain a higher dollar value of the security with the higher

excess return.

47. Under the single factor scenario, a security has a covariance of 476 with the market portfolio.

If the standard deviation of the market portfolio is 20, what is the systematic risk, as a

proportion of the total risk (measured as variance) if the security has a standard deviation of

28?

A. 72.25%

B. 27.75%

C. 71.4%

48. Under the single factor scenario, a security has a covariance of 476 with the market portfolio.

If the standard deviation of the market portfolio is 20, what is the diversifiable risk (measured

as variance) if the security has a standard deviation of 28?

A. 14.75

B. 217.56

C. 90.63

49. Which of the following models is not applicable to equities?

A. Barclay Group factor model.

B. Fama-Factor model.

C. MSCI-Barra fundamental factor model.

50. Fundamental factor models are

A. dissimilar in terms of some of the factors used compared to the Fama-French model.

B. dissimlar from the Fama-French model when it compares to the marlet porfolio.

C. equivalent to the Fama-French model.

51. Which of the following factors is not includeed in MSCI fundamental factor model?

A. Estimated earnings growth.

B. Price to Book ratio.

C. Firm size.

52. If you are creating a macroeconomic factor model, which of the following factors would not

be included?

A. GDP growth.

B. Dividend yield on the S&P 500.

C. Interest rates.

53. Which of the following factors would be used in a bond factor model?

A. Optionality risk.

B. GDP growth rate.

C. Issuer size.

54. Latent factors are used to

A. estimate impact of known factors on a variable of interest, such as stock returns.

B. weed out the effect of market portfolio.

C. understand phenomena that are difficult to explain, by reducing the potential causes that

drive a model.

55. The Arbitrage Pricing Theory assumes that returns on assets are

A. generated by a number of known finite factors.

B. generated by a number of finite but unknown factors.

C. generated by a non-linear combination of finite but unknown factors.

56. The Arbitrage Pricing Theory does not depend on

A. a linear return generating process.

B. a multi-factor model that generates returns.

C. expectations of returns.

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