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To _____ means to mitigate a financial risk.
A. invest
B. speculate
C. hedge
D. renege
C. hedge
In a defined benefit pension plan, the _____ bears all of the fund's investment performance risk.
A. employer
B. employee
C. fund manager
D. government
A. employer
In a defined contribution pension plan, the _____ bears all of the fund's investment performance risk.
A. employer
B. employee
C. fund manager
D. government
B. employee
______ insurance policy provides death benefits, with no buildup of cash value.
A. whole-life
B. universal life
C. variable life
D. term life
D. term life
You are thinking of investing in one of two assets. Asset A has higher systematic risk than asset B. You can be sure that asset A's _______ return will be higher than asset B's, but you can't be sure if asset A's _______ return will be higher than asset B's.
A. realized; expected
B. real; nominal
C. expected; realized
D. nominal; expected
C. expected; realized
A mutual fund may not hold more than ______ of the shares of any publicly traded company.
A. 5%
B. 10%
C. 25%
D. 50%
A. 5%
Which one of the following would be considered a "cash equivalent" investment?
A. Treasury bills
B. Common stock
C. Corporate bonds
D. Real estate
A. Treasury bills
For a bank, the difference between the interest rate charged to borrowers and the interest rate paid on liabilities is called the __________.
A. insurance premium
B. interest rate spread
C. risk premium
D. term premium
B. interest rate spread
Price volatility is greatest on which one of the following investments?
A. Commercial paper
B. 30-year zero-coupon bonds
C. Treasury notes
D. Treasury bills
B. 30-year zero-coupon bonds
A portfolio manager indexes part of a portfolio and actively manages the rest of the portfolio. This is called a _________ strategy.
A. passive-aggressive
B. passive core
C. passively active
D. balanced fund
B. passive core
The major asset most people have during their early working years is their ________.
A. home
B. stock portfolio
C. earning power derived from their skills
D. bond portfolio
C. earning power derived from their skills
At the early stage of an individual's working career, his or her retirement portfolio should probably consist mostly of _______.
A. annuities
B. stocks
C. bonds
D. commodities
B. stocks
Just 2 months after you put money into an investment, its price falls 25%. Assuming that none of the investment fundamentals have changed, which of the following actions would evidence the greatest risk tolerance?
A. You sell to avoid further worry and buy something else.
B. You do nothing and wait for the investment to come back.
C. You buy more, thinking that if it was a good investment before, now it's not only good but cheap too.
D. You sue your financial adviser.
C. You buy more, thinking that if it was a good investment before, now it's not only good but cheap too.
As the typical investor ages, the composition of his wealth usually switches from primarily _______ to primarily _______.
A. human capital; financial capital
B. financial capital; human capital
C. intellectual capital; physical capital
D. investable capital; noninvestable capital
A. human capital; financial capital
The two most important factors in describing an individual's or organization's investment objectives are ________________.
A. income level and age
B. income level and risk tolerance
C. age and risk tolerance
D. return requirement and risk tolerance
D. return requirement and risk tolerance
The term hedge refers to an investment that is used ________________.
A. primarily for tax-loss selling purposes
B. to mitigate specific financial risks
C. to conceal one's true investment strategy from other market participants
D. primarily to defer capital losses
B. to mitigate specific financial risks
The price of your investment increases 20% one month after you buy it. You do not believe that the stock's prospects have changed. Which one of the following actions would indicate the lowest amount of risk aversion?
A. You hang on to the stock, anticipating that it will go higher.
B. You buy more stock, anticipating that it will go higher.
C. You sell all of your stock holdings immediately.
D. You sell half of your stock holdings and invest the proceeds in other areas of your portfolio.
B. You buy more stock, anticipating that it will go higher.
An individual is on the game show Squeal or No Squeal, and she has a choice between receiving a certain gain of $100,000 and receiving a 50% chance of winning $200,000 or zero. If she takes the gamble instead of the certain $100,000, she is acting ____________________.
A. like a person who is risk-neutral
B. like a person who is risk averse
C. like a person who is a risk lover
D. irrationally
C. like a person who is a risk lover
Which of the following typically strives to earn a return on their investments that exceeds the actuarially determined rate of return?
A. Banks
B. Thrifts
C. Mutual funds
D. Pension funds
D. Pension funds
If an individual confers legal title to property to another person or institution to manage the property on their behalf, the individual has created ___________.
A. a personal trust
B. a charitable trust
C. an endowment fund
D. a mutual fund
A. a personal trust
If a defined benefit pension fund's actual rate of return is _____ than the actuarial assumed rate, then the ___________.
A. greater; employees will benefit
B. greater; firm's shareholders will benefit
C. lower; employees will benefit
D. lower; firm's shareholders will benefit
B. greater; firm's shareholders will benefit
Life insurance companies try to hedge the risks inherent in whole-life insurance policies by investing in __________.
A. long-term bonds
B. money market mutual funds
C. savings accounts
D. short-term commercial paper
A. long-term bonds
31. The risk that a downturn in the market may substantially reduce your investment principal is called _______.
A. purchasing power risk
B. interest rate risk
C. market risk
D. liquidity risk
C. market risk
The possibility that you are too conservative and your money doesn't grow fast enough to keep pace with inflation is called ________.
A. purchasing power risk
B. liquidity risk
C. timing risk
D. market risk
A. purchasing power risk
Many defined benefit pension plans have a target rate of return on investment that is equal to the ____________.
A. firm's return on equity
B. plan's assumed actuarial rate of return
C. economic inflation rate because wages often increase with inflation
D. estimated stock market return
B. plan's assumed actuarial rate of return
_______ is a life insurance policy that provides a death benefit and a fixed-rate tax-deferred savings plan.
A. Term life
B. Whole life
C. Variable life
D. Universal life
B. Whole life
Empirical evidence confirms that investors become __________ as they approach retirement.
A. greedier
B. less interested in investments
C. more risk averse
D. more risk tolerant
C. more risk averse
______ is a life insurance policy that will provide a death benefit only and has no savings plan.
A. Term life
B. Whole life
C. Variable life
D. Universal life
A. Term life
Of the following, the investment time horizon is typically the shortest for __________.
A. banks
B. endowment funds
C. life insurance companies
D. pension funds
A. banks
A passive asset allocation strategy involves _________.
A. investing in the stock of companies that are price takers
B. maintaining approximately the same proportions of a portfolio in each asset class over time
C. varying the proportions of a portfolio in each asset class in response to changing market conditions
D. selecting individual securities in different sectors that are believed to be undervalued
B. maintaining approximately the same proportions of a portfolio in each asset class over time
An active asset allocation strategy involves _________.
A. investing in the stock of companies that are price takers
B. maintaining approximately the same proportions of a portfolio in each asset class over time
C. varying the proportions of a portfolio in each asset class in response to changing market conditions
D. selecting individual securities in different sectors that are believed to be undervalued
C. varying the proportions of a portfolio in each asset class in response to changing market conditions
Endowment funds are held by __________.
A. financial intermediaries
B. individuals
C. profit-oriented firms
D. nonprofit institutions
D. nonprofit institutions
Under a "passive core" portfolio management strategy, a manager would ___________.
B. index part of the portfolio and actively manage the rest
The amount of risk an individual should take depends on his or her:
I. Return requirements
II. Risk tolerance
III. Time horizon
D. I, II, and III
When a company sets up a defined contribution pension plan, the __________ bears all the risk and the __________ receives all the return from the plan's assets.
A. employee; employee
B. employee; employer
C. employer; employee
D. employer; employer
A. employee; employee
The prudent investor rule requires __________.
A. executives of companies to avoid investing in options of companies they work for
B. executives of companies to disclose their transactions in stocks of companies they work for
C. professional investors who manage money for others to avoid all risky investments
D. professional investors who manage money for others to constrain their investments to those that would be approved by a prudent investor
D. professional investors who manage money for others to constrain their investments to those that would be approved by a prudent investo
51. The prudent investor rule is an example of a regulation designed to ensure appropriate _____________ by money managers.
A. fiduciary responsibility
B. fiscal responsibility
C. monetary responsibility
D. marketing procedures
A. fiduciary responsibility
An investor has a long time horizon and desires to earn the market rate of return. However, the investor will need to withdraw funds each year from her investment portfolio. The biggest constraint a planner would face with this client is a ___________ constraint.
A. tax
B. risk-tolerance
C. liquidity
D. social
C. liquidity
When used in the context of investment decision making, the term liquidity refers to _____________.
A. the ease and speed with which an asset can be sold at any value possible
B. the ease and speed with which an asset can be sold without having to discount the value
C. an aspect of monetary policy
D. the proportion of short-term to long-term investments held in an investor's portfolio
B. the ease and speed with which an asset can be sold without having to discount the value
The term investment horizon refers to __________.
A. the proportion of short-term to long-term investments held in an investor's portfolio
B. the planned liquidation date of an investment
C. the average maturity date of investments held in a portfolio
D. the maturity date of the longest investment in the portfolio
B. the planned liquidation date of an investment
The choice of an active portfolio management strategy rather than a passive strategy assumes ___________.
A. the ability to continuously adjust the portfolio to provide superior returns
B. asset allocation involving only domestic securities
C. stable economic conditions over the short term
D. the ability to minimize trading costs
A. the ability to continuously adjust the portfolio to provide superior returns
Conservative investors are likely to want to invest in __________ mutual funds, while risk-tolerant investors are likely to want to invest in __________.
A. income; high growth
B. income; moderate growth
C. moderate-growth; high growth
D. high-growth; moderate growth
A. income; high growth
The first step any investor should take before beginning to invest is to __________.
A. establish investment objectives
B. develop a list of investment managers with superior records to interview
C. establish asset allocation guidelines
D. decide between active management and passive management
A. establish investment objectives
A clearly understood investment policy statement is not critical for which one of the following?
I. Mutual funds
II. Individuals
III. Defined benefit pension funds
A. II only
B. III only
C. I only
D. None of these options (A policy statement is necessary for all three.)
D. None of these options (A policy statement is necessary for all three.)
An investor refuses to invest in any firm that produces alcohol or tobacco. This is an example of a ___________ constraint.
A. return requirement
B. risk-tolerance
C. liquidity
D. social
D. social
Under the provisions of a typical defined benefit pension plan, the employer is responsible for _____________.
A. investing in conservative fixed-income assets
B. paying benefits to retired employees
C. counseling employees in the selection of asset classes
D. paying employees the market rate of return on employee contributions
B. paying benefits to retired employees
A life insurance firm wants to minimize its interest rate risk, and it is planning on paying out $250,000 in 5 years. Which one of the following investments best matches its goal?
A. High-yield utility stocks
B. 5-year zero-coupon bonds
C. 10-year coupon bonds
D. Money market investments rolled over as needed
B. 5-year zero-coupon bonds
64. An investor with high risk aversion will likely prefer which of the following risk and return combinations?
A. Expected return = 12%, historical standard deviation = 17%
B. Expected return = 14%, historical standard deviation = 19%
C. Expected return = 16%, historical standard deviation = 21%
D. Expected return = 18%, historical standard deviation = 23%
A. Expected return = 12%, historical standard deviation = 17%
An investor with low risk aversion will likely prefer which of the following risk and return combinations?
A. Expected return = 11%, historical standard deviation = 12%
B. Expected return = 12%, historical standard deviation = 14%
C. Expected return = 14%, historical standard deviation = 18%
D. Expected return = 17%, historical standard deviation = 21%
D. Expected return = 17%, historical standard deviation = 21%
Medfield College's $10 million endowment fund is not allowed to spend any contributed capital or any capital gains. The fund may spend only investment earnings. The fund is expected to need between $500,000 and $1,000,000 to pay for new lab equipment for the science building. Which of the following is (are) true?
I. The fund should have a target rate of return of at least 10%.
II. The limitations on spending require that the fund limit its considerations to growth stocks.
III. The requirement to spend money out of the fund this year provides a liquidity constraint that may reduce the fund's rate of return.
A. I only
B. II only
C. I and III only
D. I, II, and III
C. I and III only
Both a wife and her husband work in the airline industry. They are in their 40s, and they have a high tax bracket and are concerned about their after-tax rate of return. A meeting with their financial planner reveals that they are primarily focused on long-term capital gains and will need at least a 9% to 11% average rate of return to meet their retirement goals. They desire a diversified portfolio, and liquidity is not currently a major concern. Which of the following asset allocations seems to best fit their situation?
A. 10% money market; 40% long-term bonds; 10% commodities; 40% high-dividend-paying stocks
B. 0% money market; 60% long-term bonds; 40% stocks
C. 10% money market; 30% long-term bonds; 10% commodities; 50% high-dividend-paying stocks
D. 5% money market; 30% long-term bonds; 5% commodities; 60% stocks, most with low dividends and high growth prospects
D. 5% money market; 30% long-term bonds; 5% commodities; 60% stocks, most with low dividends and high growth prospects
A family will retire in a few years. They have a high tax bracket and are concerned about their after-tax rate of return. A meeting with their financial planner reveals that they are primarily focused on safety of principal and will need a 6% to 8% average rate of return on their portfolio. They desire a diversified portfolio, and liquidity is likely to be a concern due to health reasons. Which of the following asset allocations seems to best fit this family's situation?
A. 10% money market; 50% intermediate-term bonds; 40% blue chip stocks, many with high dividend yields
B. 0% money market; 60% intermediate-term bonds; 40% stocks
C. 10% money market; 30% intermediate-term bonds; 60% high-dividend-paying stocks
D. 5% money market; 35% intermediate-term bonds; 60% stocks, most with low dividends
A. 10% money market; 50% intermediate-term bonds; 40% blue chip stocks, many with high dividend yields
In 1937 the Eli Lilly family donated millions of dollars in stock to fund a not-for-profit charitable organization. Such organizations are typically called _________________.
A. annuities
B. endowments
C. mutual funds
D. personal trusts
B. endowments
Which one of the following institutions typically has the longest investment horizon?
A. Mutual funds
B. Pension funds
C. Property and casualty insurers
D. Banks
B. Pension funds
For which one of the following institutions is liquidity usually the most important?
A. Mutual funds
B. Pension funds
C. Life insurers
D. Banks
D. Banks
One of the major functions of the investment committee is to ________________.
A. determine security selection of each portfolio operated by the investment company
B. translate the objectives and constraints of the investment company into an asset universe
C. determine the percentages of each security in the total investment company portfolio
D. calculate and report the overall rate of return to investment company constituents
B. translate the objectives and constraints of the investment company into an asset universe
For an investor concerned with maximizing liquidity, which of the following investments should be avoided?
A. Real estate
B. Bonds
C. Domestic stocks
D. International stocks
A. Real estate
The asset universe is the _____________________.
A. set of investments in which an investment company can legally invest
B. existing set of assets the investment company currently owns in one or more of its portfolios
C. list of assets approved by the investment committee that may be placed into the investment company's portfolio
D. market portfolio of all available risky assets
C. list of assets approved by the investment committee that may be placed into the investment company's portfolio
Major functions of the investment committee include all but which one of the following?
A. Engage in security selection for each portfolio managed
B. Broadly determine the overall asset allocation of the investment company
C. Determine the asset-class weights for each portfolio
D. Determine the asset universe
A. Engage in security selection for each portfolio managed
A portfolio consists of three index funds: an equity index, a bond index, and an international index. The portfolio manager changes the weights periodically according to forecasts for each sector. This is an example of __________.
A. a passively managed core with an actively managed component
B. a totally passively managed fund
C. passive asset allocation with active security selection
D. active asset allocation with passive security selection
D. active asset allocation with passive security selection
A portfolio consists of three index funds: an equity index accounting for 40% of the total portfolio, a bond index accounting for 30% of the total portfolio, and an international index accounting for 30% of the total portfolio. After each quarter the portfolio manager buys and sells some of each sector to preserve the original weights for each sector. This is an example of ____________.
A. a passively managed core with an actively managed component
B. a totally passively managed fund
C. passive asset allocation with active security selection
D. active asset allocation with passive security selection
B. a totally passively managed fund
81. One way that life insurance firms can hedge the risk created by offering whole-life insurance policies is by ________________.
A. holding long-term bonds
B. holding equities
C. holding short-term bonds
D. exercising its right to terminate the policy
A. holding long-term bonds
If the Black-Scholes formula is solved to find the standard deviation consistent with the current market call premium, the std dev would be called the ____
implied volatility
The ____ is the stock price minus exercise price, or the profit that could be attained by immediate exercise of an in-the money call option
intrinsic value
The _____ is the difference between the actual call price and the intrinsic value.
Time value
A call option with several months until expiration has a strike price of $55 when the stock price is $50. The option has _____ intrinsic value and ____ time value
zero ; positive
All else equal, call option values are ____ if the ____ is lower
higher ; exercise price
A ___ is an option valuation model based on the assumption that stock prices can move to only two values over any short time period
binomial model
The Black-Scholes option-pricing formula was developed for ____
European options
A put option with several months until expiration has a strike price of $55 when the stock price is $50. The option has ____ intrinsic value and ____ time value
positive ; positive
The hedge ratio is often called the option's ____
delta
A stock with a current market price of $50 and a strike price of $45 has an associated call option priced at $6.50. This call has an intrinsic value of ____ and a time value of ____
$5 ; $1.50
A stock with a current market price of $50 and a strike price of $45 has an associated put option priced at $3.50. This put has an intrinsic value of ____ and a time value of ____
$0 ; $3.50
Investor A bought a call option that expires in 6 months. Investor B wrote a put option with a 9 month maturity. All else equal, as the time to expiration approaches, the value of investor A's position will ____ and the value of investor B's position will ______
decrease ; increase
Investor A bought a call option, and investor B bought a put option. All else equal, if the interest rate increases, the value of investor A's position will ____ and the value of investor B's position will _____
increase ; decrease
Investor A bought a call option, and investor B bought a put option. All else equal, if the underlying stock price volatility increases, the value of investor A's position will ____ and the value of investor B's position will _____
increase ; increase
The percentage change in the call option price divided by the percentage change in the stock price is the ____ of the option
elasticity
Before expiration, the time value of an out-of-the-money stock option is ______
positive
The intrinsic value of a call option is equal to _____
the stock price minus the exercise price
The divergence between an option's intrinsic value and its market value is usually greatest when ______
the option is approximately at the money
The value of a call option increases with all of the following except _____
dividend yield
The value of a put option increases with all of the following except _____
stock price
Perfect dynamic hedging requires _______
continuous rebalancing
The delta of an option is _____
the change in the dollar value of an option of a dollar change in the price of the underlying asset
If you know that a call option will be profitably exercised, then the Black-scholes model price will simplify to _____
So - PV(X)
Hedge ratios for long calls are always_______
between 0 and 1
Which of the following is a true statement?
the actual value of a call option is greater than its intrinsic value prior to expiration
A longer time to maturity will unambiguously increase the value of a call option because:
II and III only
Strike prices of options are adjusted for _____ but not for ____
stock splits ; cash dividends
A high dividend payout will ____ the value of a call option and _____ the value of a put option
decrease ; increase
According to the black-scholes option-pricing model, two options of the same stock but with different exercise prices should always have the same ______
implied volatility
When the returns of an option and stock are perfectly correlated as in two-state binomial option model, the hedge ratio must be equal to the ratio of _____
the range of the option outcomes to the range of the stock outcomes
The Black-Scholes hedge ratio for a long call option is equal to ____
N(d1)
The Black-Scholes hedge ratio for a long put-option is equal to ____
N(d1) - 1
In a binomial option model with three subintervals, the probability that the stock price moves up every possible time is _____
12.5%
In the Black-Scholes model, if an option is not likely to be exercised, both N(d1) and N(d2) will be close to _____. If the option is definitely likely to be exercised, N(d1) and N(d2) will be close to ____
0 ; 1
In the Black-Scholes model, as the stock's price increases, the values of N(d1) and N(d2) will ____ for a call and _____ for a put option.
increase ; decrease
Research suggests that option-pricing models that allow for the possibility of ____ provide more accurate pricing than does the basic Black-Scholes option-pricing model.
I and III only
Research suggests that the performance of the Black-Scholes option-pricing model has _____
been deficient for stocks with high dividend payouts
Research conducted by Rubinstein (1994) suggests that _____ command a disproportionately high time value
out-of-the-money put options
Note 
Flashcard (127)