Mock Exam Questions on Risk and Return and Bonds.

1st April 2015

1. Which of the following statements is FALSE?

a. Positive covariance means that asset returns move together.
b. A zero covariance implies there is no relationship between two variables.
c. If two assets have perfect negative correlation, it is impossible to reduce the
portfolio's overall variance.
d. The covariance is equal to the correlation coefficient times the standard deviation
of the first stock times the standard deviation of the second stock.
2. What is the portfolio's standard deviation if you put 25% of your money into stock A which
has a standard deviation of returns of 15% and the rest into stock B which has a standard
deviation of returns of 10%? The correlation coefficient between the returns of the two stocks
is +.75.
a.
b.
c.
d.

11.25%
10.60%
12.40%
15.00%

3. What is the standard deviation of the portfolio in the question above, if the correlation
coefficient is now -.75?
a.
b.
c.
d.

2.8%.
4.2%.
5.3%.
10.6%.

4. Suppose an investor has two assets whose standard deviation of returns are 30% and 40%.
The assets are perfectly negatively correlated. What asset weights will eliminate all portfolio
risk?
a.
b.
c.
d.

50% and 50%.

30% and 40%.
57% and 43%.
Not enough information to answer the question.

5. Which of the following statements is FALSE?

a. Potential benefits from diversification arise when correlation is less than + I.
b. If the correlation coefficient were 0, a zero variance portfolio could be
constructed.
c. If the correlation coefficient were -1, a zero variance portfolio could be
constructed.
d. The lower the correlation coefficient the greater the potential benefits from
diversification.

6. The correlation between assets D and E is +.50. Asset D has a standard deviation of 40%
and asset E has a standard deviation of 60%. What is the standard deviation of the portfolio if
40% is invested in asset D?
a.
b.
c.
d.

21%
46%
52%
60%

7. An investor puts 60% of his money into T -Bills that earn 5% and 40% into risky stocks
which are expected to earn 10% and have a standard deviation of 15%. What is the expected
return and the standard deviation of the portfolio?
a.
b.
c.
d.

4%; 3%.
5%; 7%.
6%; 7%.
7%; 6%.

8. A measure of how well the returns of two risky assets move together is the:
a.
b.
c.
d.

Range.
Covariance.
Semi-variance.
Standard deviation.

9. A portfolio manager adds a new stock to a portfolio. The stock has the same standard
deviation as the existing portfolio but a correlation coefficient with the existing portfolio that
is less than + 1. What effect will adding the new stock have on the standard deviation of the
revised portfolio?
a.
b.
c.
d.

The standard deviation will increase

The standard deviation will decrease
The standard deviation will be unaffected
Impossible to say without more information

10. An investor currently owns Brown Corp. stock and is thinking of adding either James
Corp. or Beta Corp. stock to his holdings. All three stocks offer the same expected return and
same total risk. The correlation of returns between Brown stock and James stock is -0.50 and
the correlation between Brown stock and Beta stock is +.50. The risk of the portfolio would:
a. Decline more if you bought Beta Co.
b. Decline more if you bought James Co.
c. Decrease if you bought James Co. but increase if you bought Beta Co.

11. Which one of the fo1lowing portfolios falls below the Markowitz efficient frontier?
PORTFOLIO
A
B
C
D

EXPECTED RETURN
10%
9%
12%
15%

PORTFOLIO SD
14%
26%
22%
30%

12. In year one, Stock A's return was 10% and stock B's return was 15%. In year 2, stock A's
return was 6% and stock B's return was 9%. What is the covariance of returns between stocks
A and B?
a.
b.
c.
d.

2.
3.
6.
12.

13. Stock A's standard deviation of returns is 50% and Stock B's standard deviation of returns
is 30%. Stock A and Stock B's returns are perfectly positively correlated. According to
portfolio theory, how much should be invested in each stock to minimize the portfolio's
standard deviation?
a.
b.
c.
d.

100% in Stock A.
100% in Stock B.
30% in Stock A and 70% in Stock B.
50% in Stock A and 50% in Stock B.

14. The standard deviation of returns is 30% for Stock A and 20% for Stock B. The
covariance between the returns of A and B is 0.006. The correlation of returns between stocks
A and B is:
a.
b.
c.
d.

0.10.
0.20.
0.30.
0.35.

15. An investor put 60% of his money into a risky asset offering a 10% return with a standard
deviation of returns of 8% and the balance in a risk- free asset offering 5%. What is the
expected return and standard deviation of this portfolio?
a.
b.
c.
d.

6.0% 6.8%
7.5% 80%
8.0% 4.8%
10.0% 6.6%

16. As you increase the number of stocks in a portfolio, the systematic risk will:
a.
b.
c.
d.

Remain constant.
Increase at a decreasing rate.
Decrease at a decreasing rate.
Decrease at an increasing rate.

17. Total risk equals:

a.
b.
c.
d.

Unique plus diversifiable risk.

Market plus non-diversifiable risk.
Systematic plus unsystematic risk.
Systematic plus non-diversifiable risk.

18. According to the systematic risk principle, the market will compensate investors for
bearing:
a.
b.
c.
d.

Systematic risk.
Unsystematic risk.
Total Risk
Diversifiable risk

19. What would happen to the SML if the risk-free rate remained constant while the market
rate of return increased?
a. The SML would exhibit a parallel shift upward.
b. The SML would exhibit a parallel shift downward.
c. The vertical intercept would remain the same, but the SML would swivel
down
d. The vertical intercept would remain the same, but the SML would swivel up

20. What is the required rate of return for a stock with a beta of 1.2, when the risk-free rate is
6% and the expected market return is 12%?
a.
b.
c.
d.

6.0%.
7.2%.
12.0%.
13.2.%

21. What is the required rate of return for a stock with a beta of .70, when the risk-free rate is
7% and the market is offering 14%?
a.
b.
c.
d.

11.9%.
14.0%.
14.9%.
16.8%.

22. The risk- free rate is 6% and the expected market return is 15%. An investor sees a stock
with a beta of 1.20 selling for $25. The investor thinks that the stock will sell for $31 at year
end. The stock is ______ so the investor should _______ :
a.
b.
c.
d.

overpriced, buy it
overpriced, short (sell) it
underpriced, buy it
underpriced, short (sell) it

23. The expected market return is 15% next year and the risk-free rate is 7%. If the expected
return on a stock is 17.40%, what is the beta of the stock?
a.
b.
c.
d.

1.40
1.74
1.71.
1.30

24. The covariance of the market's returns with a stock's returns is .005. The standard
deviation
of the market's returns is 5%. What is the stock's beta?
a.
b.
c.
d.

0.1.
1.0.
1.5.
2.0.

25. The covariance of the market's returns with the stock's returns is .008. The standard
deviation of the market's returns is 8% and the standard deviation of the stock's returns is
11%. What is the correlation coefficient between the stock and market's returns?
a.
b.
c.
d.

+0.50
+ 0.91
+1
+1.25

26. Which of the following statements are TRUE?

I. The beta of a stock is primarily determined by its correlation with the market
II. Securities that fall above the SML are undervalued
III. Securities that fall below the SML are undervalued
IV. Securities that fall on the SML have no intrinsic value to the investor.
V. The risk-free rate defines where the SML intersects the Y axis.
a.
b.
c.
d.

I and III only

1,III and V only
1, II, and V only
I, II, IV, and V only

27. What's the value to you of a $1,000 face-value bond with an 8% coupon rate when your
required rate of return is 15 percent?
a. More than its face value.
b. Less than its face value.
c. $1,000.
d. True.
28. If the intrinsic value of a stock is greater than its market value, which of the following is a
reasonable conclusion?
a. The stock has a low level of risk.
b. The stock offers a high dividend payout ratio.
c. The market is undervaluing the stock.
d. The market is overvaluing the stock.
29. When the market's required rate of return for a particular bond is much less than its
coupon rate, the bond is selling at:
a. a premium.
b. a discount.
c. cannot be determined without more information.
d. face value.

30. If an investor may have to sell a bond prior to maturity and interest rates have risen since
the bond was purchased, the investor is exposed to
a. the coupon effect.
b. interest rate risk.
c. a perpetuity.
d. an indefinite maturity.
31. Virgo Airlines will pay a $4 dividend next year on its common stock, which is currently
selling at $100 per share. What is the market's required return on this investment if the
dividend is expected to grow at 5% forever?
a. 4 percent.
b. 5 percent.
c. 7 percent.
d. 9 percent.
32. If a bond sells at a high premium, then which of the following relationships hold true?
(P0 represents the price of a bond and YTM is the bond's yield to maturity.)
a. P0 < par and YTM > the coupon rate.
b. P0 > par and YTM > the coupon rate.
c. P0 > par and YTM < the coupon rate.
d. P0 < par and YTM < the coupon rate.

33. Interest rates and bond prices

a. move in the same direction.
b. move in opposite directions.
c. sometimes move in the same direction, sometimes in opposite directions
d. have no relationship with each other (i.e., they are independent).

34. In the formula ke = (D1/P0) + g, what does g represent?

a. the expected price appreciation yield from a common stock.
b.

the expected dividend yield from a common stock.

c. the dividend yield from a preferred stock.

d. the interest payment from a bond.
35. In the United States, most bonds pay interest
pay interest
a year.
a. once; twice

a year, while many European bonds

b. twice; once
c. once; once
d. twice; twice
36. The expected rate of return on a bond if bought at its current market price and held to
maturity.
a. yield to maturity
b. current yield
c. coupon yield
d. capital gains yield
37. The price of bond when calculated below its par value is classified as
a.
b.
c.
d.

classified bond
discount bond
compound bond
consideration earning
Answer

38. The required rate of return in calculating bond's cashflow is also classified as
a.
b.
c.
d.

going rate of return

yield
earning rate
Both A and B

Answer D

39. The annual interest payment divided by current price of bond is considered as
a.
b.
c.
d.

current yield
maturity yield
return yield
earning yield

Answer A
40. The interest rate which is used in calculation of cash flows of bonds is called
a.
b.
c.
d.

required rate of redemption

required rate of earning
required rate of return
required option

41. The price of an outstanding bond increases when the market rate
a. never changes
b. increases
c. decreases
d. earned
42. Find the price of a $1,000 par value bond that matures in 10 years, paying interest
annually, based on a 6% coupon rate and a market rate of interest of 5%.
43. Microgates Industries bond has a 10% coupon rate and a $1,000 face value, with interest
being paid semi-annually, and the bond has 20 years to maturity. Investors require a 12%
yield. What is the bond`s market value?
44. A corporate bond with 8 years to maturity and a face value of $1,000 is selling at $980
today. The bond pays semi-annual coupons at an annual rate of 6.4%. What would be the
price of the bond two years from now if the yield to maturity becomes 6.5%. answer
$995.10
45. The value of a 20 year zero coupon bond when the market required rate of return of 9%
is:
46. Perpetual Life Corp has issues consol bonds with coupon payment of $60. If the
prevailing market interest rate at the time they were issues was 6%, at what price were the
bonds sold to the public.
47. Calculate the yield to maturity on a bond priced at $1,036 which has 2 years to maturity, a
10% coupon rate and a face value of $1,000 at maturity.
48. A zero coupon bond has 12 years to maturity, a face value of $1,000 and currently sells
for $300 in the market. What is the yield to maturity on the bond?

49. A bond that pays coupons annually is issued with coupon rate of 4%, maturity in 30 years
and YTM of 8%. What rate of return will be earned by an investor who purchases the bond
and holds it for 1 year if the bonds YTM at the end of the year is 9%.
50. A bond with par value of $1,000 and a coupon rate of 8% is selling at a price of $970.
What is the YTM.
51. Given a 10-year bond that sold for $1,000 with a 13 percent coupon rate, what would be
the price of the bond if interest rates in the marketplace on similar bonds are now 10 percent?
Interest is paid semi-annually.
52. Given a 15-year bond that sold for $1,000 with a 9 percent coupon rate, what would be
the price of the bond if interest rates in the marketplace on similar bonds are now 12 percent?
Interest is paid semi-annually.
53. Given the facts in problem 52, what would be the price if interest rates go down to 8
percent?
54. What is the current yield of an 8 percent coupon rate bond priced at $877.60?
55. What is the yield to maturity for a 10 percent coupon rate bond priced at $1,090.90?
Assume there are 20 years left to maturity. It is a $1,000 par value bond.
56. A 15-year, 7 percent coupon rate bond is selling for $839.27.
a. What is the current yield?
b. What is the yield to maturity using the trial-and-error approach with annual
calculations?
c. Why is the current yield higher/lower than the yield to maturity?
57. What is the approximate yield to maturity of a 14 percent coupon rate, $1,000 par value
bond priced at $1,160 if it has 16 years to maturity?
58. Bond price $1140, YTM 11% matures in 5 years. Find Coupon rate.
59. Mr. Morocco is interested to purchase a bond issues by Camels Co. If the coupon
payment of the bond is 6% and the market interest is at 4%, what is the price of the bond if it
matures in 10 years, with interest paid semi-annually.
60. Based on 59, what if the bond price is $1,000, what would the market interest rate be
then.