Online Quiz

Part I (Easy questions)

1. Which one of the following terms best describes Eurodollars?

A. Dollar-denominated deposits only in European banks.
B. Dollar-denominated deposits at branches of foreign banks in the U.S.
C. Dollar-denominated deposits at foreign banks and branches of American banks outside the
U.S.
D. Dollar-denominated deposits at American banks in the U.S.
E. Dollars that have been exchanged for European currency.

Answer: C

2. A year ago, you invested $10,000 in a savings account that pays an annual interest rate of
5%. What is your approximate annual real rate of return if the rate of inflation was 1.5% over
the year?
A. 3.5%
B. 10%
C. 7%
D. 4%

Answer: A

3. A form of short-term borrowing by dealers in government securities is:

A. reserve requirements.
B. repurchase agreements.
C. bankers' acceptances.
D. commercial paper.
E. brokers' calls.

Answer: B

4. You have been given this probability distribution for the holding-period return for KMP stock:
Stock of the EconomyProbability HPR
Boom 0.30 18%
Normal growth 0.50 12%
Recession 0.20 –5%

What is the expected holding-period return for KMP stock?

 A. 10.40%
B. 9.32%
C. 11.63%
D. 11.54%
E. 10.88%

Answer: A
HPR = 0.30 × (18%) + 0.50 × (12%) + 0.20 × (−5%) = 10.4%.

5. You purchased 100 shares of IBM common stock on margin at $130 per share. Assume the
initial margin is 50%, and the maintenance margin is 30%. Below what stock price level
would you get a margin call? Assume the stock pays no dividend; ignore interest on margin.
A. $21.24
B. $92.86
C. $49.52
D. $80.33
E. $130.00

Answer: B
100 shares × $130 × 0.5 = $13,000 × 0.5 = $6,500 (loan amount); 0.30 = (100P − $6,500) ÷ 100P;
30 − P = 100P − $6,500; −70P = −$6,500; P = $92.86.

6. Assume you sold short 100 shares of common stock at $50 per share. The initial margin is
60%. What would be the maintenance margin if a margin call is made at a stock price of
$60?
A. 40%
B. 33%
C. 35%
D. 25%
E. None of the options are correct.

Answer: B
$5,000 × 1.6 = $8,000; [$8,000 − 100($60)] ÷ 100($60) = 33%.

7. The risk premium for common stocks ___

A. must always be zero, for investors would be unwilling to invest in common stocks.
B. is negative, as common stocks are risky.
C. cannot be zero, for investors would be unwilling to invest in common stocks and must
always be positive, in theory.
D. cannot be zero, for investors would be unwilling to invest in common stocks and is negative,
as common stocks are risky.

Answer: C
 8. You have been given this probability distribution for the holding-period return for Cheese,
Incorporated stock:
Stock of the Economy Probability HPR

Boom 0.20 24%

Normal growth 0.45 15%

Recession 0.35 8%

Assuming that the expected return on Cheese's stock is 14.35%, what is the standard deviation of
these returns?

A. 4.72%
B. 6.30%
C. 4.38%
D. 5.74%

Answer: D
σ = [0.20 × (24% − 14.35%)2 + 0.45 × (15% − 14.35%)2 + 0.35 × (8% −
14.35%)2]0.5 = 5.74%.

9. You purchased a share of CSCO stock for $20. One year later, you received $2 as a
dividend and sold the share for $31. What was your holding-period return?
A. 45%
B. 50%
C. 60%
D. 40%
E. None of the options are correct.

Answer: E
HPR = (Psell − Pbuy + Div) ÷ Pbuy = ($31 − $20 + $2) ÷ $20 = 0.65 = 65%

11. An investor invests 40% of his wealth in a risky asset with an expected rate of return of 0.13 and
a variance of 0.03 and 60% in a T-bill that pays 6%. His portfolio's expected return and standard
deviation are _________ and _________, respectively.
A. 0.114; 0.128
B. 0.087; 0.063
C. 0.295; 0.125
D. 0.088; 0.069

Answer: D
E(rP) = wRisky × E(rRisky) + wf × rf
= 0.4 × 0.13 + 0.6 × 0.06 = 0.088
σ = 0.4 × 0.035 = 0.069
 10. Which of the following statements regarding risk-averse investors is true?
A. They only care about the rate of return.
B. They accept investments that are fair games.
C. They only accept risky investments that offer risk premiums over the risk-free rate.
D. They are willing to accept lower returns and high risk.

Answer: C

11. Assume an investor with the following utility function: U = E(r) − 6σ2. To maximize her
expected utility, which one of the following investment alternatives would she choose?
A. A portfolio that pays 10% with a 60% probability or 5% with 40% probability.
B. A portfolio that pays 10% with 40% probability or 5% with a 60% probability.
C. A portfolio that pays 12% with 60% probability or 5% with 40% probability.
D. A portfolio that pays 12% with 40% probability or 5% with 60% probability.

Answer: C
U(C) =8.49%; the highest utility.

12. Use the below information to answer the following question.

Investment Expected Return E(r) Standard Deviation

1 0.12 0.3

2 0.18 0.5

3 0.19 0

4 0.20 0.21

Which investment would you select if you were risk neutral?

A. 1
B. 2
C. 3
D. 4
E. Cannot be determined from the information given.

Answer: D
If you are risk neutral, your only concern is with return, not risk.
 13. Consider a risky portfolio, A, with an expected rate of return of 0.15 and a standard deviation
of 0.15, that lies on a given indifference curve. Which one of the following portfolios might lie
on the same indifference curve for a risk averse investor?
A. E(r) = 0.15; Standard deviation = 0.20
B. E(r) = 0.15; Standard deviation = 0.10
C. E(r) = 0.10; Standard deviation = 0.10
D. E(r) = 0.20; Standard deviation = 0.15
E. E(r) = 0.10; Standard deviation = 0.20

Answer: C
Portfolio C is the only possible choice with the same risk-return trade-off.

14. Which of the following statements is/are false?

I. Risk-averse investors reject investments that are fair games.

II. Risk-neutral investors judge risky investments only by the expected returns.
III. Risk-averse investors judge investments only by their riskiness.
IV. Risk-loving investors will not engage in fair games.
A. I only
B. II only
C. I and II only
D. II and III only
E. III and IV only

Answer: E
 Part II (Difficult questions)

15. Which one of the following statements regarding orders is false?

A. A market order is simply an order to buy or sell a stock immediately at the prevailing market
price.
B. If stock ABC is selling at $50, a limit-buy order may instruct the broker to buy the stock if and
when the share price falls below $45.
C. A market order is an order to buy or sell a stock on a specific exchange (market).
D. All statements are true.

Answer: C

16. In a return-standard deviation space, which of the following statements is(are) true for risk-
averse investors? (The vertical and horizontal lines are referred to as the expected return-
axis and the standard deviation-axis, respectively.)

I. An investor's own indifference curves might intersect.

II. Indifference curves have negative slopes.
III. In a set of indifference curves, the highest offers the greatest utility.
IV. Indifference curves of two investors might intersect.
A. I and II only
B. II and III only
C. I and IV only
D. III and IV only
E. None of the options are correct.

Answer: D

17. Given the capital allocation line, an investor's optimal portfolio is the portfolio that ___
A. maximizes her expected profit.
B. maximizes her risk.
C. minimizes both her risk and return.
D. maximizes her expected utility.
E. None of the options are correct.

Answer: D

18. A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15. The risk-
free rate is 6%. An investor has the following utility function: U = E(r) − 0.5Aσ2. Which
value of A makes this investor indifferent between the risky portfolio and the risk-free asset?
A. 5
B. 6
 C. 7
D. 8

Answer: D
rf = U (to be indifferent)
0.06 = 0.15 − A ÷ 2 × 0.152, so A = 8

19. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P,
constructed with two risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40,
respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected
rate of return of 0.10 and a variance of 0.0081.

If you want to form a portfolio with an expected rate of return of 0.10, what percentages of your
money must you invest in the T-bill, X, and Y, respectively, if you keep X and Y in the same
proportions to each other as in portfolio P?
A. 0.25; 0.45; 0.30
B. 0.19; 0.49; 0.32
C. 0.32; 0.41; 0.27
D. 0.50; 0.30; 0.20
E. Cannot be determined.

Answer: C
E(rrisky) = wx × E(rx) + wy × E(ry)
= 0.60 × 0.14 + 0.40 × 0.10 = 0.124
E(rp) = wrisky × E(rrisky) + (1 − wrisky) × rf
0.10 = wrisky × 0.124 + (1 − wrisky) × 0.05
= wrisky × 0.074 + 0.05 →
wrisky = 0.6757 →
(1 − wrisky) = 0.32
Wx = 0.6757 × 0.60 = 0.41
Wy = 0.6757 × 0.40 = 0.27

20. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P,
constructed with two risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40,
respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected
rate of return of 0.10 and a variance of 0.0081.

What would be the dollar value of your positions in X, Y, and the T-bills, respectively, if you decide to
hold a portfolio that has an expected outcome of $1,120?
A. $568; $378; $54
B. $568; $54; $378
C. $378; $54; $568
D. $108; $514; $378
 E. Cannot be determined.

Answer: A
For $1,000 to grow to $1,120 → rp = 12%
E(rrisky) = wx × E(rx) + wy × E(ry)
= 0.60 × 0.14 + 0.40 × 0.10 = 0.124
E(rp) = wrisky × E(rrisky) + (1 − wrisky) × rf
0.12 = wrisky × 0.124 + (1 − wrisky) × 0.05
= wrisky × 0.07 + 0.05 →
wrisky = 0.946 →
wx = 0.60 × 0.946 = 0.568 → $568 in X
Wy = 0.40 × 0.946 = 0.378 → $378 in Y
(1 − wrisky) = 0.054 → $54 in Risk-free asset