Non-numerical MCQs Flashcards
(10 cards)
Q1. The Single Index model
A. allows specialization of effort in security analysis.
B. does not simplify the real-world uncertainty.
C. takes into account the industry-specific events.
D. assumes that the residuals are positively correlated across stocks.
E. assumes that abnormal return (alpha) is zero.
Answer: A
Q2. Which of the following statements about Capital Asset Pricing Model is incorrect?
A. All investors follow Markowitz procedure to form their portfolio.
B. Each investor has her own unique efficient frontier, depending on her risk aversion.
C. All investors share an identical investable universe.
D. All investors use the same input list to draw their efficient frontiers.
E. Investors’ expectations are homogeneous
B. According to CAPM all investors choose the market portfolio which is the optimal portfolio. They all choose the same weights.
Q3. Which one of the following factors is NOT in the Fama-French Five-Factor Model?
A. RMW (Robust minus Weak)
B. CMA (Conservative minus Aggressive)
C. SMB (Small minus Big)
D. WML (Winners minus Losers)
E. HML (High minus Low)
D. WML is a factor in the Fama-French four factor model
Q4. Which of the following statements is correct?
A. A possible explanation of the value effect is the neglected firm effect.
B. Liquidity risk premium can explain the value (B/M) effect.
C. Value (B/M) effect can be explained by the high and asymmetric adjustment costs of
the firms with high B/M ratios, in particular during recessions.
D. Momentum effect can be explained by the lack of growth option held by the recently
winning companies.
E. Unprofitable companies tend to have less growth option, which explains the
Profitability effect.
Answer: C
Regarding choices A and B, neglected firm effect and liquidity effect are explanations for the
size (SMB) effect, and not the value effect. Choice C is correct because firms with high B/M
ratios (value stocks) are capital-intensive and hence they are less flexible in responding to
shocks, in particular during recessions (irreversibility risk). Choice D is wrong because the
value effect and the profitability effect can be explained by the lack of growth options (e.g.,
value stocks versus growth stocks). Choice E is wrong because profitable companies are
riskier and have less growth option
Q5. The main challenge of testing Efficient Market Hypothesis is
A. to distinguish between semi-strong and strong form.
B. to distinguish between weak and semi-strong form.
C. to distinguish between public and private information.
D. to distinguish between active and passive strategies.
E. to distinguish between market inefficiency and risk-adjustment model (e.g., CAPM)
inaccuracy.
Answer: E.
The difficulty in testing the EMH is that the test is a joint test of the EMH and the risk adjustment
model. For example, if we use the CAPM and find that a portfolio generates superior returns
(positive alpha), we are not sure whether to reject the EMH or reject the risk adjustment model
(CAPM) or both: we do not know if the market is inefficient or the model is inaccurate.
Q6. Which of the following statements about the number guessing game is inaccurate?
A. The game implies how market can experience bubbles even if majority of investors
were unbounded rational.
B. If all participants of the game were unbounded rational, the winning number must be
always zero.
C. Even if all participants of the game were unbounded rational, they have to guess
each other’s guess.
D. It implies that If unbounded rational investors just believe that there are large enough
number of irrational investors, they need to guess how other investors would behave.
E. The game was played under incomplete information.
Answer: B. Even if all players are unboundedly rational, if they do not know the type of
others, the outcome depends on players’ guesses about the type and behaviour of other
players, and the winning number can be different from zero.
Q7. Which one of the following choices is not a key assumption of the Arbitrage Pricing Theory
(APT)?
A. Asset returns can be explained by a factor model.
B. There is no arbitrage opportunity.
C. The market portfolio is a well-diversified portfolio.
D. All investors are rational.
E. There are rational arbitragers in the market to execute arbitrage.
Answer: D
APT requires a small number of rational arbitragers and does not rely on the assumption that
all investors are rational. That is the CAPM, which requires all investors to be rational and
mean-variance optimizers.
Q10. Which of the following statements about derivatives is correct?
A. Holder of a long position in a futures contract is obliged to buy the underlying
instrument at predetermined price at expiry day.
B. Holder of a put option is obliged to sell the underlying instrument at predetermined
price at expiry day.
C. Holder of a call option is obliged to buy the underlying instrument at predetermined
price at expiry day.
D. Issuer of a call option has a right to sell the underlying instrument at predetermined
price at expiry day.
E. None of the above.
Answer: A
Holder of options has the right to execute the option. Thus, Choices B and C are incorrect.
Issuer of the option has the obligation to execute the option; thus, choice D is also incorrect.
Q8. Read the following case study and select the correct answer.
Smith is a portfolio manager at an alternative asset management firm, AltInvest LLC. At the
direction of her boss, she makes a one-time allocation of the expenses incurred by the Private
Credit Opportunities fund to the Private Credit Special Situations fund. Her boss wants to
temporarily boost the end-of-year results of the Private Credit Opportunities fund, which has
been underperforming. Her boss explains that the Private Credit Special Situations fund
closed recently and just entered its long investment period, thus investors in the fund would
not yet expect it to deliver good results. In contrast, the investment period of the Private Credit
Opportunities fund ended years ago, and its harvesting period is soon coming to an end.
Boosting the performance of the Private Credit Opportunities fund also should help attract
investors to the Private Credit Opportunities II fund. The consolidated performance results of
AltInvest are not affected by the reallocation of expenses between these two funds.
Smith’s actions are
A. appropriate because the consolidated performance results of AltInvest are not
affected by the reallocation of expenses.
B. appropriate because the chosen way of reporting is only temporary.
C. appropriate because Smith followed the directions of her boss.
D. Inappropriate because Private Credit Opportunities fund has been underperforming.
E. Inappropriate because reallocation of expenses between the two funds causes a
misrepresentation and is not a fair, accurate, and complete presentation of the two
funds’ performance.
Answer: E
Standard III (D). Performance Presentation: when communicating investment performance
information, Members and Candidates must make reasonable efforts to ensure that it is fair,
accurate, and complete.
Q9. Read the following case study and select the correct answer.
McDermott is president of Enhanced Investment Strategies (EIS), a small investment firm.
Most clients of EIS are longtime associates of McDermott who have had their investment
portfolios with EIS for decades. Because of his close personal relationship with his clients,
McDermott is very familiar with their investment profile, income and retirement requirements,
and tolerance for risk. He keeps abreast of the life changing events (such as health issues,
real estate purchases, children’s university expenses, and retirement) of all his clients and
adjusts their portfolios accordingly. McDermott regularly meets with his clients in EIS offices
and sees them on numerous occasions outside the office where he has a chance to give them
an update on their investments. EIS clients complete a client agreement and risk profile when
opening their account and those profiles are updated as McDermott finds the time to do so.
McDermott’s business practices are
A. acceptable because he adjusts client investments to ensure that they are suitable for
client investment needs given changes in their income and risk profile.
B. acceptable because he regularly communicates with clients about their investments.
C. unacceptable because he does not keep written records regarding client investment
profiles and he does not update client records promptly.
D. unacceptable because his close personal relationship with clients will affect his
independence and objectivity when providing investment advice.
E. acceptable because the investment firm is small and he knows the clients and their
preferences very well.
Answer: C
McDermott only updates client records “when he finds the time to do so” and apparently not
promptly or on a regular basis. Hence, the issue in this case is record keeping (record
retention).
