Investing
Dante555
chpt_9-12_testbank.docxChapter 09
Interest Rates
Multiple Choice Questions
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1. |
Which one of the following is the interest rate that the largest commercial banks charge their most creditworthy corporate customers for short-term loans?
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2. |
Which one of the following terms applies to a rate that serves as an indicator of future trends?
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3. |
Which one of the following rates is the rate that banks charge each other for overnight loans of $1 million or more?
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4. |
Which one of the following rates is the rate a commercial bank must pay the Federal Reserve to borrow reserves overnight?
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5. |
Which one of the following rates is used by brokerage firms as the basis for determining margin loan rates?
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6. |
Which one of the following is unsecured debt issued by corporations on a short-term basis?
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7. |
A $100,000 or more term deposit at a bank is called which one of the following?
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8. |
Which one of the following describes a banker's acceptance?
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9. |
Which one of the following is defined as U.S. dollar-denominated deposits held in a foreign bank?
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10. |
Which one of the following abbreviations is the interest rate that international banks charge one another for overnight Eurodollar loans?
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11. |
Which one of the following is a short-term debt instrument issued by the U.S. Treasury?
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12. |
A pure discount security is an interest-bearing asset that pays:
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13. |
Which one of the following is a basis point?
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14. |
Which one of the following is the method used to quote interest rates on money market instruments?
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15. |
The Treasury yield curve is a graph which plots Treasury yields against which one of the following?
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16. |
Which one of the following is defined as the relationship between the interest rate on default-free, pure discount bonds and the time to maturity?
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17. |
Pure discount bonds which are created by separating the interest and principal payments from U.S. Treasury bonds are called U.S. Treasury:
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18. |
Which one of the following rates is the normally quoted rate?
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19. |
Which one of the following best describes a real interest rate?
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20. |
Which one of the following best describes the Fisher hypothesis?
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21. |
Which one of the following theories states that the term structure of interest rates reveals the financial market's projections of future interest rates?
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22. |
Which one of the following is defined as a forward rate?
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23. |
Which one of the following proposes that lenders must be financially rewarded for loaning funds on a long-term versus a short-term basis?
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24. |
The market segmentation theory states that interest rates on debt vary dependent upon market segments which are segmented based upon which one of the following?
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25. |
U.S. Treasury bill rates were the highest during which one of the following time periods?
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26. |
Which one of the following statements is correct concerning U.S. Treasury bill rates for the period 1800 - 2010?
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27. |
Banks are most apt to quote short-term loan rates as:
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28. |
Which one of the following rates is generally considered the bellwether rate for bank loans to business firms?
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29. |
City Bank needs a one-day reserve loan of $2.6 million from Country Bank. Which one of the following interest rates will be charged on this loan?
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30. |
First Bank needs to borrow money overnight from the Federal Reserve in order to meet its reserve requirements. Which one of the following interest rates will be charged on this loan?
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31. |
Which one of the following actions is the Federal Reserve most likely to take if it is concerned about a slowing economy?
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32. |
The rate which an investor pays a brokerage firm for a margin loan is based on a negotiated premium which is added to which one of the following rates?
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33. |
Assume that a large corporation, such as General Electric, needs money in the short-term. Which one of the following securities is that corporation most likely to issue to meet this need?
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34. |
Which one of the following statements is correct concerning large-denomination certificates of deposit?
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35. |
Which one of the following facilitates international trade?
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36. |
You notice that the interest rate on your credit card is set at LIBOR plus 8.9 percent. Given this, the rate you will pay is primarily influenced by the money market rates in which one of the following?
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37. |
Which one of the following is the largest market in the world for new debt securities with maturities of one year or less?
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38. |
The overnight repurchase rate is the rate charged on overnight loans which are collateralized by which one of the following securities?
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39. |
Which one of the following features applies to a U.S. Treasury bill?
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40. |
The market rate on a bond fell from 8.76 percent to 8.73 percent. This is a decline of how many basis points?
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41. |
Which one of the following is correct when computing the price of a debt security when using a discount yield?
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42. |
Which of the following will increase the price of a money market instrument computed using a discount yield? I. increase in discount yield II. decrease in discount yield III. increase in days to maturity IV. decrease in days to maturity
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43. |
Which one of the following is used by Treasury dealers to indicate the price they are willing to pay to purchase a Treasury bill?
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44. |
Which one of the following statements is correct concerning a Treasury bill?
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45. |
The bond equivalent yield adjusts for leap years by using 366 days starting with:
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46. |
Money market rates are generally one or the other of which two rates? I. bank discount rate II. bond equivalent rate III. annual percentage rate IV. effective annual rate
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47. |
Consider a money market instrument with 48 days to maturity and a quoted ask price of 99. Which two of the following statements are correct as they relate to this instrument? I. The bond equivalent yield is an effective annual rate. II. The bank discount rate is lower than the bond equivalent yield. III. The bank discount rate is an effective annual rate. IV. The bond equivalent yield is lower than the effective annual rate.
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48. |
Which two of the following are the largest categories of fixed-income securities in the U.S.? I. U.S. government debt II. corporate debt III. municipal government debt IV. real estate mortgage debt
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49. |
Which one of the following borrowers will pay the rates depicted on a Treasury yield curve?
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50. |
Which of the following statements are true as applied to U.S. agency debt? I. It is equally as risky as Treasury debt. II. It is frequently subject to state taxes. III. It has the same credit guarantee as U.S. Treasury debt. IV. It generally has a lower yield than U.S. Treasury debt with the same maturity.
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51. |
Which one of the following applies to "Yankee bonds"?
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52. |
Which one of the following statements is correct?
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53. |
Treasury STRIPS are:
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54. |
The approximate nominal interest rate is computed as the real rate:
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55. |
Which one of the following statements is correct?
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56. |
Which one of the following debt instruments guarantees investors a positive real rate of return?
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57. |
Inflation-indexed Treasury securities: I. adjust the principal amount on an annual basis. II. are default-free. III. offer a positive real rate of return. IV. have a variable coupon rate.
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58. |
Based on expectations theory, the term structure of interest rates will be _____ anytime investors believe that interest rates will be higher in the future than they are today.
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59. |
The variable f1,1 as used in the expectations theory is interpreted as the forward rate for one year:
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60. |
According to the expectations theory and the Fisher hypothesis, a downward-sloping term structure is indicative of which of the following based on market expectations? I. nominal interest rates are expected to increase II. nominal interest rates are expected to decline III. inflation rates are expected to increase IV. inflation rates are expected to decrease
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61. |
Which of the following statements are true? I. Lenders have a preference for shorter maturities. II. Lenders have a preference for longer maturities. III. Borrowers have a preference for shorter maturities. IV. Borrowers have a preference for longer maturities.
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62. |
Based solely on the maturity preference theory, long-term interest rates:
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63. |
Which one of the following statements concerning the modern fixed-income market is correct?
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64. |
Which of the following comprise the nominal interest rate on default-free securities according to the modern view of the term structure of interest rates? I. liquidity premium II. real rate III. interest rate risk premium IV. inflation premium
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65. |
Modern term structure theory supports the contention that the term structure of interest rates will:
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66. |
You want to purchase a security that will pay you $1,000 seven years from now. If you want to earn an annual nominal rate of 6.5 percent, how much should you pay for this investment today?
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67. |
You invest $3,600 today at a nominal annual rate of 5.5 percent. This investment will pay one payment five years from now. What will be the amount of that payment?
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68. |
An investment will make one payment of $22,500 nine years from now. What is the current value of this investment if the nominal rate of return is 4.8 percent?
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69. |
A $1,000 face value, 120-day bond is quoted at a bank discount yield of 3.38 percent. What is the current bond price?
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70. |
A bond has a face value of $30,000 and matures in 62 days. What is the bank discount yield if the bond is currently selling for $29,750?
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71. |
A $5,000 face value bond is quoted at a bank discount yield of 2.8 percent. What is the current value of the bond if it matures in 36 days?
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72. |
A $40,000 face value bond matures in 64 days and has a bank discount yield of 4.5 percent. What is the current value of the bond?
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73. |
A Treasury bill has 21 days to maturity and a bank discount yield of 1.89 percent. What is the bond equivalent yield?
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74. |
A Treasury bill is quoted at a bank discount yield of 1.21 percent and has 15 days to maturity. What is the bond equivalent yield given that this is a leap year?
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75. |
What is the bond equivalent yield on a 30-day Treasury bill that has a bank discount yield of 2.01 percent?
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76. |
A Treasury bill has a face value of $250,000, an asked yield of 2.02 percent, and matures in 32 days. What is the price of this bill?
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77. |
A Treasury bill has a face value of $100,000, a price of $99,797.12, and matures in 35 days. What is the asked yield?
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78. |
A Treasury bill has a face value of $75,000, an asked yield of 3.05 percent, and matures in 35 days. What is the price of this bill?
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79. |
Your credit card has an annual percentage rate of 18.9 percent and compounds interest daily. What is the effective annual rate?
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80. |
A Treasury bill matures in 68 days and has a bond equivalent yield of 4.05 percent. What is the effective annual rate?
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81. |
A Treasury bill matures in 81 days and has a bond equivalent yield of 2.79 percent. What is the effective annual rate?
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82. |
A Treasury bill has 40 days left to maturity. The bank discount yield on the bill is 3.75 percent. What is the effective annual rate?
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83. |
A 90-day Treasury bill has a bank discount yield of 4.2 percent. What is the effective annual rate?
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84. |
A $50,000 face value STRIPS is quoted at 94.300. What is the dollar price?
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85. |
What is the current value of a $5,000 face value STRIPS with 6 years to maturity and a yield to maturity of 8.1 percent?
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86. |
A $50,000 face value STRIPS matures in 12 years and has a yield to maturity of 6.50 percent. What is the current dollar price of this security?
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87. |
A $5,000 face value STRIPS matures in 7 years and is currently quoted at a price of 64.238. What is the yield-to-maturity?
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88. |
A $20,000 face value STRIPS is currently quoted at 38.642 and has 8 years to maturity. What is the yield-to-maturity?
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89. |
A bond has a nominal rate of return of 5.87 percent and the inflation rate is 4.13 percent. What is the approximate real rate?
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90. |
You want to earn a real rate of return of 3.64 percent at a time when the inflation rate is 2.84 percent. What is the approximate nominal rate which you must earn?
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91. |
The one-year interest rate is 4.80 percent and the two-year interest rate is 5.13 percent. What is the one year interest rate one year from now? Assume the rates are effective annual rates.
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92. |
What is the one year interest rate one year from now if the current one-year interest rate is 2.55 percent and the two-year interest rate is 3.15 percent? Assume the rates are effective annual rates.
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93. |
A one-year STRIPS sells at an interest rate of 3.54 percent and a two-year STRIPS sells at an interest rate of 3.49 percent. What is the implied one year forward rate? Assume the rates are effective annual rates.
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94. |
A two-year STRIPS sells at an interest rate of 3.84 percent and a three-year STRIPS sells at a rate of 3.97 percent. What is the implied one year interest rate two years from now? Assume the rates are effective annual rates.
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95. |
The following premiums apply to a 3-month bond: interest rate risk premium = 0.2 percent; real return = 1.9 percent; default premium = 0.8 percent; inflation premium = 1.4 percent. What is the expected nominal interest rate on a default-free security that has 3 months to maturity?
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96. |
The following premiums apply to a 8-month bond: interest rate risk premium = 0.32 percent; liquidity premium = 0.44 percent; default premium = 1.23 percent; inflation premium = 3.12 percent; real rate = 3.20 percent. What is the expected nominal interest rate on a 8-month risky security given these values?
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97. |
The following premiums apply to a 6-month bond: interest rate risk premium = 0.22 percent; real rate = 3.50 percent; default premium = 0.12 percent; inflation premium = 1.45 percent. What is the expected difference in nominal interest rates between a 6-month risky security and a 6-month, default-free security?
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Essay Questions
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98. |
Identify and describe five interest rates that directly apply to the money market.
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99. |
Write a short paragraph comparing a bank discount rate to a bond equivalent rate.
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100. |
Identify and describe four of the six components of nominal interest rates as supported by modern term structure theory.
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Chapter 09 Interest Rates Answer Key
Multiple Choice Questions
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1. |
Which one of the following is the interest rate that the largest commercial banks charge their most creditworthy corporate customers for short-term loans?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Prime Rate |
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2. |
Which one of the following terms applies to a rate that serves as an indicator of future trends?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Bellwether Rate |
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3. |
Which one of the following rates is the rate that banks charge each other for overnight loans of $1 million or more?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Federal Funds Rate |
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4. |
Which one of the following rates is the rate a commercial bank must pay the Federal Reserve to borrow reserves overnight?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Discount Rate |
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5. |
Which one of the following rates is used by brokerage firms as the basis for determining margin loan rates?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Call Money Rate |
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6. |
Which one of the following is unsecured debt issued by corporations on a short-term basis?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Commercial Paper |
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7. |
A $100,000 or more term deposit at a bank is called which one of the following?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Certificate of Deposit |
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8. |
Which one of the following describes a banker's acceptance?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Banker's Acceptance |
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9. |
Which one of the following is defined as U.S. dollar-denominated deposits held in a foreign bank?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Eurodollars |
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10. |
Which one of the following abbreviations is the interest rate that international banks charge one another for overnight Eurodollar loans?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: London Interbank Offered Rate |
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11. |
Which one of the following is a short-term debt instrument issued by the U.S. Treasury?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: U.S. Treasury Bill |
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12. |
A pure discount security is an interest-bearing asset that pays:
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Pure Discount Security |
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13. |
Which one of the following is a basis point?
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Basis Point |
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14. |
Which one of the following is the method used to quote interest rates on money market instruments?
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bank Discount Basis |
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15. |
The Treasury yield curve is a graph which plots Treasury yields against which one of the following?
See Section 9.3. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-02 Rates and yields on fixed-income securities. Level of Difficulty: 1 Easy Section: 9.3 Topic: Treasury Yield Curve |
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16. |
Which one of the following is defined as the relationship between the interest rate on default-free, pure discount bonds and the time to maturity?
See Section 9.4. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-02 Rates and yields on fixed-income securities. Level of Difficulty: 1 Easy Section: 9.4 Topic: Term Structure of Interest Rates |
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17. |
Pure discount bonds which are created by separating the interest and principal payments from U.S. Treasury bonds are called U.S. Treasury:
See Section 9.4. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.4 Topic: U.S. Treasury Strips |
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18. |
Which one of the following rates is the normally quoted rate?
See Section 9.5. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.5 Topic: Nominal Interest Rates |
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19. |
Which one of the following best describes a real interest rate?
See Section 9.5. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.5 Topic: Real Interest Rates |
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20. |
Which one of the following best describes the Fisher hypothesis?
See Section 9.5. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.5 Topic: Fisher Hypothesis |
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21. |
Which one of the following theories states that the term structure of interest rates reveals the financial market's projections of future interest rates?
See Section 9.6. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.6 Topic: Expectations Theory |
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22. |
Which one of the following is defined as a forward rate?
See Section 9.6. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.6 Topic: Forward Rate |
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23. |
Which one of the following proposes that lenders must be financially rewarded for loaning funds on a long-term versus a short-term basis?
See Section 9.6. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.6 Topic: Maturity Preference Theory |
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24. |
The market segmentation theory states that interest rates on debt vary dependent upon market segments which are segmented based upon which one of the following?
See Section 9.6. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.6 Topic: Market Segmentation Theory |
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25. |
U.S. Treasury bill rates were the highest during which one of the following time periods?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Historical Interest Rates |
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26. |
Which one of the following statements is correct concerning U.S. Treasury bill rates for the period 1800 - 2010?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Historical Interest Rates |
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27. |
Banks are most apt to quote short-term loan rates as:
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Prime Rate |
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28. |
Which one of the following rates is generally considered the bellwether rate for bank loans to business firms?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Bellwether Rate |
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29. |
City Bank needs a one-day reserve loan of $2.6 million from Country Bank. Which one of the following interest rates will be charged on this loan?
See Section 9.1. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Federal Funds Rate |
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30. |
First Bank needs to borrow money overnight from the Federal Reserve in order to meet its reserve requirements. Which one of the following interest rates will be charged on this loan?
See Section 9.1. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Discount Rate |
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31. |
Which one of the following actions is the Federal Reserve most likely to take if it is concerned about a slowing economy?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Discount Rate |
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32. |
The rate which an investor pays a brokerage firm for a margin loan is based on a negotiated premium which is added to which one of the following rates?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Call Money Rate |
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33. |
Assume that a large corporation, such as General Electric, needs money in the short-term. Which one of the following securities is that corporation most likely to issue to meet this need?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Commercial Paper |
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34. |
Which one of the following statements is correct concerning large-denomination certificates of deposit?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Certificate of Deposit |
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35. |
Which one of the following facilitates international trade?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Banker's Acceptance |
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36. |
You notice that the interest rate on your credit card is set at LIBOR plus 8.9 percent. Given this, the rate you will pay is primarily influenced by the money market rates in which one of the following?
See Section 9.1. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: London Interbank Offered Rate |
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37. |
Which one of the following is the largest market in the world for new debt securities with maturities of one year or less?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: T-Bill |
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38. |
The overnight repurchase rate is the rate charged on overnight loans which are collateralized by which one of the following securities?
See Section 9.1. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Overnight Repurchase Rate |
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39. |
Which one of the following features applies to a U.S. Treasury bill?
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-02 Rates and yields on fixed-income securities. Level of Difficulty: 1 Easy Section: 9.2 Topic: Pure Discount Security |
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40. |
The market rate on a bond fell from 8.76 percent to 8.73 percent. This is a decline of how many basis points?
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-02 Rates and yields on fixed-income securities. Level of Difficulty: 1 Easy Section: 9.2 Topic: Basis Point |
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41. |
Which one of the following is correct when computing the price of a debt security when using a discount yield?
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-02 Rates and yields on fixed-income securities. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bank Discount Yield |
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42. |
Which of the following will increase the price of a money market instrument computed using a discount yield? I. increase in discount yield II. decrease in discount yield III. increase in days to maturity IV. decrease in days to maturity
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-02 Rates and yields on fixed-income securities. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bank Discount Yield |
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43. |
Which one of the following is used by Treasury dealers to indicate the price they are willing to pay to purchase a Treasury bill?
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bid Discount |
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44. |
Which one of the following statements is correct concerning a Treasury bill?
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Asked Yield |
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45. |
The bond equivalent yield adjusts for leap years by using 366 days starting with:
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bond Equivalent Yield |
|
46. |
Money market rates are generally one or the other of which two rates? I. bank discount rate II. bond equivalent rate III. annual percentage rate IV. effective annual rate
See Section 9.2. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 2 Medium Section: 9.2 Topic: Money Market Rates |
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47. |
Consider a money market instrument with 48 days to maturity and a quoted ask price of 99. Which two of the following statements are correct as they relate to this instrument? I. The bond equivalent yield is an effective annual rate. II. The bank discount rate is lower than the bond equivalent yield. III. The bank discount rate is an effective annual rate. IV. The bond equivalent yield is lower than the effective annual rate.
See Section 9.2. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 2 Medium Section: 9.2 Topic: Rates |
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48. |
Which two of the following are the largest categories of fixed-income securities in the U.S.? I. U.S. government debt II. corporate debt III. municipal government debt IV. real estate mortgage debt
See Section 9.3. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-02 Rates and yields on fixed-income securities. Level of Difficulty: 1 Easy Section: 9.3 Topic: Fixed-Income Securities |
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49. |
Which one of the following borrowers will pay the rates depicted on a Treasury yield curve?
See Section 9.3. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.3 Topic: Treasury Yield Curve |
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50. |
Which of the following statements are true as applied to U.S. agency debt? I. It is equally as risky as Treasury debt. II. It is frequently subject to state taxes. III. It has the same credit guarantee as U.S. Treasury debt. IV. It generally has a lower yield than U.S. Treasury debt with the same maturity.
See Section 9.3. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-02 Rates and yields on fixed-income securities. Level of Difficulty: 1 Easy Section: 9.3 Topic: Agency Debt |
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51. |
Which one of the following applies to "Yankee bonds"?
See Section 9.3. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-02 Rates and yields on fixed-income securities. Level of Difficulty: 1 Easy Section: 9.3 Topic: Yankee Bonds |
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52. |
Which one of the following statements is correct?
See Section 9.4. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.4 Topic: Term Structure |
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53. |
Treasury STRIPS are:
See Section 9.4. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.4 Topic: Treasury Strips |
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54. |
The approximate nominal interest rate is computed as the real rate:
See Section 9.5. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.5 Topic: Real Interest Rates |
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55. |
Which one of the following statements is correct?
See Section 9.5. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.5 Topic: Interest Rate |
|
56. |
Which one of the following debt instruments guarantees investors a positive real rate of return?
See Section 9.5. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.5 Topic: Inflation-Indexed Treasuries |
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57. |
Inflation-indexed Treasury securities: I. adjust the principal amount on an annual basis. II. are default-free. III. offer a positive real rate of return. IV. have a variable coupon rate.
See Section 9.5. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.5 Topic: Inflation-Indexed Securities |
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58. |
Based on expectations theory, the term structure of interest rates will be _____ anytime investors believe that interest rates will be higher in the future than they are today.
See Section 9.6. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.6 Topic: Expectations Theory |
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59. |
The variable f1,1 as used in the expectations theory is interpreted as the forward rate for one year:
See Section 9.6. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.6 Topic: Expectations Theory |
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60. |
According to the expectations theory and the Fisher hypothesis, a downward-sloping term structure is indicative of which of the following based on market expectations? I. nominal interest rates are expected to increase II. nominal interest rates are expected to decline III. inflation rates are expected to increase IV. inflation rates are expected to decrease
See Section 9.6. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.6 Topic: Expectations and Fisher |
|
61. |
Which of the following statements are true? I. Lenders have a preference for shorter maturities. II. Lenders have a preference for longer maturities. III. Borrowers have a preference for shorter maturities. IV. Borrowers have a preference for longer maturities.
See Section 9.6. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.6 Topic: Maturity Preference Theory |
|
62. |
Based solely on the maturity preference theory, long-term interest rates:
See Section 9.6. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.6 Topic: Maturity Preference Theory |
|
63. |
Which one of the following statements concerning the modern fixed-income market is correct?
See Section 9.7. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.7 Topic: Fixed-Income Market |
|
64. |
Which of the following comprise the nominal interest rate on default-free securities according to the modern view of the term structure of interest rates? I. liquidity premium II. real rate III. interest rate risk premium IV. inflation premium
See Section 9.7. |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.7 Topic: Modern Term Structure Theory |
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65. |
Modern term structure theory supports the contention that the term structure of interest rates will:
See Section 9.7. |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.7 Topic: Modern Term Structure Theory |
|
66. |
You want to purchase a security that will pay you $1,000 seven years from now. If you want to earn an annual nominal rate of 6.5 percent, how much should you pay for this investment today?
|
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Blooms: Apply Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Time Value of Money |
|
67. |
You invest $3,600 today at a nominal annual rate of 5.5 percent. This investment will pay one payment five years from now. What will be the amount of that payment?
|
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Blooms: Apply Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Time Value of Money |
|
68. |
An investment will make one payment of $22,500 nine years from now. What is the current value of this investment if the nominal rate of return is 4.8 percent?
|
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Blooms: Apply Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.1 Topic: Time Value of Money |
|
69. |
A $1,000 face value, 120-day bond is quoted at a bank discount yield of 3.38 percent. What is the current bond price?
|
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Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bank Discount Yield |
|
70. |
A bond has a face value of $30,000 and matures in 62 days. What is the bank discount yield if the bond is currently selling for $29,750?
|
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Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bank Discount Yield |
|
71. |
A $5,000 face value bond is quoted at a bank discount yield of 2.8 percent. What is the current value of the bond if it matures in 36 days?
|
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Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bank Discount Yield |
|
72. |
A $40,000 face value bond matures in 64 days and has a bank discount yield of 4.5 percent. What is the current value of the bond?
|
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Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bank Discount Yield |
|
73. |
A Treasury bill has 21 days to maturity and a bank discount yield of 1.89 percent. What is the bond equivalent yield?
|
|
Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bond Equivalent Yield |
|
74. |
A Treasury bill is quoted at a bank discount yield of 1.21 percent and has 15 days to maturity. What is the bond equivalent yield given that this is a leap year?
|
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Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bond Equivalent Yield |
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75. |
What is the bond equivalent yield on a 30-day Treasury bill that has a bank discount yield of 2.01 percent?
|
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Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bond Equivalent Yield |
|
76. |
A Treasury bill has a face value of $250,000, an asked yield of 2.02 percent, and matures in 32 days. What is the price of this bill?
|
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Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bill Price |
|
77. |
A Treasury bill has a face value of $100,000, a price of $99,797.12, and matures in 35 days. What is the asked yield?
|
|
Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Asked Yield |
|
78. |
A Treasury bill has a face value of $75,000, an asked yield of 3.05 percent, and matures in 35 days. What is the price of this bill?
|
|
Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Bill Price |
|
79. |
Your credit card has an annual percentage rate of 18.9 percent and compounds interest daily. What is the effective annual rate?
|
|
Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Effective Annual Rate |
|
80. |
A Treasury bill matures in 68 days and has a bond equivalent yield of 4.05 percent. What is the effective annual rate?
|
|
Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Effective Annual Rate |
|
81. |
A Treasury bill matures in 81 days and has a bond equivalent yield of 2.79 percent. What is the effective annual rate?
|
|
Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 1 Easy Section: 9.2 Topic: Effective Annual Rate |
|
82. |
A Treasury bill has 40 days left to maturity. The bank discount yield on the bill is 3.75 percent. What is the effective annual rate?
|
|
Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 2 Medium Section: 9.2 Topic: Effective Annual Rate |
|
83. |
A 90-day Treasury bill has a bank discount yield of 4.2 percent. What is the effective annual rate?
|
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Blooms: Apply Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 2 Medium Section: 9.2 Topic: Effective Annual Rate |
|
84. |
A $50,000 face value STRIPS is quoted at 94.300. What is the dollar price?
Price = $50,000 × .9430 = $47,150.00 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.4 Topic: Strips Quote |
|
85. |
What is the current value of a $5,000 face value STRIPS with 6 years to maturity and a yield to maturity of 8.1 percent?
|
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Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.4 Topic: Strips Price |
|
86. |
A $50,000 face value STRIPS matures in 12 years and has a yield to maturity of 6.50 percent. What is the current dollar price of this security?
|
|
Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.4 Topic: Strips Price |
|
87. |
A $5,000 face value STRIPS matures in 7 years and is currently quoted at a price of 64.238. What is the yield-to-maturity?
|
|
Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.4 Topic: Strips Ytm |
|
88. |
A $20,000 face value STRIPS is currently quoted at 38.642 and has 8 years to maturity. What is the yield-to-maturity?
|
|
Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.4 Topic: Strips Ytm |
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89. |
A bond has a nominal rate of return of 5.87 percent and the inflation rate is 4.13 percent. What is the approximate real rate?
Approximate real rate = .0587 - .0413 = 1.74 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.5 Topic: Real Interest Rates |
|
90. |
You want to earn a real rate of return of 3.64 percent at a time when the inflation rate is 2.84 percent. What is the approximate nominal rate which you must earn?
Approximate nominal rate = .0364 + .0284 = 6.48 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-04 Nominal versus real interest rates. Level of Difficulty: 1 Easy Section: 9.5 Topic: Nominal Interest Rates |
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91. |
The one-year interest rate is 4.80 percent and the two-year interest rate is 5.13 percent. What is the one year interest rate one year from now? Assume the rates are effective annual rates.
(1 + .0513)2 = (1 + .048)(1 + f1,1) f1,1 = 5.46 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 2 Medium Section: 9.6 Topic: Forward Rate |
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92. |
What is the one year interest rate one year from now if the current one-year interest rate is 2.55 percent and the two-year interest rate is 3.15 percent? Assume the rates are effective annual rates.
(1 + .0315)2 = (1 + .0255)(1 + f1,1) f1,1 = 3.75 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 2 Medium Section: 9.6 Topic: Forward Rate |
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93. |
A one-year STRIPS sells at an interest rate of 3.54 percent and a two-year STRIPS sells at an interest rate of 3.49 percent. What is the implied one year forward rate? Assume the rates are effective annual rates.
(1 + .0349)2 = (1 + .0354)(1 + f1,1) f1,1 = 3.44 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 2 Medium Section: 9.6 Topic: Forward Rate |
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94. |
A two-year STRIPS sells at an interest rate of 3.84 percent and a three-year STRIPS sells at a rate of 3.97 percent. What is the implied one year interest rate two years from now? Assume the rates are effective annual rates.
(1 + .0397)3 = (1 + .0384)2(1 + f2,1) F2,1 = 4.23 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 2 Medium Section: 9.6 Topic: Forward Rate |
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95. |
The following premiums apply to a 3-month bond: interest rate risk premium = 0.2 percent; real return = 1.9 percent; default premium = 0.8 percent; inflation premium = 1.4 percent. What is the expected nominal interest rate on a default-free security that has 3 months to maturity?
Default-free nominal return = .019 + .014 = 3.3 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.7 Topic: Modern Term Structure Theory |
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96. |
The following premiums apply to a 8-month bond: interest rate risk premium = 0.32 percent; liquidity premium = 0.44 percent; default premium = 1.23 percent; inflation premium = 3.12 percent; real rate = 3.20 percent. What is the expected nominal interest rate on a 8-month risky security given these values?
Risky nominal return = .0032 + .0044 + .0123 + .0312 + .0320 = 8.31 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.7 Topic: Modern Term Structure Theory |
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97. |
The following premiums apply to a 6-month bond: interest rate risk premium = 0.22 percent; real rate = 3.50 percent; default premium = 0.12 percent; inflation premium = 1.45 percent. What is the expected difference in nominal interest rates between a 6-month risky security and a 6-month, default-free security?
Difference = 0.12 percent |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 1 Easy Section: 9.7 Topic: Modern Term Structure Theory |
Essay Questions
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98. |
Identify and describe five interest rates that directly apply to the money market. Answer will vary Feedback: Students can select any five of the following: Discount rate: rate the Federal Reserve charges banks for overnight reserve loans. Federal funds rate: rate banks charge other banks for overnight loans of $1 million or more. Prime rate: rate the largest banks charge their most creditworthy corporate customers for short-term loans. Call money rate: rate banks charge brokerage houses for call money loans. Commercial paper rate: rate on short-term, unsecured debt issued by large corporations. CD rate: rate banks pay on large-denomination deposits. Bankers' acceptance rate: rate on acceptances issued by the largest commercial banks. Eurodollar rate: rate paid on large-denomination Eurodollar CDs. LIBOR rate: rate paid by London banks for dollar deposits from other banks. T-bill rate: rate paid on U.S. Treasury securities issued for one year or less. |
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Blooms: Understand Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 2 Medium Section: 9.1 Topic: Discount, Prime, and Fed Funds Rates |
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99. |
Write a short paragraph comparing a bank discount rate to a bond equivalent rate. Answer will vary Feedback: A bank discount rate is based on a 360-day year and ignores compounding during the year. Money market securities are generally quoted on a bank discount basis. The bond equivalent yield (BEY) is based on either a 365 or a 366-day year. The BEY is an APR and thus, also ignores the compounding of interest. |
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Blooms: Understand Learning Objective: 09-01 Money market prices and rates. Level of Difficulty: 2 Medium Section: 9.2 Topic: Bank Discount Rate and Bond Equivalent Rate |
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100. |
Identify and describe four of the six components of nominal interest rates as supported by modern term structure theory. Answer will vary Feedback: Students should identify and describe four of the following: Real interest rate: the after-inflation rate of return Inflation premium: the additional return which is paid to offset anticipated inflation during the period Interest rate risk premium: compensation for the market volatility of interest rates over time Default risk premium: compensation for the possibility that either the interest or the principal, or both, may not be paid as agreed Liquidity premium: compensation for the inability to sell a security quickly at full value Taxability premium: premium paid on taxable bonds The nominal return on default-free securities includes the real interest rate, the inflation premium, and the interest rate risk premium. The default risk premium and the liquidity premium are added to the default-free premium to compute the nominal return on a risky security. The taxability premium is applied to securities which pay taxable interest. |
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Blooms: Understand Learning Objective: 09-03 Treasury STRIPS and the term structure of interest rates. Level of Difficulty: 2 Medium Section: 9.7 Topic: Modern Term Structure Theory |
Chapter 10
Bond Prices and Yields
Multiple Choice Questions
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1. |
Which one of the following is the correct definition of a coupon rate?
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2. |
What is the annual interest divided by the market price of a bond called?
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3. |
The yield to maturity is the:
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4. |
A premium bond is defined as a bond that:
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5. |
A discount bond:
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6. |
The price of a bond, net of accrued interest, is referred to as the bond's:
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7. |
The dirty price of a bond is the:
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8. |
A callable bond:
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9. |
Which one of the following does an issuer pay to redeem a bond prior to maturity?
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10. |
Which one of the following prices is equal to the present value of a bond's future cash flows and is paid when a bond is redeemed prior to maturity?
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11. |
An issuer has a bond outstanding that matures in 18 years. Which one of the following prevents the issuer from buying back that bond today?
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12. |
The yield that a bond will earn given that it is bought back by the issuer at the earliest possible date is the:
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13. |
Which one of the following is the risk that market interest rates may increase causing the price of a bond to decline?
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14. |
The rate of return an investor actually earns from owning a bond is called which one of the following?
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15. |
Which one of the following measures a bond's sensitivity to changes in market interest rates?
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16. |
A change in a bond's price caused by which one of the following is defined as the dollar value of an 01?
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17. |
The yield value of a 32nd is the change needed in which one of the following to cause a bond's price to change by 1/32nd?
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18. |
A dedicated portfolio is a bond portfolio created to:
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19. |
Which one of the following risks is associated with investing a coupon payment at a rate that is lower than the bond's yield-to-maturity?
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20. |
Which one of the following involves creating a portfolio in a manner which minimizes the uncertainty of the portfolio's maturity target date value?
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21. |
Price risk is the risk that:
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22. |
Periodically rebalancing a portfolio so that the duration continues to match the target date is called:
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23. |
A basic bond that has a face value of $1,000 and pays regular semiannual coupon payments is referred to as which one of the following?
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24. |
Which of the following will increase if the coupon rate increases? I. face value II. market value III. yield-to-maturity IV. current yield
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25. |
Which one of the following will decrease the current yield of a bond?
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26. |
Which one of the following will occur if a bond's discount rate is lowered?
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27. |
Which one of the following statements is correct concerning premium bonds?
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28. |
Which one of the following statements is correct concerning discount bonds?
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29. |
Which one of the following statements applies to a par value bond?
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30. |
Assuming there is no default risk, both a premium bond and a discount bond must share which one of the following characteristics?
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31. |
A bond has a current yield that is equal to the yield-to-maturity. Given this, which one of the following must also be true?
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32. |
For a premium bond, the:
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33. |
Davis Industrial bonds have a current market price of $990 and a 6 percent coupon. The bonds pay interest semi-annually on March 1 and September 1. Assume today is January 1. How many months of accrued interest are included in the dirty price of these bonds?
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34. |
A bond pays interest semiannually on February 1 and August 1. Assume today is October 1. How many months of accrued interest are included in the clean price of this bond?
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35. |
The yield-to-maturity assumes which one of the following?
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36. |
Which one of the following increases the probability that a bond will be called?
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37. |
Which one of the following statements is correct concerning a callable bond that is currently selling below face value? Assume there is no risk of default. Also assume the issuer only calls bonds when they can be refinanced at a lower rate of interest.
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38. |
Which one of the following statements is correct?
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39. |
According to Malkiel's theorems, bond prices and bond yields are:
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40. |
Which combination of bond characteristics causes a bond to be most sensitive to changes in market interest rates? I. low coupon rates II. high coupon rates III. short time to maturity IV. long time to maturity
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41. |
How does the size of the change in a bond's price react in response to a given change in the yield to maturity as the time to maturity increases?
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42. |
Which one of the following statements is correct according to Malkiel's Theorems?
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43. |
Which one of the following must be equal for two bonds if they are to have similar changes in their prices given a relatively small change in bond yields?
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44. |
All else constant, which of the following will decrease the Macaulay duration of a straight bond? I. reducing the coupon payment II. shortening the time to maturity III. lowering the yield to maturity
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45. |
Which one of the following statements is correct concerning Macaulay duration?
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46. |
The modified duration:
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47. |
To immunize your portfolio, you should:
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48. |
Last year, you created an immunized portfolio with an average maturity date of 14.5 years, a yield-to-maturity of 9.8 percent, and a duration of 9.6 years. According to the policy of dynamic immunization, you should now modify your portfolio in which one of the following ways?
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49. |
Dynamic immunization is primarily aimed at reducing which one of the following risks?
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50. |
A bond pays semiannual interest payments of $42.50. What is the coupon rate if the par value is $1,000?
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51. |
A bond has a face value of $1,000 and a coupon rate of 5.5 percent. What is your annual interest payment if you own 8 of these bonds?
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52. |
A bond has a par value of $1,000 and a coupon rate of 6.5 percent. What is the dollar amount of each semiannual interest payment if you own 8 of these bonds?
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53. |
A bond has a par value of $1,000, a market price of $1,012, and a coupon rate of 5.75 percent. What is the current yield?
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54. |
A 5.5 percent coupon bond has a face value of $1,000 and a current yield of 5.64 percent. What is the current market price?
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55. |
A bond has 8 years to maturity, a 7 percent coupon, a $1,000 face value, and pays interest semiannually. What is the bond's current price if the yield to maturity is 6.91 percent?
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56. |
The Country Inn has bonds outstanding with a par value of $1,000 each and a 6.6 percent coupon. The bonds mature in 7.5 years and pay interest semiannually. What is the current value of each of these bonds if the yield to maturity is 6.8 percent?
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57. |
Last year, BT Motors issued 10-year bonds with a 9 percent coupon and semi-annual interest payments. What is the market price of a $1,000 bond if the yield to maturity is 8.9 percent?
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58. |
A $1,000 face value bond matures in 11 years, pays interest semiannually, and has a 6.5 percent coupon. The bond currently sells for $1,025. What is the yield to maturity?
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59. |
A $1,000 par value 5 percent Treasury bond pays interest semiannually and matures in 7.5 years. What is the yield to maturity if the bond is currently quoted at a price of 112.34?
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60. |
A $1,000 semiannual coupon bond matures in 15 years, has a coupon rate of 7.5 percent, and a market price of $982. What is the yield to maturity?
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61. |
An 8.5 percent coupon bond pays interest semiannually and has 10.5 years to maturity. The bond has a face value of $1,000 and a market value of $878.50. What is the yield to maturity?
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62. |
A $1,000 par value bond is currently valued at $1,037.84. The bond pays interest semi-annually, has 7 years to maturity, and has a yield to maturity of 7.3 percent. The coupon rate is _____ percent and the current yield is _____ percent.
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63. |
A $1,000 face value bond is selling for $1,016.36. The bond pays interest semiannually and has 3.5 years to maturity. The yield to maturity is 5.48 percent. The current yield is _____ percent and the coupon rate is _____ percent.
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64. |
The outstanding bonds of International Plastics mature in 6 years and pay semiannual interest payments of $33.50 on a $1,000 face value bond. The bonds are currently selling for $1,008.64. The coupon rate is _____ percent, the current yield is _____ percent, and the yield to maturity is _____ percent.
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65. |
A bond has a $1,000 par value, semiannual interest payments of $40, and a current market value of $1,054. The bonds mature in 12.5 years. The coupon rate is _____ percent, the current yield is _____ percent, and the yield to maturity is _____ percent.
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66. |
Alaskan Motors has outstanding bonds that mature in 13 years and pay $34.50 every 6 months in interest. The par value is $1,000 per bond and the market value is $990. The coupon rate is _____ percent, the current yield is _____ percent, and the yield to maturity is _____ percent.
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67. |
You are considering two bonds. Both have semi-annual, 8 percent coupons, $1,000 face values, and yields to maturity of 7.5 percent. Bond S matures in 4 years and Bond L matures in 8 years. What is the difference in the current prices of these bonds?
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68. |
Two bonds have a coupon rate of 6.5 percent, semi-annual payments, face values of $1,000, and yields to maturity of 7.1 percent. Bond S matures in 6 years and bond L matures in 12 years. What is the difference in the current prices of these bonds?
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69. |
You want to buy a bond that has a quoted price of $923. The bond pays interest semiannually on April 1 and October 1. The coupon rate is 6 percent. What is the clean price of this bond if today's date is June 1? Assume a 360-day year.
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70. |
You are buying a bond at a quoted price of $892. The bond has a 7.5 percent coupon and pays interest semiannually on February 1 and August 1. What is the dirty price of this bond if today is April 1? Assume a 360-day year.
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71. |
Green Roofing Materials has 7.5 percent bonds outstanding that are currently priced at $1,068 each. The bonds pay interest on December 1 and June 1. What is the dirty price of this bond if today's date is May 1? Assume a 360-day year.
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72. |
You own a bond that pays semiannual interest payments of $38. The bond is callable in 2 years at a premium of $76. What is the callable bond price if the yield to call is 7.9 percent?
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73. |
Ted owns a bond which is callable in 2.5 years. The bond has a 6 percent coupon, pays interest semiannually, has a par value of $1,000, and has a yield to call of 6.3 percent. What is the call premium if the bond currently sells for $1,044.54?
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74. |
Cochran's Furniture Outlet is issuing 25-year, 9 percent callable bonds. These bonds are callable in 4 years with a call premium of $45. The bonds are being issued at par and pay interest semi-annually. What is the yield to call?
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75. |
Blue Water Homes has 8 percent bonds outstanding that mature in 13 years. The bonds pay interest semiannually. These bonds have a par value of $1,000 and are callable in 2 years at a premium of $75. What is the yield to call if the current price is equal to 103.25 percent of par?
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76. |
Will owns a bond with a make-whole call provision. The bond matures in 13 years but is being called today. The coupon rate is 8.25 percent with interest paid semiannually. What is the current call price if the applicable discount rate is 7.75 percent and the make-whole call provision applies?
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77. |
Ferrous Metals has bonds outstanding which it is calling today under the make-whole call provision. The bonds mature in 6 years, have a 10 percent coupon, pay interest semiannually, and have a par value of $1,000. What is today's call price given that the applicable discount rate is 7.20 percent?
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78. |
Alex purchased a $1,000 par value bond one year ago at a price of $1,016. At the time of purchase, the bond had 12 years to maturity and a 5 percent, semiannual coupon. Today, the bond has a yield to maturity of 5.25 percent. What is his realized yield as of today?
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79. |
One year ago, you purchased a $1,000 face value bond at a yield to maturity of 9.45 percent. The bond has a 9 percent coupon and pays interest semiannually. When you purchased the bond, it had 12 years left until maturity. You are selling the bond today when the yield to maturity is 8.20 percent. What is your realized yield on this bond?
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80. |
You own a 6.5 percent, semiannual coupon bond that matures in 7 years. The par value is $1,000 and the current yield to maturity is 6.8 percent. What will the percentage change in the price of your bond be if the yield to maturity suddenly increases by 75 basis points?
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81. |
Phil owns a 7 percent, semiannual coupon bond that has a face value of $1,000 and matures in 16 years. The bond has a current yield to maturity of 7.1 percent. What will the percentage change in the price of his bond be if interest rates decrease by 50 basis points?
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82. |
A $1,000 face value bond has a 9.0 percent coupon and pays interest semiannually. The bond matures in 2 years and has a yield to maturity of 6.5 percent. What is the Macaulay duration?
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83. |
A zero-coupon bond has a par value of $1,000 and matures in 4.5 years. The yield to maturity is 6.4 percent. What is the Macaulay duration?
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84. |
A bond has a Macaulay duration of 6.25 years. What will be the percentage change in the bond price if the yield to maturity increases from 6 percent to 6.4 percent?
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85. |
The price of a bond decreased by 1.45 percent in response to an increase in the yield to maturity from 7.2 to 7.6 percent. What is the bond's Macaulay duration?
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86. |
A bond has a Macaulay duration of 5.5, a yield to maturity of 6.1 percent, a coupon rate of 7.0 percent, and semiannual interest payments. What is the bond's modified duration?
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87. |
A 6 percent, semiannual coupon bond has a yield to maturity of 7.4 percent and a Macaulay duration of 5.7. The bond has a modified duration of _____ and will have a _____ percentage increase in price in response to a 25 basis point decrease in the yield to maturity.
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88. |
A bond has a modified duration of 7.22 and a yield to maturity of 8.1 percent. If interest rates increase by 75 basis points, the bond's price will decrease by _____ percent.
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89. |
The outstanding bonds of Alpha Extracts have a yield to maturity of 8.4 percent and a modified duration of 10.8. If the yield to maturity instantly decreased to 7.5 percent, the bond's price would increase/decrease by _____ percent.
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90. |
A bond has a modified duration of 5.87 years, a par value of $1,000, and a current market value of $1,008. What is the dollar value of an 01?
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91. |
Jefferson-Smith bonds are quoted at a price of $952.42 for a $1,000 face value bond. These bonds have a modified duration of 9.84. What is the dollar value of an 01?
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92. |
A bond has a dollar value of an 01 of .0684. What is the yield value of a 32nd?
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Essay Questions
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93. |
Explain the conditions under which an investor should place more reliance on the yield-to-call than on the yield-to-maturity.
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94. |
Josh is saving money to purchase a home in 9 years. Explain why Josh should create a coupon bond portfolio with a duration of 9 years, rather than purchasing coupon bonds that mature in 9 years.
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95. |
Identify and briefly explain four of Malkiel's five theorems.
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Chapter 10 Bond Prices and Yields Answer Key
Multiple Choice Questions
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1. |
Which one of the following is the correct definition of a coupon rate?
See Section 10.1 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Coupon Rate |
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2. |
What is the annual interest divided by the market price of a bond called?
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Current Yield |
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3. |
The yield to maturity is the:
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-02 The importance of yield to maturity. Level of Difficulty: 1 Easy Section: 10.2 Topic: Yield to Maturity |
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4. |
A premium bond is defined as a bond that:
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-02 The importance of yield to maturity. Level of Difficulty: 1 Easy Section: 10.2 Topic: Premium Bonds |
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5. |
A discount bond:
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-02 The importance of yield to maturity. Level of Difficulty: 1 Easy Section: 10.2 Topic: Discount Bond |
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6. |
The price of a bond, net of accrued interest, is referred to as the bond's:
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-02 The importance of yield to maturity. Level of Difficulty: 1 Easy Section: 10.2 Topic: Clean Price |
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7. |
The dirty price of a bond is the:
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-02 The importance of yield to maturity. Level of Difficulty: 1 Easy Section: 10.2 Topic: Dirty Price |
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8. |
A callable bond:
See Section 10.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-02 The importance of yield to maturity. Level of Difficulty: 1 Easy Section: 10.3 Topic: Callable Bond |
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9. |
Which one of the following does an issuer pay to redeem a bond prior to maturity?
See Section 10.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.3 Topic: Call Price |
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10. |
Which one of the following prices is equal to the present value of a bond's future cash flows and is paid when a bond is redeemed prior to maturity?
See Section 10.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.3 Topic: Make-Whole Call Price |
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11. |
An issuer has a bond outstanding that matures in 18 years. Which one of the following prevents the issuer from buying back that bond today?
See Section 10.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.3 Topic: Call Protection Period |
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12. |
The yield that a bond will earn given that it is bought back by the issuer at the earliest possible date is the:
See Section 10.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.3 Topic: Yield to Call |
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13. |
Which one of the following is the risk that market interest rates may increase causing the price of a bond to decline?
See Section 10.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.4 Topic: Interest Rate Risk |
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14. |
The rate of return an investor actually earns from owning a bond is called which one of the following?
See Section 10.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.4 Topic: Realized Yield |
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15. |
Which one of the following measures a bond's sensitivity to changes in market interest rates?
See Section 10.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Duration |
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16. |
A change in a bond's price caused by which one of the following is defined as the dollar value of an 01?
See Section 10.6 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.6 Topic: Dollar Value of an 01 |
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17. |
The yield value of a 32nd is the change needed in which one of the following to cause a bond's price to change by 1/32nd?
See Section 10.6 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.6 Topic: Yield Value of a 32nd |
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18. |
A dedicated portfolio is a bond portfolio created to:
See Section 10.7 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.7 Topic: Dedicated Portfolio |
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19. |
Which one of the following risks is associated with investing a coupon payment at a rate that is lower than the bond's yield-to-maturity?
See Section 10.7 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.7 Topic: Reinvestment Rate Risk |
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20. |
Which one of the following involves creating a portfolio in a manner which minimizes the uncertainty of the portfolio's maturity target date value?
See Section 10.8 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 1 Easy Section: 10.8 Topic: Immunization |
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21. |
Price risk is the risk that:
See Section 10.8 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 1 Easy Section: 10.8 Topic: Price Risk |
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22. |
Periodically rebalancing a portfolio so that the duration continues to match the target date is called:
See Section 10.8 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 1 Easy Section: 10.8 Topic: Dynamic Immunization |
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23. |
A basic bond that has a face value of $1,000 and pays regular semiannual coupon payments is referred to as which one of the following?
See Section 10.1 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Straight Bonds |
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24. |
Which of the following will increase if the coupon rate increases? I. face value II. market value III. yield-to-maturity IV. current yield
See Section 10.1 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Coupon Rate |
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25. |
Which one of the following will decrease the current yield of a bond?
See Section 10.1 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Current Yield |
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26. |
Which one of the following will occur if a bond's discount rate is lowered?
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 1 Easy Section: 10.2 Topic: Interest Rate Risk |
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27. |
Which one of the following statements is correct concerning premium bonds?
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Premium Bonds |
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28. |
Which one of the following statements is correct concerning discount bonds?
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Discount Bond |
|
29. |
Which one of the following statements applies to a par value bond?
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.2 Topic: Par Bond |
|
30. |
Assuming there is no default risk, both a premium bond and a discount bond must share which one of the following characteristics?
See Section 10.2 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.2 Topic: Par Bond |
|
31. |
A bond has a current yield that is equal to the yield-to-maturity. Given this, which one of the following must also be true?
See Section 10.2 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Par Bond |
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32. |
For a premium bond, the:
See Section 10.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Yield Measures |
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33. |
Davis Industrial bonds have a current market price of $990 and a 6 percent coupon. The bonds pay interest semi-annually on March 1 and September 1. Assume today is January 1. How many months of accrued interest are included in the dirty price of these bonds?
See Section 10.2 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.2 Topic: Dirty Price |
|
34. |
A bond pays interest semiannually on February 1 and August 1. Assume today is October 1. How many months of accrued interest are included in the clean price of this bond?
See Section 10.2 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.2 Topic: Clean Price |
|
35. |
The yield-to-maturity assumes which one of the following?
See Section 10.3 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-02 The importance of yield to maturity. Level of Difficulty: 1 Easy Section: 10.3 Topic: Yield to Maturity |
|
36. |
Which one of the following increases the probability that a bond will be called?
See Section 10.3 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.3 Topic: Callable Bond |
|
37. |
Which one of the following statements is correct concerning a callable bond that is currently selling below face value? Assume there is no risk of default. Also assume the issuer only calls bonds when they can be refinanced at a lower rate of interest.
See Section 10.3 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.3 Topic: Yield to Call |
|
38. |
Which one of the following statements is correct?
See Section 10.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.4 Topic: Realized Yield |
|
39. |
According to Malkiel's theorems, bond prices and bond yields are:
See Section 10.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 1 Easy Section: 10.4 Topic: Malkiel's Theorems |
|
40. |
Which combination of bond characteristics causes a bond to be most sensitive to changes in market interest rates? I. low coupon rates II. high coupon rates III. short time to maturity IV. long time to maturity
See Section 10.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 1 Easy Section: 10.4 Topic: Malkiel's Theorems |
|
41. |
How does the size of the change in a bond's price react in response to a given change in the yield to maturity as the time to maturity increases?
See Section 10.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 2 Medium Section: 10.4 Topic: Malkiel's Theorems |
|
42. |
Which one of the following statements is correct according to Malkiel's Theorems?
See Section 10.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 2 Medium Section: 10.4 Topic: Malkiel's Theorems |
|
43. |
Which one of the following must be equal for two bonds if they are to have similar changes in their prices given a relatively small change in bond yields?
See Section 10.5 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Macaulay Duration |
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44. |
All else constant, which of the following will decrease the Macaulay duration of a straight bond? I. reducing the coupon payment II. shortening the time to maturity III. lowering the yield to maturity
See Section 10.5 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Macaulay Duration |
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45. |
Which one of the following statements is correct concerning Macaulay duration?
See Section 10.5 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 2 Medium Section: 10.5 Topic: Macaulay Duration |
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46. |
The modified duration:
See Section 10.5 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Modified Duration |
|
47. |
To immunize your portfolio, you should:
See Section 10.8 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.8 Topic: Immunization |
|
48. |
Last year, you created an immunized portfolio with an average maturity date of 14.5 years, a yield-to-maturity of 9.8 percent, and a duration of 9.6 years. According to the policy of dynamic immunization, you should now modify your portfolio in which one of the following ways?
See Section 10.8 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.8 Topic: Dynamic Immunization |
|
49. |
Dynamic immunization is primarily aimed at reducing which one of the following risks?
See Section 10.8 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.8 Topic: Dynamic Immunization |
|
50. |
A bond pays semiannual interest payments of $42.50. What is the coupon rate if the par value is $1,000?
Coupon rate = ($42.50 × 2)/$1,000 = 8.50 percent |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Coupon Rate |
|
51. |
A bond has a face value of $1,000 and a coupon rate of 5.5 percent. What is your annual interest payment if you own 8 of these bonds?
Annual coupon = $1,000 × .055 × 8 = $440 |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Annual Coupon |
|
52. |
A bond has a par value of $1,000 and a coupon rate of 6.5 percent. What is the dollar amount of each semiannual interest payment if you own 8 of these bonds?
Semiannual coupon = [($1,000 × .065)/2] × 8 = $260 |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Semiannual Coupon |
|
53. |
A bond has a par value of $1,000, a market price of $1,012, and a coupon rate of 5.75 percent. What is the current yield?
Current yield = (.0575 × $1,000)/$1,012 = 5.68 percent |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Current Yield |
|
54. |
A 5.5 percent coupon bond has a face value of $1,000 and a current yield of 5.64 percent. What is the current market price?
Market price = (.055 × $1,000)/.0564 = $975.18 |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.1 Topic: Current Yield |
|
55. |
A bond has 8 years to maturity, a 7 percent coupon, a $1,000 face value, and pays interest semiannually. What is the bond's current price if the yield to maturity is 6.91 percent?
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Bond Price |
|
56. |
The Country Inn has bonds outstanding with a par value of $1,000 each and a 6.6 percent coupon. The bonds mature in 7.5 years and pay interest semiannually. What is the current value of each of these bonds if the yield to maturity is 6.8 percent?
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Bond Price |
|
57. |
Last year, BT Motors issued 10-year bonds with a 9 percent coupon and semi-annual interest payments. What is the market price of a $1,000 bond if the yield to maturity is 8.9 percent?
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Bond Price |
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58. |
A $1,000 face value bond matures in 11 years, pays interest semiannually, and has a 6.5 percent coupon. The bond currently sells for $1,025. What is the yield to maturity?
Using a financial calculator:
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Yield to Maturity |
|
59. |
A $1,000 par value 5 percent Treasury bond pays interest semiannually and matures in 7.5 years. What is the yield to maturity if the bond is currently quoted at a price of 112.34?
Using a financial calculator:
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Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Yield to Maturity |
|
60. |
A $1,000 semiannual coupon bond matures in 15 years, has a coupon rate of 7.5 percent, and a market price of $982. What is the yield to maturity?
Using a financial calculator:
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Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Yield to Maturity |
|
61. |
An 8.5 percent coupon bond pays interest semiannually and has 10.5 years to maturity. The bond has a face value of $1,000 and a market value of $878.50. What is the yield to maturity?
Using a financial calculator:
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Yield to Maturity |
|
62. |
A $1,000 par value bond is currently valued at $1,037.84. The bond pays interest semi-annually, has 7 years to maturity, and has a yield to maturity of 7.3 percent. The coupon rate is _____ percent and the current yield is _____ percent.
Using a financial calculator:
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.1 Topic: Yields |
|
63. |
A $1,000 face value bond is selling for $1,016.36. The bond pays interest semiannually and has 3.5 years to maturity. The yield to maturity is 5.48 percent. The current yield is _____ percent and the coupon rate is _____ percent.
Using a financial calculator:
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.1 Topic: Yields |
|
64. |
The outstanding bonds of International Plastics mature in 6 years and pay semiannual interest payments of $33.50 on a $1,000 face value bond. The bonds are currently selling for $1,008.64. The coupon rate is _____ percent, the current yield is _____ percent, and the yield to maturity is _____ percent.
Using a financial calculator:
Coupon rate = ($33.50 × 2)/$1,000 = 6.70 percent
Current yield = ($33.50 × 2)/$1,008.64 = 6.643 percent
Yield to maturity = 6.52 percent
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|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Yields |
|
65. |
A bond has a $1,000 par value, semiannual interest payments of $40, and a current market value of $1,054. The bonds mature in 12.5 years. The coupon rate is _____ percent, the current yield is _____ percent, and the yield to maturity is _____ percent.
Coupon rate = ($40 × 2)/$1,000 = 8.00 percent
Current yield = ($40 × 2)/$1,054 = 7.59 percent
Yield to maturity = 7.33 percent
Using a financial calculator:
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Yields |
|
66. |
Alaskan Motors has outstanding bonds that mature in 13 years and pay $34.50 every 6 months in interest. The par value is $1,000 per bond and the market value is $990. The coupon rate is _____ percent, the current yield is _____ percent, and the yield to maturity is _____ percent.
Coupon rate = ($34.50 × 2)/$1,000 = 6.90 percent
Current yield = ($34.50 × 2)/$990 = 6.97 percent
Yield to maturity = 7.02 percent
Using a financial calculator:
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Yields |
|
67. |
You are considering two bonds. Both have semi-annual, 8 percent coupons, $1,000 face values, and yields to maturity of 7.5 percent. Bond S matures in 4 years and Bond L matures in 8 years. What is the difference in the current prices of these bonds?
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Premium Bonds |
|
68. |
Two bonds have a coupon rate of 6.5 percent, semi-annual payments, face values of $1,000, and yields to maturity of 7.1 percent. Bond S matures in 6 years and bond L matures in 12 years. What is the difference in the current prices of these bonds?
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.2 Topic: Discount Bond |
|
69. |
You want to buy a bond that has a quoted price of $923. The bond pays interest semiannually on April 1 and October 1. The coupon rate is 6 percent. What is the clean price of this bond if today's date is June 1? Assume a 360-day year.
Clean price = Quoted price = $923 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.2 Topic: Clean Price |
|
70. |
You are buying a bond at a quoted price of $892. The bond has a 7.5 percent coupon and pays interest semiannually on February 1 and August 1. What is the dirty price of this bond if today is April 1? Assume a 360-day year.
Dirty price = $892 + [(.075 × $1,000)/2] × 2/6 = $904.50 |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.2 Topic: Dirty Price |
|
71. |
Green Roofing Materials has 7.5 percent bonds outstanding that are currently priced at $1,068 each. The bonds pay interest on December 1 and June 1. What is the dirty price of this bond if today's date is May 1? Assume a 360-day year.
Dirty price = $1,068 + [(.075 × $1,000)/2] × 5/6 = $1,099.25 |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.2 Topic: Dirty Price |
|
72. |
You own a bond that pays semiannual interest payments of $38. The bond is callable in 2 years at a premium of $76. What is the callable bond price if the yield to call is 7.9 percent?
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Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.3 Topic: Callable Bond Price |
|
73. |
Ted owns a bond which is callable in 2.5 years. The bond has a 6 percent coupon, pays interest semiannually, has a par value of $1,000, and has a yield to call of 6.3 percent. What is the call premium if the bond currently sells for $1,044.54?
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Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.3 Topic: Callable Bond Price |
|
74. |
Cochran's Furniture Outlet is issuing 25-year, 9 percent callable bonds. These bonds are callable in 4 years with a call premium of $45. The bonds are being issued at par and pay interest semi-annually. What is the yield to call?
Using a financial calculator:
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.3 Topic: Yield to Call |
|
75. |
Blue Water Homes has 8 percent bonds outstanding that mature in 13 years. The bonds pay interest semiannually. These bonds have a par value of $1,000 and are callable in 2 years at a premium of $75. What is the yield to call if the current price is equal to 103.25 percent of par?
Using a financial calculator:
|
|
Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.3 Topic: Yield to Call |
|
76. |
Will owns a bond with a make-whole call provision. The bond matures in 13 years but is being called today. The coupon rate is 8.25 percent with interest paid semiannually. What is the current call price if the applicable discount rate is 7.75 percent and the make-whole call provision applies?
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Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.3 Topic: Make-Whole Call Price |
|
77. |
Ferrous Metals has bonds outstanding which it is calling today under the make-whole call provision. The bonds mature in 6 years, have a 10 percent coupon, pay interest semiannually, and have a par value of $1,000. What is today's call price given that the applicable discount rate is 7.20 percent?
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Blooms: Apply Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 2 Medium Section: 10.3 Topic: Make-Whole Call Price |
|
78. |
Alex purchased a $1,000 par value bond one year ago at a price of $1,016. At the time of purchase, the bond had 12 years to maturity and a 5 percent, semiannual coupon. Today, the bond has a yield to maturity of 5.25 percent. What is his realized yield as of today?
|
|
Blooms: Apply Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 2 Medium Section: 10.4 Topic: Realized Yield |
|
79. |
One year ago, you purchased a $1,000 face value bond at a yield to maturity of 9.45 percent. The bond has a 9 percent coupon and pays interest semiannually. When you purchased the bond, it had 12 years left until maturity. You are selling the bond today when the yield to maturity is 8.20 percent. What is your realized yield on this bond?
|
|
Blooms: Apply Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 2 Medium Section: 10.4 Topic: Realized Yield |
|
80. |
You own a 6.5 percent, semiannual coupon bond that matures in 7 years. The par value is $1,000 and the current yield to maturity is 6.8 percent. What will the percentage change in the price of your bond be if the yield to maturity suddenly increases by 75 basis points?
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Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 2 Medium Section: 10.4 Topic: Interest Rate Risk |
|
81. |
Phil owns a 7 percent, semiannual coupon bond that has a face value of $1,000 and matures in 16 years. The bond has a current yield to maturity of 7.1 percent. What will the percentage change in the price of his bond be if interest rates decrease by 50 basis points?
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|
Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 2 Medium Section: 10.4 Topic: Interest Rate Risk |
|
82. |
A $1,000 face value bond has a 9.0 percent coupon and pays interest semiannually. The bond matures in 2 years and has a yield to maturity of 6.5 percent. What is the Macaulay duration?
|
|
Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 2 Medium Section: 10.5 Topic: Macaulay Duration |
|
83. |
A zero-coupon bond has a par value of $1,000 and matures in 4.5 years. The yield to maturity is 6.4 percent. What is the Macaulay duration?
The duration of a zero-coupon bond is equal to the time to maturity. Thus, the answer is 4.5 years. |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Macaulay Duration |
|
84. |
A bond has a Macaulay duration of 6.25 years. What will be the percentage change in the bond price if the yield to maturity increases from 6 percent to 6.4 percent?
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Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Macaulay Duration |
|
85. |
The price of a bond decreased by 1.45 percent in response to an increase in the yield to maturity from 7.2 to 7.6 percent. What is the bond's Macaulay duration?
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Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Macaulay Duration |
|
86. |
A bond has a Macaulay duration of 5.5, a yield to maturity of 6.1 percent, a coupon rate of 7.0 percent, and semiannual interest payments. What is the bond's modified duration?
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Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Modified Duration |
|
87. |
A 6 percent, semiannual coupon bond has a yield to maturity of 7.4 percent and a Macaulay duration of 5.7. The bond has a modified duration of _____ and will have a _____ percentage increase in price in response to a 25 basis point decrease in the yield to maturity.
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Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Modified Duration |
|
88. |
A bond has a modified duration of 7.22 and a yield to maturity of 8.1 percent. If interest rates increase by 75 basis points, the bond's price will decrease by _____ percent.
Percentage change in bond price = -7.22 × .0075 = -5.42 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Modified Duration |
|
89. |
The outstanding bonds of Alpha Extracts have a yield to maturity of 8.4 percent and a modified duration of 10.8. If the yield to maturity instantly decreased to 7.5 percent, the bond's price would increase/decrease by _____ percent.
Percentage change in bond price = -10.8 × (.075 - .084) = 9.72 percent |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.5 Topic: Modified Duration |
|
90. |
A bond has a modified duration of 5.87 years, a par value of $1,000, and a current market value of $1,008. What is the dollar value of an 01?
Dollar value of an 01 » 5.87/100 × $1,008 × 0.01 = $0.5917 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.6 Topic: Dollar Value of an 01 |
|
91. |
Jefferson-Smith bonds are quoted at a price of $952.42 for a $1,000 face value bond. These bonds have a modified duration of 9.84. What is the dollar value of an 01?
Dollar value of an 01 » 9.84/100 × $952.42 × .01 = $0.9372 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.6 Topic: Dollar Value of an 01 |
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92. |
A bond has a dollar value of an 01 of .0684. What is the yield value of a 32nd?
Yield value of a 32nd » 1/(32 × .0684) = .4569 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 1 Easy Section: 10.6 Topic: Yield Value of a 1/32nd |
Essay Questions
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93. |
Explain the conditions under which an investor should place more reliance on the yield-to-call than on the yield-to-maturity. Answer will vary Feedback: Investors should pay more attention to the YTC rather than the YTM when a bond is likely to be called. This situation exists when a bond is past the call protection period and market interest rates are declining. |
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Blooms: Understand Learning Objective: 10-01 How to calculate bond prices and yields. Level of Difficulty: 1 Easy Section: 10.3 Topic: Yield to Call |
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94. |
Josh is saving money to purchase a home in 9 years. Explain why Josh should create a coupon bond portfolio with a duration of 9 years, rather than purchasing coupon bonds that mature in 9 years. Answer will vary Feedback: Interest rates affect both the price of a bond (price risk) and the rate at which coupon payments can be reinvested (reinvestment risk). These effects are opposing forces and combined are referred to as interest rate sensitivity. Duration measures this sensitivity. By matching the duration of a portfolio to the target date, an investor is shielding the portfolio from interest rate changes. This works because at the point of duration, the price risk offsets the reinvestment risk. While setting the maturity date to the target date does avoid price risk, it does not address the reinvestment risk. |
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Blooms: Understand Learning Objective: 10-03 Interest rate risk and Malkiel's theorems. Level of Difficulty: 2 Medium Section: 10.8 Topic: Immunization |
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95. |
Identify and briefly explain four of Malkiel's five theorems. Answer will vary Feedback: Students should address four of the five theorems which are as follows: 1. Bond prices and bond yields move in opposite directions. 2. For a given change in a bond's yield to maturity, the longer the term to maturity of the bond, the greater will be the magnitude of the change in the bonds' price. 3. For a given change in a bond's yield to maturity, the size of the change in the bond's price increases at a diminishing rate as the bond's term to maturity lengthens. 4. For a given change in a bond's yield to maturity, the absolute magnitude of the resulting change in the bond's price is inversely related to the bond's coupon rate. 5. For a given absolute change in a bond's yield to maturity, the magnitude of the price increase caused by a decrease in yield is greater than the price decrease caused by an increase in yield. |
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Blooms: Understand Learning Objective: 10-04 How to measure the impact of interest rate changes on bond prices. Level of Difficulty: 2 Medium Section: 10.4 Topic: Malkiel's Theorems |
Chapter 11
Diversification and Risky Asset Allocation
Multiple Choice Questions
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1. |
Which one of the following returns is the average return you expect to earn in the future on a risky asset?
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2. |
What is the extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset called?
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3. |
A group of stocks and bonds held by an investor is called which one of the following?
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4. |
The value of an individual security divided by the portfolio value is referred to as the portfolio:
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5. |
Diversification is investing in a variety of assets with which one of the following as the primary goal?
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6. |
Correlation is the:
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7. |
The division of a portfolio's dollars among various types of assets is referred to as:
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8. |
Which one of the following is a collection of possible risk-return combinations available from portfolios consisting of individual assets?
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9. |
An efficient portfolio is a portfolio that does which one of the following?
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10. |
Which one of the following is the set of portfolios that provides the maximum return for a given standard deviation?
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11. |
Which of the following are affected by the probability of a state of the economy occurring? I. expected return of an individual security II. expected return of a portfolio III. standard deviation of an individual security IV. standard deviation of a portfolio
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12. |
Which one of the following statements must be true?
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13. |
You own a portfolio of 5 stocks and have 3 expected states of the economy. You have twice as much invested in Stock A as you do in Stock E. How will the weights be determined when you compute the rate of return for each economic state?
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14. |
Terry has a portfolio comprised of two individual securities. Which one of the following computations that he might do is NOT a weighted average?
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15. |
You own a stock which is expected to return 14 percent in a booming economy and 9 percent in a normal economy. If the probability of a booming economy decreases, your expected return will:
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16. |
You own three securities. Security A has an expected return of 11 percent as compared to 14 percent for Security B and 9 percent for Security C. The expected inflation rate is 4 percent and the nominal risk-free rate is 5 percent. Which one of the following statements is correct?
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17. |
Which of the following will increase the expected risk premium for a security, all else constant? I. an increase in the security's expected return II. a decrease in the security's expected return III. an increase in the risk-free rate IV. a decrease in the risk-free rate
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18. |
If the future return on a security is known with absolute certainty, then the risk premium on that security should be equal to:
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19. |
You own a stock that will produce varying rates of return based upon the state of the economy. Which one of the following will measure the risk associated with owning that stock?
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20. |
Which of the following affect the expected rate of return for a portfolio? I. weight of each security held in the portfolio II. the probability of various economic states occurring III. the variance of each individual security IV. the expected rate of return of each security given each economic state
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21. |
You own a portfolio comprised of 4 stocks and the economy has 3 possible states. Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5 percent, regardless of the economic state. Given this, what must be value of the portfolio's variance be?
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22. |
As the number of individual stocks in a portfolio increases, the portfolio standard deviation:
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23. |
Which one of the following is eliminated, or at least greatly reduced, by increasing the number of individual securities held in a portfolio?
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24. |
Non-diversifiable risk:
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25. |
Which one of the following correlation coefficients can provide the greatest diversification benefit?
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26. |
To reduce risk as much as possible, you should combine assets which have one of the following correlation relationships?
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27. |
What is the correlation coefficient of two assets that are uncorrelated?
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28. |
How will the returns on two assets react if those returns have a perfect positive correlation? I. move in the same direction II. move in opposite directions III. move by the same amount IV. move by either equal or unequal amounts
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29. |
If two assets have a zero correlation, their returns will:
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30. |
Which one of the following correlation relationships has the potential to completely eliminate risk?
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31. |
Assume the returns on Stock X were positive in January, February, April, July, and November. The other months the returns on Stock X were negative. The returns on Stock Y were positive in January, April, May, July, August, and October and negative the remaining months. Which one of the following correlation coefficients best describes the relationship between Stock X and Stock Y?
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32. |
Which one of the following statements is correct?
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33. |
A portfolio comprised of which one of the following is most apt to be the minimum variance portfolio?
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34. |
Which one of the following statements is correct concerning asset allocation?
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35. |
You currently have a portfolio comprised of 70 percent stocks and 30 percent bonds. Which one of the following must be true if you change the asset allocation?
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36. |
Which one of the following distinguishes a minimum variance portfolio?
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37. |
Where does the minimum variance portfolio lie in respect to the investment opportunity set?
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38. |
Which one of the following correlation coefficients must apply to two assets if the equally weighted portfolio of those assets creates a minimum variance portfolio that has a standard deviation of zero?
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39. |
Which one of the following statements about efficient portfolios is correct?
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40. |
You are graphing the portfolio expected return against the portfolio standard deviation for a portfolio consisting of two securities. Which one of the following statements is correct regarding this graph?
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41. |
You are graphing the investment opportunity set for a portfolio of two securities with the expected return on the vertical axis and the standard deviation on the horizontal axis. If the correlation coefficient of the two securities is +1, the opportunity set will appear as which one of the following shapes?
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42. |
A portfolio that belongs to the Markowitz efficient set of portfolios will have which one of the following characteristics? Assume the portfolios are comprised of five individual securities.
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43. |
You combine a set of assets using different weights such that you produce the following results.
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44. |
What is the expected return on this stock given the following information?
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45. |
What is the expected return on this stock given the following information?
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46. |
What is the expected return on this stock given the following information?
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47. |
An investor owns a security that is expected to return 14 percent in a booming economy and 6 percent in a normal economy. The overall expected return on the security is 8.88 percent. Given there are only two states of the economy, what is the probability that the economy will boom?
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48. |
Rosita owns a stock with an overall expected return of 14.40 percent. The economy is expected to either boom or be normal. There is a 52 percent chance the economy will boom. If the economy booms, this stock is expected to return 15 percent. What is the expected return on the stock if the economy is normal?
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49. |
What is the expected return on this stock given the following information?
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50. |
The risk-free rate is 4.35 percent. What is the expected risk premium on this security given the following information?
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51. |
The risk-free rate is 4.15 percent. What is the expected risk premium on this stock given the following information?
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52. |
The risk-free rate is 4.20 percent. What is the expected risk premium on this stock given the following information?
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53. |
There is a 30 percent probability that a particular stock will earn a 17 percent return and a 70 percent probability that it will earn 11 percent. What is the risk-free rate if the risk premium on the stock is 8.60 percent?
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54. |
Tall Stand Timber stock has an expected return of 16.8 percent. What is the risk-free rate if the risk premium on the stock is 12.1 percent?
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55. |
What is the variance of the expected returns on this stock?
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56. |
What is the variance of the expected returns on this stock?
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57. |
What is the variance of the returns on a security given the following information?
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58. |
What is the variance of the returns on a security given the following information?
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59. |
What is the standard deviation of the returns on this stock?
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60. |
What is the standard deviation of the returns on this stock?
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61. |
What is the standard deviation of a security which has the following expected returns?
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62. |
A portfolio consists of the following securities. What is the portfolio weight of stock B?
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63. |
A portfolio consists of the following securities. What is the portfolio weight of stock X?
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64. |
Travis has a portfolio consisting of two stocks, A and B, which is valued at $53,800. Stock A is worth $23,900. What is the portfolio weight of stock B?
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65. |
Alicia has a portfolio consisting of two stocks, X and Y, which is valued at $89,100. Stock X is worth $57,800. What is the portfolio weight of stock Y?
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66. |
You have a portfolio which is comprised of 60 percent of stock A and 40 percent of stock B. What is the expected rate of return on this portfolio?
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67. |
You have a portfolio which is comprised of 65 percent of stock A and 35 percent of stock B. What is the expected rate of return on this portfolio?
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68. |
You have a portfolio which is comprised of 55 percent of stock A and 45 percent of stock B. What is the expected rate of return on this portfolio?
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69. |
You have a portfolio which is comprised of 75 percent of stock A and 25 percent of stock B. What is the expected rate of return on this portfolio?
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70. |
You have a portfolio which is comprised of 72 percent of stock A and 28 percent of stock B. What is the variance of this portfolio?
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71. |
You have a portfolio which is comprised of 44 percent of stock A and 56 percent of stock B. What is the variance of this portfolio?
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72. |
You have a portfolio which is comprised of 35 percent of stock A and 65 percent of stock B. What is the standard deviation of this portfolio?
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73. |
Roger has a portfolio comprised of $8,000 of stock A and $12,000 of stock B. What is the standard deviation of this portfolio?
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74. |
You have a portfolio which is comprised of 20 percent of stock A and 80 percent of stock B. What is the portfolio standard deviation?
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75. |
You have a portfolio which is comprised of 48 percent of stock A and 52 percent of stock B. What is the standard deviation of this portfolio?
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76. |
Stock A has a standard deviation of 15 percent per year and stock B has a standard deviation of 8 percent per year. The correlation between stock A and stock B is .40. You have a portfolio of these two stocks wherein stock B has a portfolio weight of 40 percent. What is your portfolio variance?
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77. |
Stock X has a standard deviation of 22 percent per year and stock Y has a standard deviation of 8 percent per year. The correlation between stock A and stock B is .21. You have a portfolio of these two stocks wherein stock Y has a portfolio weight of 40 percent. What is your portfolio variance?
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78. |
Stock A has a standard deviation of 15 percent per year and stock B has a standard deviation of 21 percent per year. The correlation between stock A and stock B is .30. You have a portfolio of these two stocks wherein stock B has a portfolio weight of 60 percent. What is your portfolio standard deviation?
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79. |
Stock X has a standard deviation of 21 percent per year and stock Y has a standard deviation of 6 percent per year. The correlation between stock A and stock B is .38. You have a portfolio of these two stocks wherein stock X has a portfolio weight of 42 percent. What is your portfolio standard deviation?
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80. |
A stock fund has a standard deviation of 17 percent and a bond fund has a standard deviation of 8 percent. The correlation of the two funds is .24. What is the approximate weight of the stock fund in the minimum variance portfolio?
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81. |
A stock fund has a standard deviation of 16 percent and a bond fund has a standard deviation of 4 percent. The correlation of the two funds is .11. What is the weight of the stock fund in the minimum variance portfolio?
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Essay Questions
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82. |
Explain the primary goal of portfolio diversification as it relates to asset allocation and correlation.
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83. |
You are advising several individual investors who are interested in investing in portfolios comprised of both stocks and bonds. In preparation for meeting with these various investors, you plot the investment opportunity set for stocks and bonds. Given this information, why might you advise some of the investors to invest in a portfolio other than the minimum variance portfolio?
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84. |
Foreign securities are generally considered to be more risky than domestic securities. Given this assumption, explain how adding foreign securities into a domestic portfolio can affect the Markowitz efficient portfolios.
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Chapter 11 Diversification and Risky Asset Allocation Answer Key
Multiple Choice Questions
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1. |
Which one of the following returns is the average return you expect to earn in the future on a risky asset?
See Section 11.1 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Expected Return |
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2. |
What is the extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset called?
See Section 11.1 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Risk Premium |
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3. |
A group of stocks and bonds held by an investor is called which one of the following?
See Section 11.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 1 Easy Section: 11.2 Topic: Portfolio |
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4. |
The value of an individual security divided by the portfolio value is referred to as the portfolio:
See Section 11.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 1 Easy Section: 11.2 Topic: Portfolio Weights |
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5. |
Diversification is investing in a variety of assets with which one of the following as the primary goal?
See Section 11.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.3 Topic: Diversification |
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6. |
Correlation is the:
See Section 11.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.4 Topic: Correlation |
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7. |
The division of a portfolio's dollars among various types of assets is referred to as:
See Section 11.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 1 Easy Section: 11.4 Topic: Asset allocation |
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8. |
Which one of the following is a collection of possible risk-return combinations available from portfolios consisting of individual assets?
See Section 11.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 1 Easy Section: 11.4 Topic: Investment Opportunity set |
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9. |
An efficient portfolio is a portfolio that does which one of the following?
See Section 11.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 1 Easy Section: 11.4 Topic: Efficient portfolio |
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10. |
Which one of the following is the set of portfolios that provides the maximum return for a given standard deviation?
See Section 11.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 1 Easy Section: 11.5 Topic: Markowitz Efficient Frontier |
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11. |
Which of the following are affected by the probability of a state of the economy occurring? I. expected return of an individual security II. expected return of a portfolio III. standard deviation of an individual security IV. standard deviation of a portfolio
See Section 11.1 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Economic States |
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12. |
Which one of the following statements must be true?
See Section 11.1 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Economic States |
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13. |
You own a portfolio of 5 stocks and have 3 expected states of the economy. You have twice as much invested in Stock A as you do in Stock E. How will the weights be determined when you compute the rate of return for each economic state?
See Section 11.1 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Portfolio Weights |
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14. |
Terry has a portfolio comprised of two individual securities. Which one of the following computations that he might do is NOT a weighted average?
See Section 11.1 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Portfolio Values |
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15. |
You own a stock which is expected to return 14 percent in a booming economy and 9 percent in a normal economy. If the probability of a booming economy decreases, your expected return will:
See Section 11.1 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Expected Return and Individual Security |
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16. |
You own three securities. Security A has an expected return of 11 percent as compared to 14 percent for Security B and 9 percent for Security C. The expected inflation rate is 4 percent and the nominal risk-free rate is 5 percent. Which one of the following statements is correct?
See Section 11.1 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Expected Risk Premium |
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17. |
Which of the following will increase the expected risk premium for a security, all else constant? I. an increase in the security's expected return II. a decrease in the security's expected return III. an increase in the risk-free rate IV. a decrease in the risk-free rate
See Section 11.1 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Risk Premium |
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18. |
If the future return on a security is known with absolute certainty, then the risk premium on that security should be equal to:
See Section 11.1 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Risk Premium |
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19. |
You own a stock that will produce varying rates of return based upon the state of the economy. Which one of the following will measure the risk associated with owning that stock?
See Section 11.1 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Variance |
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20. |
Which of the following affect the expected rate of return for a portfolio? I. weight of each security held in the portfolio II. the probability of various economic states occurring III. the variance of each individual security IV. the expected rate of return of each security given each economic state
See Section 11.2 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Returns |
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21. |
You own a portfolio comprised of 4 stocks and the economy has 3 possible states. Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5 percent, regardless of the economic state. Given this, what must be value of the portfolio's variance be?
See Section 11.2 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Variance |
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22. |
As the number of individual stocks in a portfolio increases, the portfolio standard deviation:
See Section 11.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.3 Topic: Diversification |
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23. |
Which one of the following is eliminated, or at least greatly reduced, by increasing the number of individual securities held in a portfolio?
See Section 11.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.3 Topic: Diversifiable Risk |
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24. |
Non-diversifiable risk:
See Section 11.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.3 Topic: Nondiversifiable Risk |
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25. |
Which one of the following correlation coefficients can provide the greatest diversification benefit?
See Section 11.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.4 Topic: Correlation |
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26. |
To reduce risk as much as possible, you should combine assets which have one of the following correlation relationships?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.4 Topic: Correlation |
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27. |
What is the correlation coefficient of two assets that are uncorrelated?
See Section 11.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.4 Topic: Correlation |
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28. |
How will the returns on two assets react if those returns have a perfect positive correlation? I. move in the same direction II. move in opposite directions III. move by the same amount IV. move by either equal or unequal amounts
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.4 Topic: Correlation |
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29. |
If two assets have a zero correlation, their returns will:
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.4 Topic: Correlation |
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30. |
Which one of the following correlation relationships has the potential to completely eliminate risk?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.4 Topic: Correlation |
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31. |
Assume the returns on Stock X were positive in January, February, April, July, and November. The other months the returns on Stock X were negative. The returns on Stock Y were positive in January, April, May, July, August, and October and negative the remaining months. Which one of the following correlation coefficients best describes the relationship between Stock X and Stock Y?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 2 Medium Section: 11.4 Topic: Correlation |
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32. |
Which one of the following statements is correct?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.4 Topic: Portfolio Variance |
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33. |
A portfolio comprised of which one of the following is most apt to be the minimum variance portfolio?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 1 Easy Section: 11.4 Topic: Asset allocation |
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34. |
Which one of the following statements is correct concerning asset allocation?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 2 Medium Section: 11.4 Topic: Asset allocation |
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35. |
You currently have a portfolio comprised of 70 percent stocks and 30 percent bonds. Which one of the following must be true if you change the asset allocation?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 2 Medium Section: 11.4 Topic: Investment Opportunity set |
|
36. |
Which one of the following distinguishes a minimum variance portfolio?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 2 Medium Section: 11.4 Topic: Minimum Variance Portfolio |
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37. |
Where does the minimum variance portfolio lie in respect to the investment opportunity set?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 1 Easy Section: 11.4 Topic: Minimum Variance Portfolio |
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38. |
Which one of the following correlation coefficients must apply to two assets if the equally weighted portfolio of those assets creates a minimum variance portfolio that has a standard deviation of zero?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 1 Easy Section: 11.4 Topic: Minimum Variance Portfolio |
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39. |
Which one of the following statements about efficient portfolios is correct?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 2 Medium Section: 11.4 Topic: Efficient portfolio |
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40. |
You are graphing the portfolio expected return against the portfolio standard deviation for a portfolio consisting of two securities. Which one of the following statements is correct regarding this graph?
See Section 11.4 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 2 Medium Section: 11.4 Topic: Efficient Frontier |
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41. |
You are graphing the investment opportunity set for a portfolio of two securities with the expected return on the vertical axis and the standard deviation on the horizontal axis. If the correlation coefficient of the two securities is +1, the opportunity set will appear as which one of the following shapes?
See Section 11.4 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 2 Medium Section: 11.4 Topic: Opportunity Set |
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42. |
A portfolio that belongs to the Markowitz efficient set of portfolios will have which one of the following characteristics? Assume the portfolios are comprised of five individual securities.
See Section 11.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 2 Medium Section: 11.5 Topic: Markowitz Efficient Portfolios |
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43. |
You combine a set of assets using different weights such that you produce the following results.
See Section 11.5 |
|
Blooms: Understand Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 1 Easy Section: 11.5 Topic: Markowitz Efficient Portfolios |
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44. |
What is the expected return on this stock given the following information?
E(R) = (.40 × 16) + (.60 × -22) = -6.80 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Expected Return and Individual Security |
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45. |
What is the expected return on this stock given the following information?
E(R) = (.05 × 16) + (.45 × 07) + (.50 × -12) = -2.05 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Expected Return and Individual Security |
|
46. |
What is the expected return on this stock given the following information?
E(R) = (.25 × 20) + (.55 × 15) + (.20 × -12) = 10.85 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Expected Return and Individual Security |
|
47. |
An investor owns a security that is expected to return 14 percent in a booming economy and 6 percent in a normal economy. The overall expected return on the security is 8.88 percent. Given there are only two states of the economy, what is the probability that the economy will boom?
8.88 = 14x + (1 - x)(6); x = 36% |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Expected Return and Individual Security |
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48. |
Rosita owns a stock with an overall expected return of 14.40 percent. The economy is expected to either boom or be normal. There is a 52 percent chance the economy will boom. If the economy booms, this stock is expected to return 15 percent. What is the expected return on the stock if the economy is normal?
14.40 = (.52 × 15) + (1 - .52) (x); x = 13.75 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Expected Return and Individual Security |
|
49. |
What is the expected return on this stock given the following information?
E(R) = (.15 × 22) + (.60 × 11) + (.25 × -14) = 6.40 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Expected Return and Individual Security |
|
50. |
The risk-free rate is 4.35 percent. What is the expected risk premium on this security given the following information?
E(R) = (.25 × 17) + (.55 × 13) + (.20 × -9) = 9.6 percent Risk premium = 9.6 - 4.35 = 5.25 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Risk Premium and Expected Return |
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51. |
The risk-free rate is 4.15 percent. What is the expected risk premium on this stock given the following information?
E(R) = (.35 × 14) + (.65 × 8) = 10.10 Risk premium = 10.10 - 4.15 = 5.95 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Risk Premium and Expected Return |
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52. |
The risk-free rate is 4.20 percent. What is the expected risk premium on this stock given the following information?
E(R) = (.28 × 23) + (.72 × 11) = 14.36 Risk premium = 14.36 - 4.20 = 10.16 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Risk Premium and Expected Return |
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53. |
There is a 30 percent probability that a particular stock will earn a 17 percent return and a 70 percent probability that it will earn 11 percent. What is the risk-free rate if the risk premium on the stock is 8.60 percent?
E(R) = (.30 × 17) + (.70 × 11) = 12.80 Risk premium = 12.80 - 8.6 = 4.20 percent |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Risk Premium |
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54. |
Tall Stand Timber stock has an expected return of 16.8 percent. What is the risk-free rate if the risk premium on the stock is 12.1 percent?
Risk premium = 16.8 - 12.1 = 4.70 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Risk Premium |
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55. |
What is the variance of the expected returns on this stock?
E(R) = (.40 × 15) + (.60 × 19) = 17.4 Var = .40(15 - 17.4)2 + .60(19 - 17.4)2 = 3.84 |
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Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Variance of Individual Security |
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56. |
What is the variance of the expected returns on this stock?
E(R) = (.30 × 25) + (.70 × 12) = 15.90 Var = .30(25 - 15.90)2 + .70(12 - 15.90)2 = 35.49 |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Variance of Individual Security |
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57. |
What is the variance of the returns on a security given the following information?
E(R) = (.05 × 27) + (.30 × 15) + (.65 × -22) = -8.45 Var = .05[27 - (-8.45)]2 + .30[15 - (-8.45)]2 + .65[-22 - (-8.45)]2 = 347.15 |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Variance of Individual Security |
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58. |
What is the variance of the returns on a security given the following information?
E(R) = (.25 × 16) + (.45 × 10) + (.30 × -8) = 6.10 Var = .25(16 - 6.1)2 + .45(10 - 6.1)2 + .30(-8 - 6.1)2 = 91.35 |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Variance of Individual Security |
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59. |
What is the standard deviation of the returns on this stock?
E(R) = (.27 × 6) + (.73 × 19) = 15.49 Var = .27(6 - 15.49)2 + .73(19 - 15.49)2 = 33.31 Std Dev = √33.31 = 5.77 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Standard Deviation of Individual Security |
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60. |
What is the standard deviation of the returns on this stock?
E(R) = (.22 × 24) + (.66 × 12) + (.12 × -60) = 6.00 Var = .22(24 - 6)2 + .66(12 - 6)2 + .12(-60 - 6)2 = 661.52 Std Dev = √661.52 = 25.72 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Standard Deviation of Individual Security |
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61. |
What is the standard deviation of a security which has the following expected returns?
E(R) = (.10 × 19) + (.75 × 13) + (.15 × -7) = 10.6 Var = .10(19 - 10.6)2 + .75(13 - 10.6)2 + .15(-7 - 10.6)2 = 57.84 Std Dev = √57.84 = 7.61 percent |
|
Blooms: Apply Learning Objective: 11-01 How to calculate expected returns and variances for a security. Level of Difficulty: 1 Easy Section: 11.1 Topic: Standard Deviation |
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62. |
A portfolio consists of the following securities. What is the portfolio weight of stock B?
XB = (150 × $33)/[(200 × $48) + (150 × $33) + (350 × $21)] = .2260 |
|
Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 1 Easy Section: 11.2 Topic: Portfolio Weights |
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63. |
A portfolio consists of the following securities. What is the portfolio weight of stock X?
Xx = (600 × $17)/[(600 × $17) + (900 × $23) + (400 × $49)] = .202 |
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Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 1 Easy Section: 11.2 Topic: Portfolio Weights |
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64. |
Travis has a portfolio consisting of two stocks, A and B, which is valued at $53,800. Stock A is worth $23,900. What is the portfolio weight of stock B?
XB = ($53,800 - $23,900)/$53,800 = .5558 |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 1 Easy Section: 11.2 Topic: Portfolio Weights |
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65. |
Alicia has a portfolio consisting of two stocks, X and Y, which is valued at $89,100. Stock X is worth $57,800. What is the portfolio weight of stock Y?
XY = ($89,100 - $57,800)/$89,100 = .351 |
|
Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 1 Easy Section: 11.2 Topic: Portfolio Weights |
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66. |
You have a portfolio which is comprised of 60 percent of stock A and 40 percent of stock B. What is the expected rate of return on this portfolio?
E(R-Boom) = .60(15%) + .40(9%) = 12.6% E(R-Normal) = .60(8%) + .40(20%) = 12.8% E(R-Portfolio) = (.20)(12.6%) + (.80)(12.8%) = 12.76% |
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Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Expected Return |
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67. |
You have a portfolio which is comprised of 65 percent of stock A and 35 percent of stock B. What is the expected rate of return on this portfolio?
|
|
Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Expected Return |
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68. |
You have a portfolio which is comprised of 55 percent of stock A and 45 percent of stock B. What is the expected rate of return on this portfolio?
E(R-Boom) = (.55 × 22) + (.45 × 14) = 18.4 E(R-Normal) = (.55 × 14) + (.45 × 8) = 11.3 E(R-Recession) = (.55 × -10) + (.45 × 5) = -3.25 E(R-Portfolio) = (.18 × 18.4) + (.62 × 11.3) + (.20 × -3.25) = 9.67% |
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Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Expected Return |
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69. |
You have a portfolio which is comprised of 75 percent of stock A and 25 percent of stock B. What is the expected rate of return on this portfolio?
|
|
Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Expected Return |
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70. |
You have a portfolio which is comprised of 72 percent of stock A and 28 percent of stock B. What is the variance of this portfolio?
E(R-Boom) = (.72 × 12%) + (.28 × 22%) = 14.8% E(R-Normal) = (.72 × -12%) + (.28 × -44%) = -20.96% E(R-Portfolio) = (.60 × 14.8) + (.40 × -20.96) = 0.50% Var(Portfolio) = .60(14.8 - .50)2 + .40(-21.0 - .50)2 = 306.91 |
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Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Variance |
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71. |
You have a portfolio which is comprised of 44 percent of stock A and 56 percent of stock B. What is the variance of this portfolio?
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Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Variance |
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72. |
You have a portfolio which is comprised of 35 percent of stock A and 65 percent of stock B. What is the standard deviation of this portfolio?
E(R-Boom) = (.40 × 22) + (.60 × 19) = 20.20 E(R-Normal) = (.60 × 12) + (.40 × 10) = 10.80 E(R-Recession) = (.60 × -26) + (.40 × -4) = -12.80 E(R-Portfolio) = (.15 × 20.20) + (.80 × 10.80) + (.05 × -12.80) = 11.03 Var(Portfolio) = .15(20.20 - 11.03)2 + .80(10.8 - 11.03)2 + .05(-12.80 - 11.03)2 = 41.05 Std Dev(Portfolio) = √41.05 = 6.41% |
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Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Standard Deviation |
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73. |
Roger has a portfolio comprised of $8,000 of stock A and $12,000 of stock B. What is the standard deviation of this portfolio?
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Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Standard Deviation |
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74. |
You have a portfolio which is comprised of 20 percent of stock A and 80 percent of stock B. What is the portfolio standard deviation?
E(R-Boom) = (.20 × 19) + (.80 × 13) = 14.2 E(R-Normal) = (.20 × 12) + (.80 × 10) = 10.4 E(R-Recession) = (.20 × -22) + (.80 × -3) = -6.8 E(R-Portfolio) = (.15 × 14.2) + (.75 × 10.4) + (.10 × -6.8) = 9.25% Var(Portfolio) = .15(14.2 - 9.25)2 + .75(10.4 - 9.25)2 + (-6.8 - 9.25)2 = 30.88 Std dev(Portfolio) = √30.88 = 5.56% |
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Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Standard Deviation |
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75. |
You have a portfolio which is comprised of 48 percent of stock A and 52 percent of stock B. What is the standard deviation of this portfolio?
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Blooms: Apply Learning Objective: 11-02 How to calculate expected returns and variances for a portfolio. Level of Difficulty: 2 Medium Section: 11.2 Topic: Portfolio Standard Deviation |
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76. |
Stock A has a standard deviation of 15 percent per year and stock B has a standard deviation of 8 percent per year. The correlation between stock A and stock B is .40. You have a portfolio of these two stocks wherein stock B has a portfolio weight of 40 percent. What is your portfolio variance?
VarPort = [(1 - .40)2 × .152] + [.402 × .082] + [2 × (1 - .40) × .40 × .15 × .08 × .40] = .011428 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 2 Medium Section: 11.4 Topic: Portfolio Variance |
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77. |
Stock X has a standard deviation of 22 percent per year and stock Y has a standard deviation of 8 percent per year. The correlation between stock A and stock B is .21. You have a portfolio of these two stocks wherein stock Y has a portfolio weight of 40 percent. What is your portfolio variance?
VarPort = [(1 - .40)2 × .222] + [.402 × .082] + [2 × (1 - .40) × .40 × .22 × .08 × .21] = .02022 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 2 Medium Section: 11.4 Topic: Portfolio Variance |
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78. |
Stock A has a standard deviation of 15 percent per year and stock B has a standard deviation of 21 percent per year. The correlation between stock A and stock B is .30. You have a portfolio of these two stocks wherein stock B has a portfolio weight of 60 percent. What is your portfolio standard deviation?
VarPort = [(1 - .60)2 × .152] + [.602 × .212] + [2 × (1 - .60) × .60 × .15 × .21 × .30] = .024314 Std DevPort = √.024012 = 15.50 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 2 Medium Section: 11.4 Topic: Portfolio Standard Deviation |
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79. |
Stock X has a standard deviation of 21 percent per year and stock Y has a standard deviation of 6 percent per year. The correlation between stock A and stock B is .38. You have a portfolio of these two stocks wherein stock X has a portfolio weight of 42 percent. What is your portfolio standard deviation?
VarPort = [.422 × .212] + [(1 - .42)2 × .062] + [2 × .42 × (1 - .42) × .21 × .06 × .38] = .011323 Std DevPort = √.011323 = 10.64 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 2 Medium Section: 11.4 Topic: Portfolio Standard Deviation |
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80. |
A stock fund has a standard deviation of 17 percent and a bond fund has a standard deviation of 8 percent. The correlation of the two funds is .24. What is the approximate weight of the stock fund in the minimum variance portfolio?
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Blooms: Apply Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 2 Medium Section: 11.4 Topic: Minimum Variance Portfolio |
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81. |
A stock fund has a standard deviation of 16 percent and a bond fund has a standard deviation of 4 percent. The correlation of the two funds is .11. What is the weight of the stock fund in the minimum variance portfolio?
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Blooms: Apply Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 2 Medium Section: 11.4 Topic: Minimum Variance Portfolio |
Essay Questions
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82. |
Explain the primary goal of portfolio diversification as it relates to asset allocation and correlation. Answer will vary Feedback: The goal of portfolio diversification is the elimination of diversifiable risk which is achieved through asset allocation. Asset allocation is the spreading of a portfolio among various assets. To achieve maximum diversification, the assets selected need to have low, zero, or negative correlations. |
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Blooms: Understand Learning Objective: 11-03 The importance of portfolio diversification. Level of Difficulty: 1 Easy Section: 11.3 Topic: Diversification |
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83. |
You are advising several individual investors who are interested in investing in portfolios comprised of both stocks and bonds. In preparation for meeting with these various investors, you plot the investment opportunity set for stocks and bonds. Given this information, why might you advise some of the investors to invest in a portfolio other than the minimum variance portfolio? Answer will vary Feedback: The minimum variance portfolio identifies the portfolio with the least amount of risk. This portfolio is the most leftward edge of the efficient set of portfolios. Risk-tolerant investors may prefer to assume more risk in hopes of realizing a higher rate of return. Thus, it would be more appropriate in those cases to recommend an efficient portfolio other than the minimum variance portfolio. |
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Blooms: Understand Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 2 Medium Section: 11.4 Topic: Risk and Return |
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84. |
Foreign securities are generally considered to be more risky than domestic securities. Given this assumption, explain how adding foreign securities into a domestic portfolio can affect the Markowitz efficient portfolios. Answer will vary Feedback: Foreign securities generally have low, zero, or negative correlations with domestic securities. Thus, by adding foreign securities into a domestic portfolio, you can move the set of Markowitz efficient portfolios either to the left or upward, or both. |
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Blooms: Understand Learning Objective: 11-04 The efficient frontier and the importance of asset allocation. Level of Difficulty: 2 Medium Section: 11.5 Topic: Markowitz Portfolios |
Chapter 12
Return, Risk, and the Security Market Line
Multiple Choice Questions
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1. |
Which one of the following is the type of risk that affects a large number of assets?
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2. |
Which one of the following is the type of risk that only affects either a single firm or just a small number of firms?
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3. |
According to the systematic risk principle, the reward for bearing risk is based on which one of the following types of risk?
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4. |
Which one of the following measures systematic risk?
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5. |
The security market line depicts the graphical relationship between which two of the following? I. expected return II. surprise return III. systematic risk IV. unsystematic risk
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6. |
Which one of the following is expressed as "E(RM) - Rf"?
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7. |
Which one of the following is the theory which states that the value of a security is dependent upon the pure time value of money, the reward for bearing systematic risk, and the amount of systematic risk?
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8. |
Which one of the following terms is the measure of the tendency of two things to move or vary together?
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9. |
Retail Specialties just announced that its Chief Operating Officer is retiring at the end of this month. This announcement will cause the firm's stock price to:
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10. |
Which one of the following is the best example of a risk associated with stock ownership?
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11. |
Which one of the following announcements is most apt to cause the price of a firm's stock to increase?
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12. |
Which one of the following terms is another name for systematic risk?
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13. |
Which one of the following is the best example of systematic risk?
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14. |
Which one of the following statements applies to unsystematic risk?
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15. |
Which one of the following is the best example of unsystematic risk?
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16. |
Which one of the following qualifies as diversifiable risk?
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17. |
Which one of the following betas represents the greatest level of systematic risk?
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18. |
A stock with which one of the following betas has an expected return that most resembles the overall market expected rate of return?
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19. |
What is the beta of a risk-free security?
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20. |
Which one of the following stocks has the highest expected risk premium?
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21. |
Of the following, Stock _____ has the greatest level of total risk and Stock _____ has the highest risk premium.
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22. |
A portfolio beta is computed as which one of the following?
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23. |
You own a portfolio which is invested equally in two stocks and a risk-free security. The stock betas are .89 for Stock A and 1.26 for Stock B. Which one of the following will increase the portfolio beta, all else constant?
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24. |
A portfolio of securities has a beta of 1.14. Given this, you know that:
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25. |
You own three stocks which have betas of 1.16, 1.34, and 1.02. You would like to add a fourth security such that your portfolio beta will match that of the market. Given this situation, the new security:
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26. |
The amount of risk premium allocated to Security A is dependent upon which one of the following?
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27. |
What is the beta of an average asset?
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28. |
All else held constant, which of the following will increase the expected return on a security based on CAPM? Assume the market return exceeds the risk-free rate and both values are positive. Also assume the beta exceeds 1.0. I. decrease in the security beta II. increase in the market risk premium III. decrease in the risk-free rate IV. increase in the market rate of return
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29. |
The slope of the security market line is equal to the:
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30. |
Where will a security plot in relation to the security market line (SML) if it has a beta of 1.1 and is overvalued?
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31. |
Where will a security plot in relation to the security market line (SML) if it is considered to be a good purchase because it is underpriced?
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32. |
According to the capital asset pricing model, which of the following will increase the expected rate of return on a security that has a beta that is less than that of the market? Assume the market rate of return is greater than the risk-free rate and both rates are positive. I. increase in the risk-free rate II. decrease in the risk-free rate III. increase in the market risk premium IV. decrease in the market rate of return
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33. |
Which one of the following has the highest expected risk premium?
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34. |
Which one of the following must be equal for two individual securities with differing betas if those securities are correctly priced according to the capital asset pricing model?
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35. |
Stocks D, E, and F have actual reward-to-risk ratios of 7.1, 6.8, and 7.4, respectively. Given this, you know for certain that:
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36. |
Which one of the following will increase the slope of the security market line? Assume all else constant.
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37. |
Which two of the following determine how sensitive a security is relative to movements in the overall market? I. the standard deviation of the security II. correlation between the security's return and the market return III. the volatility of the security relative to the market IV. the amount of unsystematic risk inherent in the security
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38. |
Which of the following are needed to compute the beta of an individual security? I. average return on the market for the period II. standard deviation of the security and the market III. returns on the security and the market for multiple time periods IV. correlation of the security to the market
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39. |
A security has a zero covariance with the market. This means that:
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40. |
Which of the following will affect the beta value of an individual security? I. interval of time frequency used for the data sample II. length of the time period used for the data sample III. particular time period selected for the sampling IV. choice of index used as the measure of the market
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41. |
Which one of the following is most commonly used as the measure of the overall market rate of return?
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42. |
Which one of the following statements is true?
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43. |
Which of the following correctly identifies the factors included in the Fama-French three-factor model?
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44. |
Which one of the following combinations will tend to produce the highest rate of return according to the Fama-French three-factor model? Assume beta is constant in all cases.
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45. |
Phil realized a total return of 13.2 percent which is less than his expected return of 14.4 percent. What is the amount of his unexpected return?
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46. |
Brooke invested $4,500 in the stock market with the expectation of earning 6.25 percent. She actually earned 7.15 percent for the year. What is the amount of her unexpected return?
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47. |
Reed Plastics just announced the earnings per share for the quarter just ended were $.45 a share. Analysts were expecting $.51. What is the amount of the surprise portion of the announcement?
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48. |
The risk-free rate is 3.0 percent and the expected return on the market is 9 percent. Stock A has a beta of 1.20. For a given year, Stock A returned 12.5 percent while the market returned 9.75 percent. The systematic portion of Stock A's unexpected return was _____ percent and the unsystematic portion was _____ percent.
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49. |
The risk-free rate is 3.4 percent and the expected return on the market is 10.8 percent. Stock A has a beta of 1.18. For a given year, stock A returned 13.6 percent while the market returned 11.8 percent. The systematic portion of the unexpected return was _____ percent and the unsystematic portion was _____ percent.
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50. |
A portfolio is comprised of two stocks. Stock A comprises 65 percent of the portfolio and has a beta of 1.31. Stock B has a beta of .98. What is the portfolio beta?
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51. |
A portfolio consists of two stocks and has a beta of 1.07. The first stock has a beta of 1.48 and comprises 38 percent of the portfolio. What is the beta of the second stock?
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52. |
What is the beta of a portfolio which consists of the following?
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53. |
What is the beta of a portfolio which consists of the following?
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54. |
A portfolio consists of one risky asset and one risk-free asset. The risky asset has an expected return of 11.2 percent and a beta of 1.39. The risk-free asset has an expected return of 3.4 percent. How much of the portfolio is invested in the risk-free asset if the portfolio beta is 1.07?
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55. |
The following portfolio has an expected return of _____ percent and a beta of _____.
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56. |
The following portfolio has an expected return of _____ percent and a beta of _____.
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57. |
Laura has one risk-free asset and one risky stock in her portfolio. The risk-free asset has an expected return of 3.2 percent. The risky asset has a beta of 1.3 and an expected return of 14.9 percent. What is the expected return on the portfolio if the portfolio beta is .975?
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58. |
A risky asset has a beta of .90 and an expected return of 7.4 percent. What is the reward-to-risk ratio if the risk-free rate is 2.69 percent?
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59. |
The reward-to-risk ratio is 6.8 percent and the risk-free rate is 5.3 percent. What is the expected return on a risky asset if the beta of that asset is 1.03?
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60. |
A risky asset has a beta of 1.40 and an expected return of 17.6 percent. What is the risk-free rate if the risk-to-reward ratio is 8.4 percent?
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61. |
Stock A is a risky asset that has a beta of 1.4 and an expected return of 13.2 percent. Stock B is also a risky asset and has a beta of 1.25. The risk-free rate is 5.5 percent. Assuming both stocks are correctly priced, what is the expected return on stock B?
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62. |
Stock X has a beta of .95 and an expected return of 10.8 percent. Stock Y has a beta of 1.2 and an expected return of 13.1 percent. What is the risk-free rate of return assuming that both stock X and stock Y are correctly priced?
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63. |
The stock of Healthy Eating, Inc., has a beta of .88. The risk-free rate is 3.8 percent and the market return is 9.6 percent. What is the expected return on Healthy Eating's stock?
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64. |
The common stock of Industrial Technologies has an expected return of 12.4 percent. The market return is 9.2 percent and the risk-free return is 3.87 percent. What is the stock's beta?
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65. |
A stock has an expected return of 14.59 percent and a beta of 1.35. What is the risk-free rate if the market rate is 12.7 percent?
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66. |
Farm Tractors, Inc., stock has a beta of 1.12 and an expected return of 12.8 percent. The risk-free rate is 3.84 percent. What is the market rate of return?
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67. |
Wilson Farms' stock has a beta of .84 and an expected return of 7.8 percent. The risk-free rate is 2.6 percent and the market risk premium is 6 percent. This stock is _____ because the CAPM return for the stock is _____ percent.
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68. |
Home Interior's stock has an expected return of 13.2 percent and a beta of 1.28. The market return is 10.7 percent and the risk-free rate is 2.8 percent. This stock is _____ because the CAPM return for the stock is _____ percent.
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69. |
A stock has a beta of 1.58 and an expected return of 16.2 percent. The risk-free rate is 3.8 percent. What is the market risk premium?
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70. |
The risk-free rate is 4.1 percent, the market rate is 13.2 percent, and the expected return on a stock is 15.84 percent. What is the beta of the stock?
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71. |
The market has an expected return of 11.4 percent and a risky asset with a beta of 1.18 has an expected return of 13 percent. Based on this information, what is the pure time value of money?
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72. |
Dinner Foods stock has a beta of 1.45 and an expected return of 13.43 percent. Edwards' Meals stock has a beta of .95 and an expected return of 10.27 percent. Assume that both stocks are correctly priced. Given this, the risk-free rate is _____ percent and the market rate of return is _____ percent.
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73. |
What is the covariance of security A to the market given the following information?
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74. |
What is the covariance of security A to the market given the following information?
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75. |
What is the covariance of security A to the market given the following information?
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76. |
A risky security has a variance of .036190 and a covariance with the market of .0222. The variance of the market is .01975. What is the correlation of the risky security to the market?
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77. |
Uptown Markets stock has a standard deviation of 16.8 percent and a covariance with the market of .0178. The market has a standard deviation of 13.6 percent. What is the correlation of this stock with the market?
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78. |
Western Exports stock has a standard deviation of 15.6 percent and a covariance with the market of .0150. The market has a standard deviation of 13.7 percent. What is the correlation of this stock with the market?
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79. |
The common stock of Blasco Books has a standard deviation of 16.4 percent as compared to the market standard deviation of 12.7 percent. The covariance of this stock with the market is .0217. What is the beta of Blasco Books' stock?
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80. |
A stock has a standard deviation of 25.4 percent and a covariance with the market of .0160. The market has a standard deviation of 12.2 percent. What is the beta of this stock?
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81. |
The market has a standard deviation of 10.8 percent (0.108) while a risky security has a standard deviation of 22.5 (0.225) percent. The covariance of the stock with the market is .0149. What is the beta of the stock?
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Essay Questions
|
82. |
Explain the relationship between the security market line and market efficiency.
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83. |
Identify and describe each of the three components of a security's expected return according to the capital asset pricing model.
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84. |
Alfonso Rodriquez has served as the president of Imports United for the past six years. During his tenure, the company has grown significantly and provided above-average returns to its shareholders. Thus, Mr. Rodriquez is highly admired. Yesterday, he announced that he will be retiring at the end of this quarter. You expected the stock price of Imports United to decline on this news because of the admiration investors have for this gentleman. Contrary to your expectations, the price of the stock remained unchanged. There was no other relevant market news related to this firm and the overall market also remained relatively unchanged for the day. What explanation can be given for the market not reacting as you expected to Mr. Rodriquez's announcement?
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Chapter 12 Return, Risk, and the Security Market Line Answer Key
Multiple Choice Questions
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1. |
Which one of the following is the type of risk that affects a large number of assets?
See Section 12.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-02 The difference between systematic risk and unsystematic risk. Level of Difficulty: 1 Easy Section: 12.2 Topic: Systematic Risk |
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2. |
Which one of the following is the type of risk that only affects either a single firm or just a small number of firms?
See Section 12.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-02 The difference between systematic risk and unsystematic risk. Level of Difficulty: 1 Easy Section: 12.2 Topic: Unsystematic Risk |
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3. |
According to the systematic risk principle, the reward for bearing risk is based on which one of the following types of risk?
See Section 12.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.4 Topic: Systematic Risk Principle |
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4. |
Which one of the following measures systematic risk?
See Section 12.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.4 Topic: Beta Coefficient |
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5. |
The security market line depicts the graphical relationship between which two of the following? I. expected return II. surprise return III. systematic risk IV. unsystematic risk
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Security Market Line |
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6. |
Which one of the following is expressed as "E(RM) - Rf"?
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Market Risk Premium |
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7. |
Which one of the following is the theory which states that the value of a security is dependent upon the pure time value of money, the reward for bearing systematic risk, and the amount of systematic risk?
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Capital Asset Pricing Model |
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8. |
Which one of the following terms is the measure of the tendency of two things to move or vary together?
See Section 12.6 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.6 Topic: Covariance |
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9. |
Retail Specialties just announced that its Chief Operating Officer is retiring at the end of this month. This announcement will cause the firm's stock price to:
See Section 12.1 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-01 The difference between expected and unexpected returns. Level of Difficulty: 1 Easy Section: 12.1 Topic: Surprise |
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10. |
Which one of the following is the best example of a risk associated with stock ownership?
See Section 12.1 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-01 The difference between expected and unexpected returns. Level of Difficulty: 1 Easy Section: 12.1 Topic: Surprise |
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11. |
Which one of the following announcements is most apt to cause the price of a firm's stock to increase?
See Section 12.1 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-01 The difference between expected and unexpected returns. Level of Difficulty: 1 Easy Section: 12.1 Topic: Surprise |
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12. |
Which one of the following terms is another name for systematic risk?
See Section 12.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-02 The difference between systematic risk and unsystematic risk. Level of Difficulty: 1 Easy Section: 12.2 Topic: Systematic Risk |
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13. |
Which one of the following is the best example of systematic risk?
See Section 12.2 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-02 The difference between systematic risk and unsystematic risk. Level of Difficulty: 1 Easy Section: 12.2 Topic: Systematic Risk |
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14. |
Which one of the following statements applies to unsystematic risk?
See Section 12.2 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-02 The difference between systematic risk and unsystematic risk. Level of Difficulty: 1 Easy Section: 12.2 Topic: Unsystematic Risk |
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15. |
Which one of the following is the best example of unsystematic risk?
See Section 12.2 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-02 The difference between systematic risk and unsystematic risk. Level of Difficulty: 1 Easy Section: 12.2 Topic: Unsystematic Risk |
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16. |
Which one of the following qualifies as diversifiable risk?
See Section 12.3 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-02 The difference between systematic risk and unsystematic risk. Level of Difficulty: 1 Easy Section: 12.3 Topic: Unsystematic Portion |
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17. |
Which one of the following betas represents the greatest level of systematic risk?
See Section 12.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Beta |
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18. |
A stock with which one of the following betas has an expected return that most resembles the overall market expected rate of return?
See Section 12.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Beta |
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19. |
What is the beta of a risk-free security?
See Section 12.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Beta |
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20. |
Which one of the following stocks has the highest expected risk premium?
See Section 12.4 |
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Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Beta and Standard Deviation |
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21. |
Of the following, Stock _____ has the greatest level of total risk and Stock _____ has the highest risk premium.
See Section 12.4 |
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Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Beta and Standard Deviation |
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22. |
A portfolio beta is computed as which one of the following?
See Section 12.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Portfolio Beta |
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23. |
You own a portfolio which is invested equally in two stocks and a risk-free security. The stock betas are .89 for Stock A and 1.26 for Stock B. Which one of the following will increase the portfolio beta, all else constant?
See Section 12.4 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Portfolio Beta |
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24. |
A portfolio of securities has a beta of 1.14. Given this, you know that:
See Section 12.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Portfolio Beta |
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25. |
You own three stocks which have betas of 1.16, 1.34, and 1.02. You would like to add a fourth security such that your portfolio beta will match that of the market. Given this situation, the new security:
See Section 12.4 |
|
Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Portfolio Beta |
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26. |
The amount of risk premium allocated to Security A is dependent upon which one of the following?
See Section 12-04 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Systematic Risk Principle |
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27. |
What is the beta of an average asset?
See Section 12.4 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Beta |
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28. |
All else held constant, which of the following will increase the expected return on a security based on CAPM? Assume the market return exceeds the risk-free rate and both values are positive. Also assume the beta exceeds 1.0. I. decrease in the security beta II. increase in the market risk premium III. decrease in the risk-free rate IV. increase in the market rate of return
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 2 Medium Section: 12.5 Topic: CAPM |
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29. |
The slope of the security market line is equal to the:
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Security Market Line |
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30. |
Where will a security plot in relation to the security market line (SML) if it has a beta of 1.1 and is overvalued?
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Security Market Line |
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31. |
Where will a security plot in relation to the security market line (SML) if it is considered to be a good purchase because it is underpriced?
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Security Market Line |
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32. |
According to the capital asset pricing model, which of the following will increase the expected rate of return on a security that has a beta that is less than that of the market? Assume the market rate of return is greater than the risk-free rate and both rates are positive. I. increase in the risk-free rate II. decrease in the risk-free rate III. increase in the market risk premium IV. decrease in the market rate of return
See Section 12.5 |
|
Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: CAPM |
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33. |
Which one of the following has the highest expected risk premium?
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Risk Premium |
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34. |
Which one of the following must be equal for two individual securities with differing betas if those securities are correctly priced according to the capital asset pricing model?
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Reward-to-Risk Ratio |
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35. |
Stocks D, E, and F have actual reward-to-risk ratios of 7.1, 6.8, and 7.4, respectively. Given this, you know for certain that:
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Reward-to-Risk Ratio |
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36. |
Which one of the following will increase the slope of the security market line? Assume all else constant.
See Section 12.5 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Reward-to-Risk Ratio |
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37. |
Which two of the following determine how sensitive a security is relative to movements in the overall market? I. the standard deviation of the security II. correlation between the security's return and the market return III. the volatility of the security relative to the market IV. the amount of unsystematic risk inherent in the security
See Section 12.6 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.6 Topic: Security Sensitivity |
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38. |
Which of the following are needed to compute the beta of an individual security? I. average return on the market for the period II. standard deviation of the security and the market III. returns on the security and the market for multiple time periods IV. correlation of the security to the market
See Section 12.6 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Beta Computation |
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39. |
A security has a zero covariance with the market. This means that:
See Section 12.6 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.6 Topic: Covariance |
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40. |
Which of the following will affect the beta value of an individual security? I. interval of time frequency used for the data sample II. length of the time period used for the data sample III. particular time period selected for the sampling IV. choice of index used as the measure of the market
See Section 12.6 |
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Accessibility: Keyboard Navigation Blooms: Understand Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Beta Values |
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41. |
Which one of the following is most commonly used as the measure of the overall market rate of return?
See Section 12.6 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.6 Topic: Market Index |
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42. |
Which one of the following statements is true?
See Section 12.7 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 2 Medium Section: 12.7 Topic: General Principles |
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43. |
Which of the following correctly identifies the factors included in the Fama-French three-factor model?
See Section 12.7 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.7 Topic: Fama-French Three-Factor Model |
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44. |
Which one of the following combinations will tend to produce the highest rate of return according to the Fama-French three-factor model? Assume beta is constant in all cases.
See Section 12.7 |
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Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.7 Topic: Fama-French Three-Factor Model |
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45. |
Phil realized a total return of 13.2 percent which is less than his expected return of 14.4 percent. What is the amount of his unexpected return?
U = 13.2 percent - 14.4 percent = -1.2 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-01 The difference between expected and unexpected returns. Level of Difficulty: 1 Easy Section: 12.1 Topic: Unexpected Return |
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46. |
Brooke invested $4,500 in the stock market with the expectation of earning 6.25 percent. She actually earned 7.15 percent for the year. What is the amount of her unexpected return?
U = 7.15 percent - 6.25 percent = 0.9 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-01 The difference between expected and unexpected returns. Level of Difficulty: 1 Easy Section: 12.1 Topic: Unexpected Return |
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47. |
Reed Plastics just announced the earnings per share for the quarter just ended were $.45 a share. Analysts were expecting $.51. What is the amount of the surprise portion of the announcement?
Surprise = $.45 - $.51 = -$.06 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-01 The difference between expected and unexpected returns. Level of Difficulty: 1 Easy Section: 12.1 Topic: Surprise |
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48. |
The risk-free rate is 3.0 percent and the expected return on the market is 9 percent. Stock A has a beta of 1.20. For a given year, Stock A returned 12.5 percent while the market returned 9.75 percent. The systematic portion of Stock A's unexpected return was _____ percent and the unsystematic portion was _____ percent.
E(Ra) = 3.0 + 1.2(9 - 3) = 10.20% Ra - E(Ra) = 12.5 - 10.2 = 2.3% Rm - E(Rm) = 9.75 - 9 = 0.75 [Rm - E(Rm)] × Beta = 0.75 × 1.2 = 0.90% [Ra - E(Ra)] - [Rm - E(Rm)] × beta = 2.3 - 0.75 = 1.400 The systematic portion of the unexpected return is 0.90 percent and the unsystematic portion is 1.40 percent. |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-02 The difference between systematic risk and unsystematic risk. Level of Difficulty: 2 Medium Section: 12.2 Topic: Systematic and Unsystematic Risk |
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49. |
The risk-free rate is 3.4 percent and the expected return on the market is 10.8 percent. Stock A has a beta of 1.18. For a given year, stock A returned 13.6 percent while the market returned 11.8 percent. The systematic portion of the unexpected return was _____ percent and the unsystematic portion was _____ percent.
|
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Blooms: Apply Learning Objective: 12-02 The difference between systematic risk and unsystematic risk. Level of Difficulty: 2 Medium Section: 12.2 Topic: Systematic and Unsystematic Risk |
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50. |
A portfolio is comprised of two stocks. Stock A comprises 65 percent of the portfolio and has a beta of 1.31. Stock B has a beta of .98. What is the portfolio beta?
βp = (.65 × 1.31) + [(1 - .65) × .98] = .85 + .34 = 1.19 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Portfolio Beta |
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51. |
A portfolio consists of two stocks and has a beta of 1.07. The first stock has a beta of 1.48 and comprises 38 percent of the portfolio. What is the beta of the second stock?
1.07 = (.38 × 1.48) + [(1 - .38) × βB]; βB = .82 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Portfolio Beta |
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52. |
What is the beta of a portfolio which consists of the following?
Portfolio value = $5,000 + $3,000 + $5,000 + $7,000 = $20,000
|
|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Portfolio Beta |
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53. |
What is the beta of a portfolio which consists of the following?
Portfolio value = $2,000 + $5,000 + $9,000 + $4,000 = $20,000
|
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Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.4 Topic: Portfolio Beta |
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54. |
A portfolio consists of one risky asset and one risk-free asset. The risky asset has an expected return of 11.2 percent and a beta of 1.39. The risk-free asset has an expected return of 3.4 percent. How much of the portfolio is invested in the risk-free asset if the portfolio beta is 1.07?
1.06 = 1.39XA + 0; XA = .77; Xrf = 1 - .77 = 23 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.5 Topic: Beta |
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55. |
The following portfolio has an expected return of _____ percent and a beta of _____.
Portfolio value = $17,000 + $12,000 + $11,000 = $40,000
|
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Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.5 Topic: Expected Return and Beta |
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56. |
The following portfolio has an expected return of _____ percent and a beta of _____.
Portfolio value = $26,000 + $24,000 + $30,000 = $80,000
|
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Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 1 Easy Section: 12.5 Topic: Expected Return and Beta |
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57. |
Laura has one risk-free asset and one risky stock in her portfolio. The risk-free asset has an expected return of 3.2 percent. The risky asset has a beta of 1.3 and an expected return of 14.9 percent. What is the expected return on the portfolio if the portfolio beta is .975?
.975 = 1.3XA + 0; XA = .75 E(R) = (.75 × 14.9) + [(1 - .75) × 3.2] = 11.98 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.5 Topic: Expected Return and Beta |
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58. |
A risky asset has a beta of .90 and an expected return of 7.4 percent. What is the reward-to-risk ratio if the risk-free rate is 2.69 percent?
Slope = (7.4 - 2.69)/.90 = 5.233% |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Reward-to-Risk Ratio |
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59. |
The reward-to-risk ratio is 6.8 percent and the risk-free rate is 5.3 percent. What is the expected return on a risky asset if the beta of that asset is 1.03?
|
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Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Reward-to-Risk Ratio |
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60. |
A risky asset has a beta of 1.40 and an expected return of 17.6 percent. What is the risk-free rate if the risk-to-reward ratio is 8.4 percent?
8.4 = (17.6 - rf)/1.40; rf = 5.84% |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Reward-to-Risk Ratio |
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61. |
Stock A is a risky asset that has a beta of 1.4 and an expected return of 13.2 percent. Stock B is also a risky asset and has a beta of 1.25. The risk-free rate is 5.5 percent. Assuming both stocks are correctly priced, what is the expected return on stock B?
|
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Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Reward-to-Risk Ratio |
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62. |
Stock X has a beta of .95 and an expected return of 10.8 percent. Stock Y has a beta of 1.2 and an expected return of 13.1 percent. What is the risk-free rate of return assuming that both stock X and stock Y are correctly priced?
[10.80 - rf]/.95 = [13.1 - rf]/1.2; rf = 2.06% |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Reward-to-Risk Ratio |
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63. |
The stock of Healthy Eating, Inc., has a beta of .88. The risk-free rate is 3.8 percent and the market return is 9.6 percent. What is the expected return on Healthy Eating's stock?
E(R) = 3.80 + .88(9.60 - 3.80) = 8.90 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Security Market Line |
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64. |
The common stock of Industrial Technologies has an expected return of 12.4 percent. The market return is 9.2 percent and the risk-free return is 3.87 percent. What is the stock's beta?
12.4 = 3.87 + β (9.2 - 3.87); β = 1.60 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Security Market Line |
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65. |
A stock has an expected return of 14.59 percent and a beta of 1.35. What is the risk-free rate if the market rate is 12.7 percent?
14.59 = rf + 1.35 (12.7 - rf); rf = 7.3 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Security Market Line |
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66. |
Farm Tractors, Inc., stock has a beta of 1.12 and an expected return of 12.8 percent. The risk-free rate is 3.84 percent. What is the market rate of return?
12.8 = 3.84 + 1.12(E(RM) - 3.84); E(RM) = 11.84 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: Security Market Line |
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67. |
Wilson Farms' stock has a beta of .84 and an expected return of 7.8 percent. The risk-free rate is 2.6 percent and the market risk premium is 6 percent. This stock is _____ because the CAPM return for the stock is _____ percent.
E (RA) = 2.6 + .84(6.0) = 7.64 percent The stock is undervalued because its expected return of 7.8 percent exceeds the CAPM return of 7.64 percent. |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 2 Medium Section: 12.5 Topic: CAPM |
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68. |
Home Interior's stock has an expected return of 13.2 percent and a beta of 1.28. The market return is 10.7 percent and the risk-free rate is 2.8 percent. This stock is _____ because the CAPM return for the stock is _____ percent.
E (RA) = 2.8 + 1.28(10.7 - 2.8) = 12.91 percent The stock is slightly undervalued because its expected return of 13.2 percent is more than the CAPM return of 12.91 percent. |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 2 Medium Section: 12.5 Topic: CAPM |
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69. |
A stock has a beta of 1.58 and an expected return of 16.2 percent. The risk-free rate is 3.8 percent. What is the market risk premium?
16.2 = 3.8 + 1.58(MRP); MRP = 7.85 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: CAPM |
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70. |
The risk-free rate is 4.1 percent, the market rate is 13.2 percent, and the expected return on a stock is 15.84 percent. What is the beta of the stock?
15.84 = 4.1 + β (13.2 - 4.1); β = 1.29 |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: CAPM |
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71. |
The market has an expected return of 11.4 percent and a risky asset with a beta of 1.18 has an expected return of 13 percent. Based on this information, what is the pure time value of money?
13 = rf + 1.18(11.4 - rf); rf = 2.51 percent |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 1 Easy Section: 12.5 Topic: CAPM |
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72. |
Dinner Foods stock has a beta of 1.45 and an expected return of 13.43 percent. Edwards' Meals stock has a beta of .95 and an expected return of 10.27 percent. Assume that both stocks are correctly priced. Given this, the risk-free rate is _____ percent and the market rate of return is _____ percent.
[13.34 - rf]/1.45 = [10.27 - rf]/.95; rf = 4.266% ≈ 4.27% [13.3 - 4.27]/1.45 = [Rm - 4.27]/1.00; Rm = 10.586% ≈ 10.59% |
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Accessibility: Keyboard Navigation Blooms: Apply Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 2 Medium Section: 12.5 Topic: Reward-to-Risk Premium |
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73. |
What is the covariance of security A to the market given the following information?
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|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Covariance |
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74. |
What is the covariance of security A to the market given the following information?
|
|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Covariance |
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75. |
What is the covariance of security A to the market given the following information?
|
|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Covariance |
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76. |
A risky security has a variance of .036190 and a covariance with the market of .0222. The variance of the market is .01975. What is the correlation of the risky security to the market?
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|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Correlation |
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77. |
Uptown Markets stock has a standard deviation of 16.8 percent and a covariance with the market of .0178. The market has a standard deviation of 13.6 percent. What is the correlation of this stock with the market?
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|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Correlation |
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78. |
Western Exports stock has a standard deviation of 15.6 percent and a covariance with the market of .0150. The market has a standard deviation of 13.7 percent. What is the correlation of this stock with the market?
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|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Correlation |
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79. |
The common stock of Blasco Books has a standard deviation of 16.4 percent as compared to the market standard deviation of 12.7 percent. The covariance of this stock with the market is .0217. What is the beta of Blasco Books' stock?
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|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Beta |
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80. |
A stock has a standard deviation of 25.4 percent and a covariance with the market of .0160. The market has a standard deviation of 12.2 percent. What is the beta of this stock?
|
|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Beta |
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81. |
The market has a standard deviation of 10.8 percent (0.108) while a risky security has a standard deviation of 22.5 (0.225) percent. The covariance of the stock with the market is .0149. What is the beta of the stock?
|
|
Blooms: Apply Learning Objective: 12-04 The importance of beta. Level of Difficulty: 2 Medium Section: 12.6 Topic: Beta |
Essay Questions
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82. |
Explain the relationship between the security market line and market efficiency. Answer will vary Feedback: In an efficient market, every security will have a reward-risk ratio equal to every other security and to the market in general. This reward-to-risk ratio is the slope of the security market line. Thus, securities that are correctly priced, according to CAPM, in an efficient market will plot on the security market line. |
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Blooms: Understand Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 2 Medium Section: 12.5 Topic: Security Market Line and Market Efficiency |
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83. |
Identify and describe each of the three components of a security's expected return according to the capital asset pricing model. Answer will vary Feedback: CAPM states that investors should be compensated for the time value of money (risk-free rate) plus a risk premium based on the level of systematic risk assumed (security β) and the reward-to-risk premium (market return minus the risk-free rate). |
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Blooms: Understand Learning Objective: 12-03 The security market line and the capital asset pricing model. Level of Difficulty: 2 Medium Section: 12.5 Topic: CAPM |
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84. |
Alfonso Rodriquez has served as the president of Imports United for the past six years. During his tenure, the company has grown significantly and provided above-average returns to its shareholders. Thus, Mr. Rodriquez is highly admired. Yesterday, he announced that he will be retiring at the end of this quarter. You expected the stock price of Imports United to decline on this news because of the admiration investors have for this gentleman. Contrary to your expectations, the price of the stock remained unchanged. There was no other relevant market news related to this firm and the overall market also remained relatively unchanged for the day. What explanation can be given for the market not reacting as you expected to Mr. Rodriquez's announcement? Answer will vary Feedback: The retirement announcement was probably anticipated and already incorporated into the price of Imports United stock. Only unexpected, or surprise, announcements will affect stock prices at the time of the announcement. |
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Blooms: Understand Learning Objective: 12-01 The difference between expected and unexpected returns. Level of Difficulty: 1 Easy Section: 12.1 Topic: Announcements |
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