SET 1 ANSWERS to PRACTICE QUESTIONS Background Chapters 1-5

CHAPTER 1:
1.
2.
3.
4.
5.
6.
7.
8.

b (definition)
a (they minimize risk consistent with return)
c (a and d are incorrectmust be upward sloping for the future)
a
c (common stocks are more risky than preferreds or bonds)
d (could bedoes not have to be)
b (always involves return and risk; must be expected for future)
a

CHAPTER 2:
9.
c (it is possible to invest only indirectly, using mutual funds)
10.
b (savings bond are monmarketable; other Treasury bonds are marketable)
11.
b (this is a nonmarketable security)
12.
d
13.
b
14.
c (Treasuries have the lowest risk of all)
15.
b (there are no guarantees from bond ratings)
16.
a (first four are investment grade)
17.
b (AAA would have lowest yield, AA next lowest)
18.
d (with c, average return should be more; with a, long-term fund should do better over
long run)
19.

d (.055/[1 - .35] = .0846 or 8.46%

20.

b (.037/[1 - .35] = .0569 which is >.056

21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32

c
d
a
d
c
c
a
d
a
b
b
d

(cshould be homogeneous)
(hybrid security, therefore middle position)
(no guarantees, last priority)
(there are no specific promises with common stock that can be counted on)
(puts and calls are created by investors)
(same reason as #27)
(calls are short term options to buy)
(believes price will be flat or rise)
(most contracts are offset, not exercised)
(short-term, wasting asset)

CHAPTER 3:
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.
44.
45.

b
a
a (they earn money by charging a management fee)
d (barring an emergency)
b
b
a (from $1 trillion to about $7 trillion)
c (money market shares are, as standard practice, set at $1/share)
c
d
c
d (no sales fee, are open-end, can hold taxable or nontaxable)
d (computed once a day, change often)

46.

a ($55.46 + .92 + .73 - .72 2.12 = $54.27)

47.
48.
49.
50.
51.

b
a
b
d (must buy from and sell to the company)
b

52.

c ($10,000 X 1.103 X .868 X 1.143 = $10,943.13)

53.

c ($10,000 X 1.143 X .981 = $11,212.83)

54.

b ($10,943.13 [from #52] X .981 [for 2002] = $10,735.21)

55.

b (11.5% = 1.115; [1.115]5 = 1.7234; 1.7234 1.0 = .723 or 72.3%)

56.
57.

a (for a one-year period, the annual return = the cumulative total return)
d (b and c are equivalent; both represent compounding)

CHAPTER 4:
58.
59.
60.
61.
62.
63.
64.
65.
66.

b
b
d
a
c
b
c
d
d

(up from 1995 through 1999, down 2000 through 2002)

(Nasdaq has most number of companies)
(secondary market, which the NYSE refers to as an agency auction market)
(NYSE, Amex and Nasdaq have listed stocks)

67.
68.
69.
70.
71.
72.
73.
74.
75.
76.
77.
78.
79.

a
d
b
b
c
c
d
b
d
b
c
a
d

(not linked to all brokers; clearly a threat)

(S&P Index is higher)
(a few corporates trade on exchanges)
(left undefined, more change expected)
(growth stocks often split, lowering their price)
(remember, only the DJIA is price weighted)
(all indexes except DJIA are capitalization weighted)
($7.50/.10 = 75 points on Dow; 75/225 = 1/3)

CHAPTER 5:
80.
81.
82.
83.
84.
85.
86.
87.
88.
89.

b (investors not assured of exact price)

c
d
d
b
d
a
a (only required full disclosure; no assurance of quality)
d
c

90.

a (200 shares x $100 = $20,000; $20,000 x .6 = $12,000)

91.
a (100 shares x $20 profit = $2,000; amount investor puts up = $60% of $20,000, or
$12,000; $2,000/$12,000 = 16.67%)
92.

c ($1675 x 55% borrowed = $921.25)

93.

b ($3,000/.60 = $5,000; borrow $2,000; buy 100 shares)

94.

a ($2,000/.40 = $5,000; borrow $3,000; buy 125 shares)

95.
96.
97.
98.

b (no time limit; need margin account; must pay dividends)

c (price moves against you)
a
d

99.

d (your out-of-pocket investment is $2000 [buy on margin] + $40 brokerage cost;

you receive $100 dividends and $200 price appreciation;
you pay $200 interest + $42 brokerage cost to sell; therefore,
you net $300 - $242 = $58;
return on actual cash investment = $58/$2040 = 2.84%)
100.

d (you have a paper gain only because you have not sold yet)

SET 2 ANSWERS to PRACTICE QUESTIONS Returns and Bonds Chapters 6-9

CHAPTER 6:
1.
2.

d
d ([$60 for semiannual coupon + $45 price gain]/1005 = 10.45%)

3.

a ($90 interest is offset by $90 loss on sale; therefore zero return)

4.

c (10% TR = .10; 1 + .10 = 1.10 return relative)

5.

a ([$46 + $1]/$34 = 1.38)

6.

a ([$38 + $1]/40 = .975; this is a TR of -2.5%)

7.

a (-.10 + 1.0 = .90)

8.
9.
10.
11.
12.

c (divide CWI by CYI; geometric mean of $30.41 is 4.2%; $30.41 = (1.042)83

therefore, dividing CWI by (1.042)83 produces the same answer)
a
c (this is approximate, but clearly the closest of the answers given)
b (always true by definition)
a (note that c is reversedshould be (1 + G)2 = (1 + A.M.) 2 etc.)

13.

d ($1 x 1.1676 x .98 = $1.1442)

14.
15.
16.
17.

a (it is identical to cumulative total return, so d is incorrect)

b (remember, no addition or subtraction with CWI)
c (multiply these two together to get CWI)
c

18.

b (RR = [(46+ 2)/50 = .96]; currency adj. = .96; .96 (.96) = .9216 as a RR;
.9216 1.0 = -7.84% as a TR)

19.

20.

a (TR for French investor = ([300 + 10]/250) 1.0 = 24%)

CHAPTER 7:
21.

a (10% x .2 + 20% x .5 + (-25%) x .3 = 4.5%)

22.
23.

b (the two factors are the expected returns for securities and the weights)
c (correlation coefficient is not in equation for expected return)

24.
25.

c
c (1/2 of 10% + 1/2 of 18%)

26.

b (choose the stock with the smallest standard deviation because corr. is +1.0)

27.

d (total # of terms = n2; 30 x 30 = 900)

28.
29.
30.
31.
32.

b (covariance = corr. coeff x std. dev x std. dev; .30 x 12 x 20 = 72)

c (covariance = n (n 1); unique covariances = [n (n -1)] /2)
c
a (proper weights must also be chosen to eliminate all risk in this situation)
d

CHAPTER 8:
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.
44.
45.
46.
47.
48.
49.
50.

d (covariances or correlations must also be provided)

c
d
b
c (the Markowitz efficient frontier is an arc and not a straight line)
a
d
b (B is dominated by D; the other 2 portfolios are the extreme ends of the eff. frontier)
c
c (3n + 2)
a
a
d
b (many observers argue it is the most important decision)
d
a (market risk premium is expected market return RF = 16 7)
d
c

CHAPTER 9:
51.
52.
53.
54.
55.
56.
57.
58.
59.
60.

d
c
d
b
d
b
d (15% x .6 + 5% x .4 = 11%)
a (riskless asset has no risk here; therefore, 60% of 18% = 10.8%)
a
a

61.
62.
63.
64.
65.
66.
67.
68.
69.
70.
71.
72.
73.
74.
75.

a
d
d
c
c
c (stocks risk premium = market risk premium x stocks beta)
d (the market risk premium = 9%)
c
d
b (investors are compensated for taking systematic risk)
b (7 + 1.4[16 7] = 19.6%
a (calculate required return for each stock and compare to expected return)
b
b (it has less restrictive assumptions)
c (requires less assumptions)

SET 3 ANSWERS to PRACTICE QUESTIONS Common Stocks (Valuation and

Management), Efficient Markets, Market/Economy, Industry, Company Analysis
Chapters 10-15
CHAPTER 10:
1.
2.
3.
4.
5.
6.

a
a
b
b
b (d is incorrectit is the value for someone using the equation)
b (dividends, not earnings)

7.

b ([$1.20(1.07)] / [.14 - .07]) Note: $1.20 = current dividend

8.

e (k = Dl/P0 + g; therefore, g = k Dl/P0; g = .15 - .05 = .10

9.

b ($20 / [.15 .10] = 400)

10.

d (beta = .85 because BLC is 15% less risky; k = 6 + .85 [8] = 12.8;
P0 = D1 / [k g] = $1.50 / [12.8 - .07] = $25.86)

11.

a (D0 = $2.55; D1 = $2.75; P0 = $2.75 / [.15 - .08] = $39.29)

12.

b (k = 6 + 1.0 [8] = 14%; P0 = $1.20(1.07) / [.14 - .07] = $18.34)

13.

d (D1 = Earnings X payout ratio = $4.00 X .3 = $1.20; k = 5 + 1.1[14 - 5] = 14.9;

P0 = $1.20 / [14.9 - .08] = $17.39)

14.

d (g = estimated growth rate, therefore use 6%; D1 = $2(1.06) = $2.12;

P0 = $2.12 / [.16 - .06] = $21.20)

15.

b (k = expected return = D1/P0 + g; 2/40 + .07 = 12%)

16.

a (g = 8% [found by rule of 72]; D1 = $1.00 X 1.08 = $1.08;

P0 = $1.08 / [.15 - .08] = $15.43)

17.

b (expected return = D1/P0 + g = 14.9; required return of 15.1 is greater than

expected return; therefore, you cannot justify buying the stock)

18.

c (value is determined by a procedure regardless of holding period)

19.

c ([$2 / (.15 - .07)] = [$2 / (.16 - .08)]; D1 stays the same)

20.

c (D1 = $1.50 X 1.05 = $1.575; dividend yield = $1.575 / $15.75 = 10%;

capital gains yield = the growth rate; Note: the sum of the two must be 15%)

21.

e (D0 = $2.00; D1 = $2 X .95 = $1.90; D2 = $1.90 X .95 = $1.81; D3 = $1.81 X

.95 = $1.72; D4 = $1.72 x .95 = $1.63; D5 = $1.63 x .95 = $1.55;
P4 = D5 / [k g] = $1.55 / (k [-.05]) = $1.55 / [.14 + .05] = $8.16)

22.

e (P0 = $2.00 (1/1.14) + $1.50 (1/(1.14)2) + $2.00 (1/(1.14)3) + $3.50 (1/(1.14)4) +

($3.50(1.08) / [.14 - .08)]) X (1/(1.14)4) = $43.62)

23.

c (multiple growth rate company; D0 = $2.00; D1 = $2.28; D2 = $2.60;

D3 = $2.96; PV of D1 = $1.93; PV of D2 = $1.87; PV of D3 = $1.80;
sum of these 3 present values = $5.60; constant growth rate is 6%;
P3 = D4 / [k-g;]; D4 = $2.96 x 1.06 = $3.14; P3 = $3.14 / [.18 - .06] = $26.15;
PV of $26.15 = $15.92; $15.92 + $5.60 = $21.52)
(NOTE: round off error can account for a few cents difference)

24.

b (k = 7 + 2[11 7] = 15%); D1 = $3(1.20) = $3.60; D2 = $3.60(1.20) = $4.32;

D3 = $4.32(1.10) = $4.75; PV of D1 and D2 = $6.40;
P2 = D3 / [k g] = $4.75 / [.15 - .10] = $95; PV of P2 = $71.83;
P0 = $71.83 + $6.40 = $78.23;
Dividend yield = $3.60 / $78.23 = 4.6%)

25.
26.

b
d

27.

c (P/E = [D/E] / (k g) = .75 / [.16 - .06] = 7.5)

28.

a (if 70% is retained, 30% is paid out, therefore Earnings must be

$1.50 / .3 = $5.00; k = 8 + 2 [12 8] = .16;
P0 = $1.50 (1.10) / [.16 - .10] = $27.50
P/E = $27.50 / $5.50 = $5
Note: E0 = $5.00 and E1 = $5.00(1.10) = $5.50

29.

CHAPTER 11

30.
31.
32.
33.
34.
35.
36.
37.
38.
39.

c
a
d
b
d
b
a
c
c
b

(pessimism leads to an increase)

(risk-free rate + stocks risk premium)

(the top-down approach)

(rising, not falling)

CHAPTER 12
40.
41.
42.
43.
44.
45.
46.
47.
48.
49.
50.
51.

d
c
b
c
c
b
a
a
c (all have not been refuted)
c
c
d

CHAPTER 13
52.
53.
54.
55.
56.
57.
58.
59.
60.
61.

c (stock prices tend to lead the economy)

d
d
(E1 = $30; D1 = $30 X .4 = $12; k = 9 + 8 = 17%;
P0 = $12 / [.17 - .10] = $171.43)
b
c (can be calculated using estimated data)
c
a
d (market tends to lead economy)
d

CHAPTER 14
62.
63.
64.
65.

b
b
c
a

66.
67.
68.
69.
70.
71.
72.
73.

a
a
a
c
c
b
b
b

CHAPTER 15
74.
75.
76.
77.

b
a
b
d

78.

a (.15 x 2)

79.
80.
81.
82.

d (.3 x 1.5)
c
c
b (ROE = .1845 x 2.278; EPS = BVps x ROE)

83.

d ($10 x .10 = $1)

84.
85.
86.
87.
88.

d (g = ROE x retention rate)

c
c (should be Total Assets / Stockholders Equity)
a
c

89.

c (D1 = $2 X .10 = $2.20; P0 = $2.20 / [.20 - .10] = $22)

90.
91.
92.
93.
94.

b
b
a (negative numbers count the same as positive, therefore choose largest)
c
d (minimum expected return; NOTE: a is correct because it does not specify
stock required rate of return or market required rate of return)
c
c
c
b
a
d ($2 / $4 = .5 payout; .5 / [.16 - .06] = 5)

95.
96.
97.
98.
99.
100.

SET 4 ANSWERS to PRACTICE QUESTIONS Technical Analysis Chapter 16

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.

d
d
d
a
d
c
a
a
b
c
d
d
a
b
b

SET 5 ANSWERS to PRACTICE QUESTIONS Bonds Chapters 17-18

CHAPTER 17:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.

c
c (remember, it is expected inflation)
a
b (price and yield move inversely; 1 3/32 = 1.0938%; .010938 x 1000 = $10.938)
c (current yield = coupon/bond price; for bonds selling at a discount [<$1,000],
current yield has to be > coupon rate)
d (a debenture is an unsecured bond)
a (since there are no coupons, there is nothing to reinvest)
c
b
d
d (YTM is a promised return)
c (intrinsic value is a present value process)
c
b (not reinvesting the coupons lowers the realized yield)
a
b
a
c
d (long-term bond prices fluctuate more than do short-term bond prices)
c
d (YTM has a reinvestment rate assumption, therefore c is incorrect)

22.

d (using a calculator, n = 40; PMT = 35; PV = -810; FV = 1000)

23.

d (using a calculator, n = 28; PMT = 30; FV = 1000; I/Y = 8%)

24.

d (1/24 = .0417; 1000/400 = 2.50; 2.50.0417 1.0 = 3.89; 3.89 x 2 = 7.79)

25.

a (.09/2 + 1.0 = 1.045; 1.04530 = 3.7453; 1 / 3.7453 = .267; $1000 x .267 = $267)

26.
27.
28.
29.
30.
31.

c (coupons; capital gain; interest-on-interest)

c
d
a (coupon is inverse; decreasing rate; weighted average)
b (it is the same as the bonds maturity)
d

32.

b (-8 x .0075 = -.06 or -6%)

33.

CHAPTER 18:
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.
44.
45.
46.

b
c
a
c
c
a
c
b
d
c
d
a
b

(term structure is static because it is one point in time)

(this is dealt with in the term structure)
(forward rates are anticipated but unobservable)
(during boom periods, risk decreases, spreads narrow)
(remember, immunization deals with interest rate risk)
(the horizon is specified)

SET 6 ANSWERS to PRACTICE QUESTIONS Derivative Securities Chapters 19

and 20
CHAPTER 17:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.

d (right only)
c (could remain steady)
d
c
e
c
e
a
c
b
c
a
b

CHAPTER 18:
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.

c
d
c
c
d
b
d
d
a
b
d
a
c (10 point loss [because investor sold and price went up] X $250 multiplier)
d

SET 7 ANSWERS to PRACTICE QUESTIONS Portfolio Management,

Performance Evaluation
Chapters 21 and 22
CHAPTER 21:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.

c
a
c
d
d
b
c
b
b
c
b
d

CHAPTER 22:
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.

b
a
b
b
d
b
b
a
c (for d, alpha is the difference between excess return and what should have been
earned given the risk of the portfolio)
c
a (13.2% is required using the CAPM, but only 13% was earned, therefore inferior)
a
a
b (the square of the correlation coefficient is the coefficient of determination)
b
b
d (for a, should be after the fact)
d (need to know the risk of each portfolio)
c (the largest R2)
c (the largest beta)
a (the largest standard deviation)
b (this is the only fund with a statistically significant alpha)
d (the one with the lowest R2)