Deck 9: Investment Management: Concepts and Strategies

Question 1

Distinguish between fundamental analysis and technical analysis.

Answer 1

This topic is extensively covered on pages 432 through 440 of the text.

Question 2

Why is the periodic rebalancing of a portfolio important?

Answer 2

Because of the market's strong advances in the 1990s, and subsequent declines since the beginning of 2000, it is likely that the equity portion of investors' portfolios has significantly changed, throwing off the original asset allocation distribution.
One effective way of guarding against risk creep and maintaining a consistent investment strategy is to regularly rebalance the portfolio. This simply means periodically shifting money among the various asset classes in order to keep the portfolio diversification in line with the desired asset allocation strategy.

Question 3

Write a short essay on Beta.

Answer 3

The measure of stock risk, which is commonly referred to as a beta, or beta coefficient, is an index of the risk that measures the volatility of the security's return relative to the market. The reference point is an aggregate measure of the market, such as the Standard & Poor's 500 Index. A beta of 1 means that the stock's return generally moves with the market index. A beta of less than 1 indicates that the stock's return fluctuates less than the market, and a beta of more than 1 suggests that the stock's return fluctuates more than the market.
Like an individual security, a portfolio of stocks and bonds can be assigned a beta value. A portfolio beta is a weighted average of betas for the individual securities. To calculate the weighted average, the beta for each security in the portfolio is multiplied by that security's weight in the portfolio. The resulting betas are then added together to find the overall beta for the portfolio.
Beta values play an important role in the construction of an investor's portfolio. By constructing a diversified portfolio of assets (stocks, bonds, money market funds, and so on) issued by firms from different industries (manufacturing, utility, transportation, and so on) and by various levels of government (federal, state, local agencies), an investor attempts to eliminate, or significantly reduce, the diversifiable risk to arrive at an acceptable portfolio beta.

Question 4

Is there a strategy for selling bonds?

Question 5

What are the important steps in the development of the AAM?

Question 6

What is meant by risk-reward connection?

Question 7

Are the strategies different for dealing with the two types of common stock risks?

Question 8

What are the strategies for selling the stock?

Question 9

Based on the results of various studies, what statements can you make about the AAM?

Question 10

Explain the different types of risk associated with fixed income securities.

Question 11

List the key benefits of the AAM.

Question 12

Describe the strategies available for reducing risk on equity investments.

Question 13

When is it appropriate to consider selling a mutual fund?

Question 14

How do you calculate your tax liability on your mutual fund investment?

Question 15

Describe the concept of the efficient frontier.

Question 16

Explain the nature of common stock risk.

Question 17

Describe strategies that can be used to reduce bond risks.

Question 18

Explain the basic concept of the Asset Allocation Model.

Question 19

Describe the key measures of measuring equity risk.

Question 20

Explain the rating system used by Morningstar.

Question 21

After you have explained the concept of the AAM, Jim Waddel has approached you with the following "If you keep on reorganizing my investment portfolio by applying the AAM, won't that amount to a churning of my portfolio?"

Question 22

Question 7. You have purchased a 30-year bond with a coupon of 7%. If you hold it to maturity, your annual return would be:

A) 7.25%
B) 7%
C) Less than 7%
D) None of the above

Question 23

Question 6. If you have purchased 100 shares of ABC stock at $8 per share, and a year later the price of the stock was $12 per share, what would be your capital appreciation rate for the first quarter of the year?

A) 25%
B) 50%
C) 100%
D) Unable to determine

Question 24

Question 15. The standard deviation of the stock A is twice as high as the stock

A) in bull markets their returns will probably be the same
B) Which of the following statements is the most correct?
B) in bull market stock A will probably produce a higher return
C) in bear market stock B will probably decline more than stock A
D) in flat market stock B will probably outperform S&P 500

Question 25

Question 3. The longer an investor parts with her funds, the more uncertain she is about the prospect of realizing a capital loss. This statement refers to ________ risk?

A) default
B) liquidity
C) market
D) maturity
E) liability

Question 26

Question 4. Laddering will help you achieve all these goals except:

A) Purchase at prevailing market rates
B) Diversify your portfolio
C) Protect yourself from market downturn
D) Decrease portfolio volatility

Question 27

Question 2. If the interest rates rise, which of the following will be true?

A) The 15-year bond price will decline more than the 30-year bond price
B) The price of the 10-year bond will rise while the price of the 15-year bond will decline
C) The prices of different bonds will move in a different way
D) None of the above

Question 28

Question 8. When purchasing common stock, an investor assumes:

A) market/diversifiable or non-market/undiversifiable risk
B) market/undiversifiable or non-market/diversifiable risk
C) non-market/diversifiable or market/diversifiable risk
D) market risk
E) B and D

Question 29

Question 11. The Beta of the stock is 0.89. You can come to conclusion that:

A) this is a low risk stock
B) the stock usually fluctuates less than S&P 500
C) sudden sharp movements of Dow Jones Industrial Average will not affect the stock
D) in advancing market, this is a good investment choice

Question 30

Question 10. To deal with undiversifiable risk you could:

A) require higher returns from investments with higher risks
B) require lower returns from investments with higher risks
C) require higher returns from investments with lower risks
D) none of the above

Question 31

Question 5. All of the following can be classified as risk reduction strategies for bond purchasing except:

A) Buying both domestic and international bonds
B) Investing in tax-exempt bonds
C) Investing in taxable bonds
D) Using dollar cost averaging strategy

Question 32

Question 14. The three methods of taxing mutual fund gains are:

A) Average Cost Method, FIFO Method, and LIFO Method
B) FIFO Method, LIFO Method, and Specific Identification Method
C) Average Cost Method, Minimum Balance Method, and Specific Identification Method
D) FIFO Method, Average Cost Method, and Specific Identification Method
E) FIFO Method, Average Cost Method, and Valuation Method

Question 33

Question 9. Market risk refers to all of the following except:

A) recessions
B) changes in company's management
C) political developments
D) investor psychology

Question 34

Joe McCarthy is excited about buying a bond that yields 14 percent. The stockbroker is trying to sell the bond arguing that this bond is relatively safe and that, at that rate, Joe will double his money in five years. Joe wants to know if he is being misled by the broker.

Question 35

Maria Entell has read in a financial column that market timing can quadruple a person's investment in less than five years. She wants to know if this claim is valid. What is your advice?

Question 36

Sylvia Tower refuses to move her money from a CD because, as she puts it, CDs are safe and riskless. Can you enlighten Sylvia on this issue?

Question 37

Question 12. The key measures of risk are all of these except:

A) Alpha
B) Beta
C) Delta
D) Standard deviation

Question 38

Question 13. Which of the following statements is true?

A) A beta measures the volatility of a security return compared to the market
B) A beta of 1 indicates that the stock is more volatile than the market
C) A portfolio of stocks cannot be assigned a beta
D) Stocks with a beta lower than one would likely have a higher expected return
E) A and D

Question 39

Dick Light is excited about investing a substantial amount in Chrysler stock, because in recent months, the stock has had a spectacular growth. Dick has asked you for your recommendation.

Question 40

Question 1. Joe Turner purchased a bond. As a result of an increase/decrease in market interest rates, the price of this bond falls/rises. This is an example of which type of risk?

A) Interest rate
B) Market
C) Inflation
D) Liquidity
E) A and C

Question 41

Question 17. Morningstar's 4-star rating guarantees:

A) that the fund will outperform the market in the next calendar year
B) that the investors will gain higher returns if they buy this fund
C) that the fund will suffer smaller losses than the market in case of the market downturn
D) none of the above

Question 42

Question 33. Which of the following statements is not one of the steps in the Asset Allocation Model?

A) Short-term direction of interest rates
B) Asset split
C) Selection of investment arenas
D) Percentage assignment to favorite investments
E) None of the above

Question 43

Question 25. The best way to minimize tax liability when selling mutual fund shares would be to

A) calculate cost basis using FIFO approach
B) calculate cost basis using average cost approach
C) calculate cost basis using specific identification approach
D) disregard cost basis

Question 44

Question 27. The Modern Portfolio Theory is based upon

A) Capital Asset Pricing Model
B) Markowitz Model
C) Sharpe Ratio
D) A and B only

Question 45

Question 30. We should invest globally for all of the following reasons except:

A) ½ of the world's stock market values are outside of the US
B) overseas markets may not be correlated with the US markets
C) it increases our diversification
D) foreign investments provide higher returns, especially emerging markets

Question 46

Question 26. You are trying to build an optimum portfolio for your client. Which combination of mutual funds would be the best:

A) growth, income, international, and balanced-1 of each
B) growth, income, international, and balanced-2-3 of each
C) growth, income, and balanced - 3 of each
D) growth and income only, 5 of each

Question 47

Question 31. The efficient frontier is the curve on which:

A) the least efficient portfolios appear
B) the most efficient portfolios appear
C) both efficient and inefficient portfolios could appear, depending upon the prevailing market conditions
D) portfolios of only efficient investors could appear

Question 48

Question 20. All of these are risk management techniques except:

A) Dollar Cost Averaging
B) Constant Ratio Plan
C) Writing Covered Calls
D) Writing Uncovered Calls

Question 49

Question 19. You have placed a stop limit order. It means that:

A) you are guaranteed an execution at the limit price when the stock hits the stop price
B) you are guaranteed an execution at the stop price when the stock hits the limit price
C) you are not guaranteed an execution
D) none of the above

Question 50

Question 22. You are using a Constant Ratio Plan. If the market goes down, you

A) put more money into the money fund
B) put more money into the stock fund
C) put equal amounts of money into each fund
D) none of the above

Question 51

Question 23. You write a covered call when you

A) own the stock
B) do not own the stock
C) want to buy the stock
D) want to sell the stock

Question 52

Question 28. All of the following are basic assumptions of the CAPM except:

A) Investors are risk-averse
B) Investors want to maximize their returns
C) Investors optimize their portfolios by avoiding risky assets
D) Investors use diversification

Question 53

Question 32. Asset Allocation Model users take all of the following steps in constructing a portfolio except:

A) determining the investor's risk tolerance
B) analyzing the prevailing market conditions
C) waiting for a temporary market reversal to obtain better pricing
D) determining allocation of funds among major asset classes

Question 54

Question 18. You placed a stop market order. It means that:

A) you are guaranteed to get out of stock at stop price
B) you will get out of stock when the stop price is hit
C) you are not guaranteed to get out of stock
D) none of the above

Question 55

Question 24. To determine the cost basis for your mutual fund shares, you can use

A) Specific Identification Method
B) First-in, First-out Method
C) Average Cost Method
D) All of the above

Question 56

Question 16. Stock A has a lower Sharpe ratio than stock

A) historically stock A performed better than stock b
B) It means that:
B) in a bull market stock B performs better than stock A
C) shareholders of stock A are less exposed to market risk than shareholders of stock B
D) none of the above

Question 57

Question 21. Dollar Cost Averaging:

A) guarantees a profit on your stock sale
B) reduces the effect of market fluctuations in the long run
C) prevents a loss on your stock sale
D) is a good tool for a day trader

Question 58

Question 29. None of the following is true except:

A) To diversify properly you need to buy dozens of securities
B) To diversify properly you need to buy about 15 securities
C) You cannot diversify properly, no matter how many securities
D) You don't need to diversify if your securities are blue chips