78 terms

Analysis: Portfolio Analysis

STUDY
PLAY
Market risk is the same as:
a. systematic risk
b. non-systematic risk
c. credit risk
d. selection risk
systematic risk
Which of the following is NOT considered to be a cyclical stock?
a. home appliance manufacturer
b. automobile manufacturer
c. natural gas producer
d. home builder
natural gas producer
Which of the following industries is NOT considered to be defensive?
a. pharmaceuticals
b. building materials
c. food products
d. electric power
building materials
Growth companies typically have which of the following?
I. low dividend payout ratios
II. high dividend payout ratios
III. low price / earnings ratio
IV. high price / earnings ratio
low dividend payout ratios
high price / earnings ratio
The measure of "stock specific" risk is:
a. alpha
b. beta
c. delta
d. sigma
alpha
The market theory that states that technical and fundamental analysis is of no use in selecting stocks for a portfolio is known as the:
a. efficient market theory
b. Keynesian theory
c. monetarist theory
d. market equilibrium theory
efficient market theory
An older female customer, in the lowest tax bracket, wants an investment that will provide asset growth for retirement. The best recommendation would be:
a. emerging markets fund
b. single stock
c. municipal bond
d. index fund
index fund
A portfolio with a beta of +1 has:
a. systematic risk
b. unsystematic risk
c. both systematic and unsystematic risk
d. no risk
systematic risk
What would be the best investment recommendation for a single mother who is in a low tax bracket who wishes to start savings for her young child's college education?
a. municipal bonds
b. treasury bills
c. growth stocks
d. speculative stocks
growth stocks
A wealthy, sophisticated investor with a high risk tolerance has just turned extremely bearish on the market. To profit from this, the best recommendation to the client would be to:
a. buy index calls
b. buy index puts
c. buy inverse floaters
d. buy leveraged inverse ETFs
buy leveraged inverse ETFs
Strategic portfolio management is the selection of the:
a. securities in which to invest
b. asset classes in which to invest
c. target asset allocation for each asset class selected for investment
d. allocation for each asset class selected for investment
target asset allocation for each asset class selected for investment
Tactical portfolio management is the selection of the:
a. securities in which to invest
b. asset classes in which to invest
c. target asset allocation for each asset class selected for investment
d. allocation for each asset class selected for investment
allocation for each asset class selected for investment
Passive asset management is:
a. buying securities positions and holding them to the liquidation date of the portfolio
b. buying securities positions and holding them until pre-established price are reached
c. selected securities to be purchased for each asset class based upon fundamental analysis
d. using index funds as the investments for each assets class
using index funds as the investments for each assets class
Diversification among multiple asset classes reduces the:
I. market risk of the portfolio
II. marketability risk of the portfolio
III. standard deviation of the portfolio returns
market risk of the portfolio
standard deviation of the portfolio returns
A value investor would consider all of the following except a company's:
a. price / earning ratio
b. price / book value ratio
c. stock price growth rate
d. market share
stock price growth rate
When the investment performance of each asset class varies from the anticipated rate of return, the:
a. selection of the type and number of asset classes used for the portfolio must be changed
b. target allocation percentages assigned to each asset class must be changed
c. tactical limits on target allocation percentages for each asset class must be changed
d. portfolio must be rebalanced by liquidating portions of overperforming classes and investing the proceeds in underperforming classes
portfolio must be rebalanced by liquidating portions of overperforming classes and investing the proceeds in underperforming classes
Which statements are TRUE about asset classes and investment time horizons?
I. equity investments are the better choice for short term equity horizons
II. interest bearing investments are the better choice for short term horizons
III. equity investments are the better choice for long term time horizons
IV. interest bearing investments are the better choice for long term time horizons
interest bearing investments are the better choice for short term horizons
equity investments are the better choice for long term time horizons
The use of index funds as investment vehicles for asset classes increases:
a. diversification
b. expected rate of return
c. standard deviation of return
d. market risk
diversification
Active asset managers select investments based primarily upon:
a. inefficient market pricing of the investment
b. efficient market pricing of the investment
c. minimum time needed to achieve projected investment returns
d. minimum number of investments needed to achieve projected investment returns
inefficient market pricing of the investment
If 26-week T-bills are yielding 5%, all common stocks are yielding 10%, and growth stocks are yielding 15%, the risk premium for investing in growth stocks is:
a. 0%
b. 5%
c. 10%
d. 15%
10%
When recommending domestic corporate long-term debt instruments to a customer, which of the following risks is the LEAST important consideration?
a. Inflation (purchasing power) risk
b. market risk
c. credit risk
d. currency exchange risk
currency exchange risk
A new client with no other investment assets has just come into an inheritance of $500,000 of ABCD stock, a blue chip company listed on the NYSE. As the adviser to this customer, your IMMEDIATE concern should be:
a. whether the company is a candidate for delisting
b. the possibility that the value of ABCD stock may decline sharply
c. the lack of diversification of the customer's investment
d. whether the customer paid any estate tax liability due
the lack of diversification of the customer's investment
A customer owns 1,000 shares of XYZZ stock, purchased at $40 per share. The stock is now at $45 and the customer has become extremely bearish on the company. The client asks her representative for an aggressive recommendation. The client should be told to:
a. sell 10 XYZZ 45 call contracts
b. buy 10 XYZZ 45 put contracts
c. sell 1,000 shares of XYZZ and buy 10 XYZZ put contracts
d. sell 10 XYZZ 45 put contracts
sell 1,000 shares of XYZZ and buy 10 XYZZ put contracts
The use of multiple asset classes when constructing a portfolio reduces:
a. regulatory (legislative) risk
b. market (capital) risk
c. interest rate risk
d. purchasing power risk
market (capital) risk
The target allocation for a specific asset class has been set at 20% of total assets under an asset allocation scheme. The manager is permitted to reduce this percentage to 15%; and can increase it to 25%; as he or she sees fit. If this action is taken by the manager, this is termed:
a. portfolio rebalancing
b. strategic asset management
c. tactical asset management
d. active asset management
tactical asset management
Customers who actively trade their listed stock portfolios should have a strong understanding of:
a. liquidity risk
b. inflation risk
c. timing risk
d. call risk
timing risk
A customer, age 69, has never invested in securities. She is retired with no dependents, living on a fixed pension of $35,000 per year. She has a savings account with $160,000 and her home is fully paid. She desires to supplement her retirement income, assuming minimal risk. The BEST recommendation would be for the customer to invest $100,000 of her cash savings into a(n):
a. variable annuity contract
b. CMO planned amortization class tranch
c. SPDR
d. income (adjustment) bond
CMO planned amortization class tranch
Customer Z is a single 26-year-old man who earns $125,000 annually. He informs you that he is getting married and that his new wife's income of $75,000 per year will put them into the highest federal tax bracket. The couple will have investable income of $25,000 per year. The couple wishes to buy a home in 5 years that will be substantially more expensive than the condo in which they currently reside. To meet the customer's needs for the large cash down payment in 5 years and to reduce taxable income, the best recommendation is to:
a. open a margin account and invest in income bonds
b. open a IRA and invest in tax-deferred variable annuities
c. open a cash account and invest in mutual funds holding high yielding common and preferred stocks
d. open a trust account and invest in treasury STRIPS
open a cash account and invest in mutual funds holding high yielding common and preferred stocks
A 60-year-old widow is looking for an investment that will provide safety of principal and a moderate level of income. All of the following recommendations are suitable EXCEPT a(n):
a. income mutual fund
b. income bond
c. US gov bond
d. US gov bond fund
income bond
A couple wants to invest for the college education of their two children, currently ages 1 and 3. They estimate they will need to start using the funds to pay for college in 15 years. The BEST recommendation is to invest in:
a. treasury bills
b. 10 year treasury notes
c. 20 year treasury bonds
d. 30 year treasury bonds
10 year treasury notes
Mature companies are characterized by:
I. High price / earnings ratios
II. Low price / earnings ratios
III. High dividend payout ratios
IV. Low dividend payout ratios
Low price / earnings ratios
High dividend payout ratios
Growth companies typically have which of the following?
I. Low dividend payout ratios
II. High dividend payout ratios
III. Low Price / Earnings ratios
IV. High Price / Earnings ratios
Low dividend payout ratios
High Price / Earnings ratios
A counter-cyclical stock would be described by which of the following?
A. No earnings variability due to changes in economic growth
B. A stock which remains unaffected in good or bad economies
C. A stock price that tends to move in the same direction of the market as a whole
D. A stock price that tends to move in the opposite direction of the market as a whole
A stock price that tends to move in the opposite direction of the market as a whole
All of the following are defensive stocks EXCEPT:
A. Beer Manufacturer
B. Supermarket Chain
C. Home Builder
D. Public Utility
Home Builder
Which of the following securities are directly interest rate sensitive?
I. Utility Stocks
II. Growth Stocks
III. Preferred Stocks
IV. Common Stocks
Utility Stocks
Preferred Stocks
Which of the following best describes a stock that pays out most of its earnings as dividends?
A. Income stock
B. Special situations stock
C. Defensive stock
D. Blue Chip stock
Income stock
Historically, which of the following investments has provided the highest return over time?
A. Treasury Bills
B. Treasury Bonds
C. Listed common stocks
D. Listed corporate bonds
Listed common stocks
Which of the following investment portfolios is MOST liquid?
A. An aggressive growth fund
B. A U.S. Government bond fund
C. A money market fund
D. An income fund
A money market fund
By definition, a money market instrument is liquid. They are readily traded at a discount equal to the market rate of interest because any purchaser knows that he or she will be paid when it matures in the near future. Long term governments are not as liquid - there is not nearly as much long term government debt outstanding as there are T-Bills (the biggest of the money market instruments), making these somewhat less liquid. Income funds are composed mainly of high yielding preferred stocks and corporate bonds. These are not as liquid as U.S. Government issues. Finally, aggressive growth stocks are the least liquid of the choices offered, since they are not traded on the NYSE, but rather OTC - which is a less liquid marketplace.
Which of the following investments is LEAST liquid?
A. Mutual funds
B. Long term corporate bonds
C. Private placements
D. Closed-end funds
Private placements

Closed-end funds trade like any other stock, so they are highly liquid. Corporate bonds are traded OTC and have slightly higher liquidity risk than listed securities, but the trading market for these is active. Mutual funds do not trade, but they are redeemable every business day. In contrast, private placement securities cannot be traded in the public markets, either on an exchange or OTC. The only way to "cash out" is to sell the private placement to someone else in a private securities transaction, which is difficult to do. These are the least liquid securities.
Which of the diversification factors below will not reduce the non-systematic (credit) risk of a bond portfolio?
A. Maturity
B. Industry in which issuer operates
C. Coupon rate
D. Geographic location of issuer
Coupon rate

The coupon rate has no bearing on diversification to reduce potential credit risk. In the trading market, the price of a bond is determined by the market yield for that type of security - not the coupon rate. To reduce non-systematic risk (meaning the risk that any one security may be a "bad" investment), diversification of a bond portfolio by choosing different issuers, different industries, different geographic issuer locations, and different maturities (since long term bonds give issuers longer time periods in which they can go broke) are all valid.
Passive asset management is:
A. buying securities positions and holding them to the liquidation date of the portfolio
B. buying securities positions and holding them until pre-established prices are reached
C. selecting securities to be purchased for each asset class based upon fundamental analysis
D. using index funds as the investments for each asset class
using index funds as the investments for each asset class

Passive asset management does not mean that there is no management. Passive asset management is the use of index funds (which are managed to mirror a chosen index benchmark) as the security selections within an asset class. Thus, the actual specific security selection and management is embedded within the index fund chosen for investment.
Active portfolio management is:
A. buying and holding the investments chosen by the Registered Representative
B. determining the securities to be bought or sold based on investment research performed by the Registered Representative
C. managing a portfolio to meet the performance of a benchmark portfolio
D. managing a portfolio to exceed the performance of a benchmark portfolio
managing a portfolio to exceed the performance of a benchmark portfolio
Establishing the structure of a portfolio to meet specific financial goals is called:
A. Strategic allocation
B. Tactical allocation
C. Rebalancing
D. Risk adjustment
Strategic allocation
Which of the following are appropriate investment strategies for a client with a 20-year time horizon?
I. Holding less cash
II. Holding more stock
III. Holding less bonds
All of them
Value investors:
A. seek to find investments that are undervalued by the market
B. determine the value of a security through fundamental analysis
C. invest in securities included in the Value Line Index
D. make their investment decision based upon the market performance of the security
seek to find investments that are undervalued by the market
An investment strategy where a higher price is paid for a stock based upon expected returns is:
A. growth investing
B. value investing
C. conservative investing
D. passive investing
growth investing
When the investment performance of each asset class varies from the anticipated rate of return, the:
A. selection of the type and number of asset classes used for the portfolio must be changed
B. target allocation percentages assigned to each asset class must be changed
C. tactical limits on target allocation percentages for each asset class must be changed
D. portfolio must be rebalanced by liquidating portions of overperforming classes and investing the proceeds in underperforming classes
portfolio must be rebalanced by liquidating portions of overperforming classes and investing the proceeds in underperforming classes
A customer has an existing portfolio that is mainly invested in high quality corporate bonds for stable income. As market interest rates have dropped, the customer's income has declined and she would like to reallocate part of the portfolio to corporate bonds that offer potential growth. The BEST recommendation is to buy:
A. convertible debentures
B. equipment trust certificates
C. long term zero coupon bonds
D. commercial paper
convertible debentures
A customer calls her registered representative and says the following: "I'm looking for a safe investment for $100,000 that I have, that will give me a moderate level of income. I have 2 children, ages 12 and 13, and I will need to use these monies to pay for their college education, starting in 5 years." All of the following recommendations would be suitable EXCEPT:
A. Treasury bond mutual fund
B. Treasury bonds with 5, 6, 7, 8, and 9 year maturities
C. GNMA pass-through certificates with 5, 6, 7, 8, and 9 year maturities
D. FNMA debentures with 5, 6, 7, 8, and 9 year maturities
GNMA pass-through certificates with 5, 6, 7, 8, and 9 year maturities
A retired customer that has a portfolio of blue chip stocks is looking to supplement his retirement income. An appropriate recommendation would be to:
A. sell covered calls
B. sell naked calls
C. sell covered puts
D. sell naked puts
sell covered calls

Covered call writing is the most popular retail income strategy in a flat market, and is appropriate for conservative investors that are looking for extra income. The customer sells calls against stock that is already owned, getting premium income. If the stock stays flat, the calls expire and the customer keeps the premium. If the stock rises, the calls are exercised and the stock is called away at no loss to the customer. If the market falls, the calls expire and the customer loses on the stock (which he would have lost on anyway!).
A customer in a low tax bracket has just inherited $10,000 and is looking for an investment that will provide current income and liquidity. The BEST recommendation is a:
A. Corporate Bond ETF
B. Variable Rate Bond
C. Municipal Bond Fund
D. Treasury STRIPS
Corporate Bond ETF

The Corporate Bond ETF is liquid because it is exchange traded, and it provides taxable income from its bond investments. Because the customer is in a low tax bracket, lower yielding tax-free municipal bond investments are not appropriate.
Variable rate bonds would be good investment if it is expected that interest rates would rise (a point not addressed in this question), but direct bond investments are not that liquid, unless they are Treasury or Agency bonds. Treasury STRIPS are a liquid investment (a ready market exists at all times and they are easy to trade with low transaction costs), but they do not give current income. These are zero-coupon issues.
A retired customer has an existing stock portfolio held in a cash account. He has heard that "leveraging" his portfolio can increase his return. The portfolio holds blue chip stocks that pay current dividends. He wants to transfer the positions to a margin account and use them as collateral to buy more stocks of the same blue chip companies. Which statement is TRUE?
A. This is an appropriate strategy that will increase the customer's income
B. This is not an appropriate strategy because the customer's tax liability will increase if the securities appreciate and are sold
C. This is not an appropriate strategy because the customer's income will decline
D. This is an appropriate strategy because the customer has the potential for larger capital gains
This is not an appropriate strategy because the customer's income will decline

This customer needs income. If he margins the blue chip stock positions to "double up" on the amount of stock owned (since Regulation T margin is 50%), this does not come for free! He is borrowing the extra money to buy the new shareholding, using his existing stock as collateral, and he must pay interest on the loan. The interest charge will eat up any dividends that the stocks pay - so there goes his income!
A young couple wishes to save $50,000 as the down payment on a new house that they plan to purchase in the next 6 months. Which of the following are suitable investment vehicles to recommend to the couple?
I. Money market funds
II. Bank certificates of deposit
III. Blue chip stocks
IV. Commercial paper
Money market funds
Bank certificates of deposit
Commercial paper

This couple needs $50,000 cash in 6 months. Clearly, money market funds and bank certificates of deposit are suitable. Blue chip stocks are not suitable, since they are subject to market risk. Commercial paper is usually not marketed to individuals; it is mainly an institutional market. However, some corporations sell commercial paper directly to customers in minimum $10,000 units via their websites. This is another very safe short term investment, and is suitable.
A younger female customer, in the highest tax bracket, already has a substantial investment portfolio that is invested in a balance of quality stocks and bonds. She wants an investment that will provide rapid asset growth and is willing to assume risk. The BEST recommendation would be:
A. Emerging markets fund
B. Single stock
C. Municipal bond
D. Index fund
Emerging markets fund

Since this customer already has a balanced quality portfolio and is looking for rapid growth, an emerging markets fund would give the customer the rapid growth she is seeking (along with greater risk).
A 79-year old customer in the highest tax bracket with $1,000,000 to invest is risk averse. Which investment recommendation would be appropriate?
A. Money market funds
B. Municipal bonds
C. A Dow Jones Industrial Average index fund
D. Certificates of deposit
Municipal bonds

Since this customer is in the highest tax bracket, and appears to be wealthy (with $1,000,000 to invest), tax-free municipal bonds are the best recommendation.
An older female customer, in the lowest tax bracket, wants an investment that will provide asset growth for retirement. The best recommendation would be:
A. Emerging markets fund
B. Single stock
C. Municipal bond
D. Index fund
Index fund

A municipal bond is not appropriate for a low tax bracket customer and it does not give growth. An emerging markets fund certainly offers high growth, but it also high risk and this customer is "older." A single stock might be a great investment, but there is no diversification. An index fund gives growth potential with diversification and is the best of the choices offered.
A 60-year old man, whose investment objectives are income and capital gains, wishes to buy securities that allow for liquidity during the trading day. The BEST recommendation would be:
A. ETFs
B. ETNs
C. UITs
D. Mutual Funds
ETFs

Both ETFs (Exchange Traded Funds) and ETNs (Exchange Traded Notes) trade, so they allow for liquidity during the trading day. There is no trading of mutual funds and UITs - these are redeemable securities. Mutual funds can be redeemed at NAV based that the close of the trading day; UITs are redeemable with the marketing agent, who will buy them at current NAV and remarket them to another investor for their remaining value.
A 70-year old client wants to invest in U.S. Treasury securities. When performing the suitability determination, the client informs the registered representative that he is looking for after-tax income, liquidity, and to avoid market risk. The registered representative should be LEAST concerned with the:
A. client's tax bracket
B. client's age
C. coupon of recommended Treasury securities
D. maturity of recommended Treasury securities
client's age

Since Treasury securities are the safest security, they are an appropriate recommendation for a 70-year old client. So age really is not a concern with this recommendation. The client's tax bracket is a concern because the income is Federally taxable. If the client is in the highest tax bracket, maybe municipal bonds would be a better recommendation. The coupon of the recommended Treasury securities is important because this client wants income. Regarding the maturity of the recommended Treasury securities, the recommendation of a 30-year bond as opposed to a shorter-term investment could subject the customer to a high level of market risk (loss of market value if interest rates rise). This is another concern, since the customer wants to avoid market risk.
An elderly customer seeking extra income who has $100,000 to invest could be recommended which of the following?
I. The $100,000 purchase of a variable annuity
II. The $100,000 purchase of dividend paying blue chip stocks in a cash account against which calls are sold
III. The $200,000 purchase of dividend paying blue chip stocks at 50% margin in a margin account
IV. The $100,000 purchase of Treasury bonds
The $100,000 purchase of dividend paying blue chip stocks in a cash account against which calls are sold
The $100,000 purchase of Treasury bonds

The purchase of a variable annuity is not suitable for an elderly customer. The whole concept behind a variable annuity is that the product has time to build value on a tax deferred basis in the separate account prior to annuitization. An elderly customer needs the income now.
A Registered Investment Adviser has a retired client who wishes to put aside funds for the purchase of a car 5 years from now. Preservation of capital is important to this client. The RIA should recommend investments in:
I. Money market funds
II. Bank certificates of deposit
III. 5 Year Treasury Bonds
IV. 30 Year Treasury STRIPS
Money market funds
Bank certificates of deposit
5 Year Treasury Bonds

This customer needs funds in 5 years and preservation of capital is important to the client. Money market funds and bank certificates of deposit are clearly suitable. The 5 year Treasury Bond works as well, since the funds are needed in 5 years and this bond will mature at that time. The 30 year Treasury STRIPS is clearly unsuitable, since in 5 years, its value may have dropped sharply if interest rates rise (bonds with low coupons and long maturities are most affected by interest rate risk).
A new client who is in the lowest tax bracket has 2 young children. He has just inherited $10,000 and wants to use the money to invest for the college education of both children. The client has never invested before and states that he wants an investment with no risk. What recommendation is appropriate?
A. Municipal bonds
B. Treasury bills
C. Municipal bond fund
D. Blue chip stocks
Treasury bills

The key wording here is that the customer wants "no risk." The only risk-free security offered as a choice is T-Bills. It could be argued that blue chip stocks would be a better choice to build a college education fund over a long-term time frame, but they are not risk free. Also note that municipal bonds are not appropriate because the customer is in the lowest tax bracket.
A self-employed client has an annual income of $200,000 and is in a high tax bracket. He is not covered by a retirement plan and would like to make the maximum contribution to one to reduce his taxable income. He believes that he will be in a lower tax bracket once he retires. The BEST recommendation is to contribute to a:
A. Traditional IRA
B. Roth IRA
C. 401(k)
D. SEP IRA
SEP IRA

A Roth IRA does not work for 3 reasons - the maximum contribution is only $5,500 (in 2017); the contribution is not deductible; and this person is a high earner and cannot use a Roth. He can use a Traditional IRA, but it only allows for a maximum contribution of $5,500. A 401(k) plan allows for a larger deductible contribution ($18,000 in 2017), but it is really designed for big companies because it is expensive to set up and run. It does not really work for self-employed persons. A SEP (Simplified Employee Pension) IRA is designed for self-employed individuals and small employers. It is easy to set up and administrate and it allows for maximum contribution equal to 20% of income (25% statutory rate), capped at $54,000 in 2017. It would allow this self-employed individual to make a 20% x $200,000 = $40,000 deductible contribution.
A 57-year old customer, earning $85,000 per year, is currently employed as an outside salesman. He enjoys his work so much that he has no intention of retiring until at least age 75. He wants to put extra money away for his retirement at that time and can make contributions of about $5,000 per year. He does not want to be forced to take distributions starting at age 70 1/2. The BEST type of retirement plan for this individual is a:
A. Traditional IRA
B. Roth IRA
C. Coverdell ESA
D. 401(k) Plan
Roth IRA

Only a Roth IRA permits contributions to continue after age 70 1/2 if one is still working and only a Roth IRA does not require that distributions start at age 70 1/2. Roth IRA contributions are not deductible; the account grows tax deferred; and when distributions are taken, no tax is due. These are great from a tax standpoint, but they are not available to high-earning individuals (this individual is not a "high-earner" and is below the income phase-out range. Distributions from Traditional IRAs and 401(k) accounts must start at age 70 1/2 and are taxable. Coverdell ESAs (Education Savings Accounts) are not retirement plans.
If a portfolio manager's market sentiment is bullish, then which of the following are appropriate actions?
I. Cash positions will be decreased
II. Cash positions will be increased
III. Investments in stock positions will be decreased
IV. Investments in stock positions will be increased
Cash positions will be decreased
Investments in stock positions will be increased

From a "market sentiment" standpoint, a portfolio manager will decrease his or her cash position; and increase the portion of funds invested in securities, when he or she is bullish on the market. Conversely, if the manager is bearish, he or she will increase the cash position and decrease the invested portion of the portfolio.
Institutional portfolio managers have been allocating an increasing percentage of their funds to cash and cash equivalent positions. This is an indication that their market sentiment is:
A. bullish
B. neutral
C. bearish
D. cautious
bearish

From a "market sentiment" standpoint, a portfolio manager will increase his or her cash position; and decrease the portion of funds invested in securities, when he or she is bearish on the market. Conversely, if the manager is bullish, he or she will decrease the cash position and increase the invested portion of the portfolio.
A customer has a $1,000,000 portfolio that is invested in the following:
$250,000 Large Cap Growth Stocks
$250,000 Large Cap Defensive Stocks
$250,000 U.S. Government Bonds
$250,000 Investment Grade Corporate Bonds

During a period of economic expansion, the securities which will enjoy the greatest price appreciation are likely to be the:
I. Large Cap Growth Stocks
II. Large Cap Defensive Stocks
III. U.S. Government Bonds
IV. Investment Grade Corporate Bonds
Large Cap Growth Stocks
Investment Grade Corporate Bonds

In a period of economic expansion, growth companies do well, so their stock prices increase. Defensive companies are those that are unaffected by the general economy (such as drug companies), so an economic expansion does not give their business an added boost, and their stock prices do not benefit as much from the improved economic conditions. In a period of economic growth, investors that hold bonds tend to sell their government bond holdings and buy more corporate bonds that give a higher yield. This gives a price boost to corporate bonds during a period of economic expansion.
A customer account holds the following:
10% Market Index-Linked CDs
20% Plain Vanilla CMOs
20% ACME Drug Company shares
10% REITs
25% Health Care Sector ETFs
15% Growth Fund Shares

This portfolio is MOST susceptible to which risk?
A. market risk
B. business risk
C. interest rate risk
D. purchasing power risk
business risk

This portfolio is concentrated in the Health Care sector, with 25% of the portfolio being in Heath Care ETFs and 20% in a drug company. A portfolio concentrated in one stock or industry is susceptible to business risk - the risk that the business may turn sour. For drug companies, this can result from existing profitable drugs losing patent protection, so prices and profitability drops; class-action lawsuits for selling dangerous drugs, etc.
A customer has the following investment mix:
25% Growth Stocks
25% Defensive Stocks
25% High Quality Corporate Bonds
25% Speculative Stocks

During a period of economic expansion, the best performing asset classes are likely to be:
I. Growth Stocks
II. Defensive Stocks
III. High Quality Corporate Bonds
IV. Speculative Stocks
Growth Stocks
Speculative Stocks

During a period of economic expansion, growth stocks and speculative stocks perform well compared to the overall market. However, during a period of recession, these tend to decline in value. In contrast, in a period of expansion, defensive stocks (stocks unaffected by an overall market downturn, such as pharmaceuticals and food) and high quality corporate bonds underperform the overall market by not increasing in price as rapidly; but in a period of recession, they outperform the overall market, since they don't readily lose value.
When making a recommendation of a 10 year Treasury Note to a customer, the MOST important risk consideration is:
A. liquidity risk
B. credit risk
C. market risk
D. call risk
market risk

Market risk for a bondholder is the risk of rising interest rates forcing the price of a bond to drop, with longer maturity issues dropping fastest. 10-Year Bonds have a fairly long term maturity and are subject to this risk. The other risks are not applicable to Treasury Notes. The Treasury market is the most active trading market in the world. Treasuries have no default/credit risk (because of the Government guarantee); and are non-callable.
A constant ratio investment plan is one which:
A. invests a fixed percentage amount periodically in equity securities
B. invests a fixed percentage amount periodically in debt securities
C. maintains a fixed percentage amount of a portfolio's assets in equities
D. maintains a dollar amount of a portfolio's assets in debt
maintains a fixed percentage amount of a portfolio's assets in equities

Under a constant ratio plan, a portfolio manager sets a fixed percentage level (say 70% of total asset value) to be maintained in equity securities. If the value rises above 70%, the excess is invested in debt securities. Conversely, if the equity market value drops below 70% of the portfolio, bonds are liquidated and invested in equities to bring the equity balance to the constant 70%.
The "Efficient Market Theory" states that:
I. undervalued securities should exist
II. undervalued securities should not exist
III. overvalued securities should exist
IV. overvalued securities should not exist
undervalued securities should not exist
overvalued securities should not exist

The "Efficient Market" Theory holds that prices of securities in the market fully reflect all publicly available information, so that undervalued or overvalued securities should not exist. Thus, securities selection based on any type of analytical method is irrelevant. In reality, most individuals believe that the market is only "partly" efficient in pricing securities - so that undervalued and overvalued securities will always exist. These could be identified by both fundamental and/or technical analysis.
The Capital Asset Pricing Model (CAPM) is a methodology that values securities based upon:
A. fundamental analysis of the company
B. technical analysis of the company
C. the issue's risk-free rate of return plus a risk premium
D. book value of the issuer plus intangible asset value
the issue's risk-free rate of return plus a risk premium

CAPM is a methodology for finding the most efficient investments - those that give the greatest return for the amount of risk assumed. The model identifies the most efficient investments as those that give a rate of return equal to the "risk-free" rate of return (the rate of return for investments only having systematic risk) plus a premium for any non-systematic risk inherent in the investment.
Which of the following statements is TRUE about non-systematic risk?
I. It is the same as stock selection risk
II. It is the same as market risk
III. It can be diversified away
IV. It cannot be diversified away
It is the same as stock selection risk
It can be diversified away

Market risk is the same as systematic risk. It is the risk of the market moving adversely, and one's securities positions moving with the market. This risk cannot be diversified away; but it can be hedged against. Non-systematic risk is the portion of risk in a portfolio that is "stock specific." Also known as selection risk, this can be diversified away by adding more and more stocks to the portfolio, until the portfolio becomes reflective of the "market" as a whole.
Which of the investments listed below offers the greatest protection against market risk?
A. Common Stocks
B. Treasury Bills
C. Preferred Stocks
D. Treasury Bonds
Treasury Bills

Market risk is the risk the securities prices, as a whole, will fall, dragging down both good and bad investments. To minimize market risk, common stocks should be avoided, as should long term fixed income securities, such as preferred stock and long bonds. To minimize this risk, investors "flee to safety" in the form of Treasury Bills. These are the safest type of credit - backed by the U.S. Government; and the price cannot drop that much because of their short term maturities. Since they will be redeemed shortly at par, the price cannot fall much below par, no matter what happens to the market as a whole.
Which statement is TRUE about a stock's Beta Coefficient?
A. Beta measures price movement of a stock relative to its industry
B. Beta measures price movement of a stock relative to the market
C. Beta measures the credit rating of a stock relative to its industry
D. Beta measures the credit rating of a stock relative to the market
Beta measures price movement of a stock relative to the market

The "Beta" coefficient is a measure of price volatility of a stock (or a portfolio) relative to the market. A Beta of +1 indicates that a particular security moves as fast, and in the same direction, as the market. A Beta of +1/2 indicates that the stock's price moves half as fast, and in the same direction, as the overall market.
Which statement is TRUE regarding a portfolio that has a "Beta" of +1?
A. Changes in the value of the portfolio should be both in the same direction and velocity as price movements in the market
B. Changes in the value of the portfolio should be at the same velocity, but opposite direction to price movements in the market
C. Changes in the value of the portfolio should be in the same direction, but greater velocity than market price movements
D. Changes in the value of the portfolio should be in the same direction, but lower velocity than market price movements
Changes in the value of the portfolio should be both in the same direction and velocity as price movements in the market

A portfolio with a "beta" coefficient of +1 is one that moves in both the same direction and same velocity as the market as a whole. A portfolio with a "beta" coefficient of +2 is one that moves in the same direction as the market as a whole, but which moves twice as fast as the market.

A portfolio with a "beta" coefficient on -1 is one that moves at the same velocity as the market as a whole, but it moves in the opposite direction to the market. There are very few "negative" beta stocks - gold stocks being one of them. When the stock market "tanks," investors flee to safety -gold - so these stocks rise when the market falls, and vice-versa.
Which of the following statements are TRUE about a stock's Beta coefficient?
I. A Beta of -1 indicates that the stock moves as fast as, but in the exact opposite direction of, the market
II. A Beta of -1 indicates that the stock moves as fast as, and in the same direction as, the market
III. A stock with a negative beta is a cyclical stock
IV. A stock with a negative beta is a counter-cyclical stock
A Beta of -1 indicates that the stock moves as fast as, but in the exact opposite direction of, the market
A stock with a negative beta is a counter-cyclical stock
The alpha coefficient is a measure of:
I. stock specific risk
II. market risk
III. a stock's price movement relative to the market as a whole
IV. a stock's price movement independent of the market as a whole
stock specific risk
a stock's price movement independent of the market as a whole