Ch 12 Portfolio Management and Investment Risk Part II

Question 1

If an adviser attempts to exceed the performance of the market, it is using ______ portfolio management.

Answer 1

active

Question 2

True or False: With a buy and hold strategy, investors are consistently rebalancing their portfolios.

Answer 2

False. Buy and hold involves no rebalancing.

Question 3

True or False: Systematic risk may be avoided through diversification.

Answer 3

False. Systematic (non-diversifiable) risk may not be avoided through diversification.

Question 4

List some formulas used to measure liquidity.

Answer 4

Working capital, current ratio, and quick asset ratio (acid test)

Question 5

Name four asset classes.

Answer 5

Stocks, Bonds, Real Estate, Cash

Question 6

Describe positive financial leveraging.

Answer 6

Paying less interest than earnings received (e.g., client pays 4% on a margin loan, but earns 10% on stock gains)

Question 7

What is the risk that Congress may enact tax law changes that negatively impact the value of an investment?

Answer 7

Legislative risk

Question 8

If a security’s beta is more than 1, is it considered more or less volatile than the market as a whole?

Answer 8

The higher the beta, the greater the volatility.

Question 9

Identify the risk: Investors miss out on receiving a better return by placing their funds elsewhere.

Answer 9

Opportunity risk

Question 10

A __________ is a stream of cash flows that continues forever.

Answer 10

perpetuity

Question 11

If an investor is attempting to maximize her portfolio growth over a long period, what is her strategy called?

Answer 11

Capital appreciation

Question 12

What form of asset allocation attempts to keep the asset percentages balanced over a long period?

Answer 12

Strategic asset allocation

Question 13

If a client eliminates unsystematic or diversifiable risk in his portfolio, he is willing to accept ______ risk.

Answer 13

market risk.

Question 14

What is the formula for the P/E ratio?

Answer 14

Price ÷ EPS (Earnings Per Share)

Question 15

True or False: A bottom up approach to investing uses the economy as a main factor in determining which stocks to buy.

Answer 15

False. Bottom up investing uses company specific items (e.g., earnings and dividend payments) to pick stocks.

Question 16

Which would have the most risk—large-, mid-, or small-cap companies?

Answer 16

Small cap stocks would have the most risk.

Question 17

True or False: The S&P 400 is a large-cap index.

Answer 17

False, the S&P 400 is a mid-cap index.

Question 18

If an asset outperforms the market when prices are up, but underperforms when prices are down, what is its beta?

Answer 18

Its beta must be greater than 1.00.

Question 19

An investment earns 10%, 50%, and 30% in three years. How would the annualized average rate of return be calculated?

Answer 19

When calculating an annualized rate of return over time, the geometric mean is used.

Question 20

In the secondary market, a customer _____ at the bid and ____ at the ask (offer).

Answer 20

sells at the bid and buys at the ask (offer).

Question 21

An investor buys stock that returns 2% for the year rather than a T-Bond yielding 6%. The ____________ cost is 4%.

Answer 21

opportunity cost is 4%.

Question 22

What are some of the characteristics of a value stock?

Answer 22

Low P/E ratios, history of profitability, high dividend payout, and low market-to-book ratio

Question 23

What type of risk is avoided through indexing?

Answer 23

Business risk, since indexing involves purchasing stocks of many companies

Question 24

The S&P 400 Index is a ___-cap index.

Answer 24

mid-cap index.

Question 25

What are two assumptions of MPT?

Answer 25

Investors want to minimize risk and maximize returns

Question 26

True or False: The longer a bond's duration, the less sensitive the bond's price is to changes in interest rates.

Answer 26

False. The longer the duration, the greater a bond's price sensitivity to changes in interest rates.

Question 27

A capital needs analysis is done to determine a client's _________ needs in order to fund future financial goals.

Answer 27

insurance needs

Question 28

Assuming a 12% rate of return, how long will it take $50,000 to double?`

Answer 28

Six years. Using the Rule of 72, 72 divided by the rate of return determines the number of years (72 ÷ 12 = 6 years).

Question 29

What are TIPS?

Answer 29

Treasury Inflation-Protected Securities

Question 30

True or False: Systematic rebalancing assumes markets are inefficient.

Answer 30

False

Question 31

The greater the dispersion of historical returns of a security, the _________ its standard deviation.

Answer 31

higher

Question 32

_______ investors are concerned with a company's future earnings potential.

Answer 32

Growth

Question 33

True or False: The S&P 500 is an asset class.

Answer 33

False. Stocks, bonds, real estate, and cash are asset classes.

Question 34

What is considered an optimal portfolio?

Answer 34

One that has the highest expected return given the client's tolerance for risk

Question 35

The quick asset ratio is calculated by excluding _________ from a company's current assets.

Answer 35

inventory

Question 36

If a bond is trading at a premium to its value based on DCF, will an investor earn more or less than a comparable bond?

Answer 36

A bond trading at a premium to its DCF value will earn less than comparably priced bonds.

Question 37

If there is no relationship between the movement of two investments, they are considered to be _______________.

Answer 37

uncorrelated.

Question 38

True or False: Tactical asset allocation is considered a passive asset allocation approach.

Answer 38

False. Tactical asset allocation is considered an active approach.

Question 39

True or False: Stop-limit orders are guaranteed execution if the trigger is touched.

Answer 39

False. Stop-limit orders may not be executed if the limit price cannot be met.

Question 40

Buy limit orders are placed ________ the market.

Answer 40

below

Question 41

An investor who follows the __________ style of investing bets against market trends.

Answer 41

contrarian style

Question 42

To determine a bond's real interest rate, the bond's yield is subtracted by the rate of ___________.

Answer 42

inflation.

Question 43

What type of trading strategy would be used if you believe markets are efficient?

Answer 43

Passive strategies, such as indexing or systematic rebalancing

Question 44

True or False: Alpha represents an investment's actual return in excess of its expected return.

Answer 44

True

Question 45

What types of securities tend to have a low beta?

Answer 45

Defensive stocks

Question 46

What is a common method used to calculate the returns on an equity indexed annuity?

Answer 46

Point-to-point indexing

Question 47

What is the formula for determining holding period return?

Answer 47

(Ending Value - Beginning Value + Dividends/Interest) ÷ Beginning Value

Question 48

Working Capital, Current Ratio, and the Quick Asset Ratio (Acid Test) are examples of ____________ ratios.

Answer 48

liquidity ratios

Question 49

Define range.

Answer 49

Range is the difference between the largest value and smallest value of a given set of numbers.

Question 50

What is the Capital Asset Pricing Model (CAPM)?

Answer 50

A model of the relationship between expected risk and expected return

Question 51

What risk is based on the possibility that new regulations may have a negative impact on an investment’s value?

Answer 51

Regulatory risk

Question 52

_____________ return allows an investor to compare the performance of two investment advisers.

Answer 52

Time-weighted

Question 53

What type of trading strategy would be used if you believe markets are inefficient?

Answer 53

Active strategies, such as tactical asset allocation or sector rotation

Question 54

What is the name for the graph of optimal portfolios?

Answer 54

The efficient frontier

Question 55

How is market capitalization (cap) determined?

Answer 55

A company's current share price multiplied by the number of shares outstanding

Question 56

Stop and stop-limit orders are triggered when a round lot trades at, or through, the _____ ______.

Answer 56

stop price.

Question 57

In a rising market, is a low beta security expected to outperform or underperform the market as a whole?

Answer 57

Underperform

Question 58

What are two measures of liquidity?

Answer 58

Current ratio and the quick asset ratio (acid test) both measure a company's liquidity.