Answer to MC Questions

1. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index
model holds. If the s of your portfolio was 0.18 and sM was 0.22, the b of the portfolio would be approximately
________. 
A. 0.64
B. 1.19
C. 0.82
D. 1.56
E. none of the above

s2p / s2m = b2; (0.18)2/(0.22)2 = 0.669; b = 0.82.

Bodie - Chapter 08 #67

Difficulty: Difficult
 

2. A common strategy for passive management is ____________. 

A. creating an index fund
B. creating a small firm fund
C. creating an investment club
D. A and C
E. B and C

The index fund is, by definition, passively managed. The other investment alternatives may or may not be
managed passively.

Bodie - Chapter 11 #17

Difficulty: Easy
 
3. A two-asset portfolio with a standard deviation of zero can be formed when 
A. the assets have a correlation coefficient less than zero.
B. the assets have a correlation coefficient equal to zero.
C. the assets have a correlation coefficient greater than zero.
D. the assets have a correlation coefficient equal to one.
E. the assets have a correlation coefficient equal to negative one.

When there is a perfect negative correlation, the equation for the portfolio variance simplifies to a perfect
square. The result is that the portfolio's standard deviation equals |wAsA - wBsB|, which can be set equal to zero.
The solution wA = sB/(sA + sB) and wB = 1 - wA will yield a zero-standard deviation portfolio.

Bodie - Chapter 07 #55

Difficulty: Moderate
 

4. Security returns 
A. are based on both macro events and firm-specific events.
B. are based on firm-specific events only.
C. are usually positively correlated with each other.
D. A and B.
E. A and C.

Stock returns are usually highly positively correlated with each other. Stock returns are affected by both macro
economic events and firm-specific events.

Bodie - Chapter 08 #49

Difficulty: Easy
 

5. Consider the one-factor APT. The variance of returns on the factor portfolio is 11%. The beta of a well-
diversified portfolio on the factor is 1.45. The variance of returns on the well-diversified portfolio is
approximately __________. 
A. 23.1%
B. 6.0%
C. 7.3%
D. 14.1%
E. none of the above

s2P = (1.45)2(11%) = 23.13%.

Bodie - Chapter 10 #73

Difficulty: Moderate
 
6. Kahneman and Tversky (1973) reported that __________ give too weight to recent experience compared to
prior beliefs when making forecasts. 
A. young men
B. young women
C. people
D. older men
E. older women

Kahneman and Tversky (1973) reported that people give too much weight to recent experience compared to
prior beliefs when making forecasts.

Bodie - Chapter 12 #48

Difficulty: Moderate
 

7. Steve is more risk-averse than Edie. On a graph that shows Steve and Edie's indifference curves, which of the
following is true? Assume that the graph shows expected return on the vertical axis and standard deviation on
the horizontal axis.
I) Steve and Edie's indifference curves might intersect.
II) Steve's indifference curves will have flatter slopes than Edie's.
III) Steve's indifference curves will have steeper slopes than Edie's.
IV) Steve and Edie's indifference curves will not intersect.
V) Steve's indifference curves will be downward sloping and Edie's will be upward sloping. 
A. I and V
B. I and III
C. III and IV
D. I and II
E. II and IV

This question tests whether the student understands the graphical properties of indifference curves and how they
relate to the degree of risk tolerance.

Bodie - Chapter 06 #24

Difficulty: Moderate
 
8. A coupon bond pays annual interest, has a par value of $1,000, matures in 4 years, has a coupon rate of
8.25%, and has a yield to maturity of 8.64%. The current yield on this bond is ___________. 
A. 8.65%
B. 8.45%
C. 7.95%
D. 8.36%
E. none of the above

FV = 1000, n = 4, PMT = 82.50, i = 8.64, PV = 987.26; $82.50 / $987.26 = 8.36%.

Bodie - Chapter 14 #10

Difficulty: Moderate
 

9. Kahneman and Tversky (1973) report that __________ and __________. 

A. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are
too extreme given the uncertainty of their information
B. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are
too extreme given the uncertainty of their information
C. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are
not extreme enough given the uncertainty of their information
D. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are
not extreme enough given the uncertainty of their information
E. none of the above

Kahneman and Tversky (1973) report that people give too much weight to recent experience compared to prior
beliefs and tend to make forecasts that are too extreme given the uncertainty of their information.

Bodie - Chapter 12 #39

Difficulty: Difficult
 
10. The likelihood of an investment newsletter's successfully predicting the direction of the market for three
consecutive years by chance should be 
A. between 50% and 70%.
B. between 25% and 50%.
C. between 10% and 25%.
D. less than 10%.
E. greater than 70%.

The probability of successful prediction for 3 consecutive years is 23, or 12.5%.

Bodie - Chapter 11 #39

Difficulty: Moderate
 

11. The APT differs from the CAPM because the APT _________. 
A. places more emphasis on market risk
B. minimizes the importance of diversification
C. recognizes multiple unsystematic risk factors
D. recognizes multiple systematic risk factors
E. none of the above

The CAPM assumes that market returns represent systematic risk. The APT recognizes that other
macroeconomic factors may be systematic risk factors.

Bodie - Chapter 10 #33

Difficulty: Moderate
 

12. A coupon bond is reported as having an ask price of 113% of the $1,000 par value in the Wall Street Journal.
If the last interest payment was made two months ago and the coupon rate is 12%, the invoice price of the bond
will be ____________. 
A. $1,100
B. $1,110
C. $1,150
D. $1,160
E. none of the above

$1,130 + $20 (accrued interest) = $1,150.

Bodie - Chapter 14 #22

Difficulty: Moderate
 
13. If the annual real rate of interest is 5% and the expected inflation rate is 4%, the nominal rate of interest
would be approximately 
A. 1%.
B. 9%.
C. 20%.
D. 15%.
E. none of the above.

5% + 4% = 9%.

Bodie - Chapter 05 #5
Difficulty: Easy
 

14. A bond with a 12% coupon, 10 years to maturity and selling at 88 has a yield to maturity of _______. 
A. over 14%
B. between 13% and 14%
C. between 12% and 13%
D. between 10% and 12%
E. less than 12%

YTM = 14.33%.

Bodie - Chapter 14 #69

Difficulty: Moderate
 

15. Treasury bills are commonly viewed as risk-free assets because 

A. their short-term nature makes their values insensitive to interest rate fluctuations.
B. the inflation uncertainty over their time to maturity is negligible.
C. their term to maturity is identical to most investors' desired holding periods.
D. Both A and B are true.
E. Both B and C are true.

Treasury bills do not exactly match most investor's desired holding periods, but because they mature in only a
few weeks or months they are relatively free of interest rate sensitivity and inflation uncertainty.

Bodie - Chapter 06 #47

Difficulty: Easy
 
16. The bond market 
A. can be quite "thin".
B. primarily consists of a network of bond dealers in the over the counter market.
C. consists of many investors on any given day.
D. A and B.
E. B and C.

The bond market, unlike the stock market, can be a very thinly traded market. In addition, most bonds are
traded by dealers.

Bodie - Chapter 14 #24

Difficulty: Easy
 

17. Non-systematic risk is also referred to as 

A. market risk, diversifiable risk.
B. firm-specific risk, market risk.
C. diversifiable risk, market risk.
D. diversifiable risk, unique risk.
E. none of the above.

Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk
that can be eliminated from the portfolio by diversification.

Bodie - Chapter 07 #7
Difficulty: Easy
 

18. The Capital Allocation Line can be described as the 

A. investment opportunity set formed with a risky asset and a risk-free asset.
B. investment opportunity set formed with two risky assets.
C. line on which lie all portfolios that offer the same utility to a particular investor.
D. line on which lie all portfolios with the same expected rate of return and different standard deviations.
E. none of the above.

The CAL has an intercept equal to the risk-free rate. It is a straight line through the point representing the risk-
free asset and the risky portfolio, in expected-return/standard deviation space.

Bodie - Chapter 06 #25

Difficulty: Moderate
 
19. In a multi-factor APT model, the coefficients on the macro factors on often called ______. 
A. systemic risk
B. firm-specific risk
C. idiosyncratic risk
D. factor loadings
E. none of the above

The coefficients are called factor betas, factor sensitivities, or factor loadings.

Bodie - Chapter 10 #5
Difficulty: Easy
 

20. An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will
yield a sure profit. 
A. positive
B. negative
C. zero
D. all of the above
E. none of the above

If the investor can construct a portfolio without the use of the investor's own funds and the portfolio yields a
positive profit, arbitrage opportunities exist.

Bodie - Chapter 10 #7
Difficulty: Easy
 

21. Suppose the following equation best describes the evolution of b over time:
bt = 0.30 + 0.70bt-1
If a stock had a b of 0.82 last year, you would forecast the b to be _______ in the coming year. 
A. 0.91
B. 0.77
C. 0.63
D. 0.87
E. none of the above

0.30 + 0.70(0.82) = 0.874.

Bodie - Chapter 08 #84

Difficulty: Easy
 
22. Assume that a security is fairly priced and has an expected rate of return of 0.17. The market expected rate
of return is 0.11 and the risk-free rate is 0.04. The beta of the stock is ___? 
A. 1.25
B. 1.86
C. 1
D. 0.95
E. none of the above.

17% = [4% +b(11% - 4%)]; 13% = b(7%); b = 1.86

Bodie - Chapter 09 #79

Difficulty: Moderate
 

23. Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of 0.92. The risk-free rate
is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this
security is 
A. underpriced.
B. overpriced.
C. fairly priced.
D. cannot be determined from data provided.
E. none of the above.

9.52% - 4% + 0.92(10% - 4%) = 0.0%; therefore, the security is fairly priced.

Bodie - Chapter 09 #32

Difficulty: Moderate
 

24. A coupon bond that pays interest of $100 annually has a par value of $1,000, matures in 5 years, and is
selling today at a $72 discount from par value. The yield to maturity on this bond is __________. 
A. 6.00%
B. 8.33%
C. 12.00%
D. 60.00%
E. none of the above

FV = 1000, PMT = 100, n = 5, PV = -928, i = 11.997%

Bodie - Chapter 14 #44

Difficulty: Moderate
 
25. The difference between a random walk and a submartingale is the expected price change in a random walk
is ______ and the expected price change for a submartingale is ______. 
A. negative; zero
B. negative; positive
C. zero; negative
D. zero; positive
E. zero; zero

A random walk has an expected price change of zero and a submartingale has a positive expected price change.

Bodie - Chapter 11 #6
Difficulty: Easy
 

26. You purchased an annual interest coupon bond one year ago with 6 years remaining to maturity at the time
of purchase. The coupon interest rate is 10% and par value is $1,000. At the time you purchased the bond, the
yield to maturity was 8%. If you sold the bond after receiving the first interest payment and the bond's yield to
maturity had changed to 7%, your annual total rate of return on holding the bond for that year would have been
_________. 
A. 7.00%
B. 8.00%
C. 9.95%
D. 11.95%
E. none of the above

FV = 1000, PMT = 100, n = 6, i = 8, PV = 1092.46; FV = 1000, PMT = 100, n = 5, i = 7, PV = 1123.01; HPR =

(1123.01 - 1092.46 + 100) / 1092.46 = 11.95%.

Bodie - Chapter 14 #63

Difficulty: Difficult
 
27. The beta of a stock has been estimated as 1.4 by Merrill Lynch using regression analysis on a sample of
historical returns. The Merrill Lynch adjusted beta of the stock would be ___________. 
A. 1.27
B. 1.32
C. 1.13
D. 1.0
E. none of the above

Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.4) + 1/3 = 1.27.

Bodie - Chapter 08 #74

Difficulty: Moderate
 

 There are three stocks, A, B, and C. You can either invest in these stocks or short sell them. There are three
possible states of nature for economic growth in the upcoming year; economic growth may be strong, moderate,
or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given
below:

   

Bodie - Chapter 10
 

28. If you wanted to take advantage of a risk-free arbitrage opportunity, you should take a short position in
_________ and a long position in an equally weighted portfolio of _______. 
A. A, B and C
B. B, A and C
C. C, A and B
D. A and B, C
E. none of the above

E(RA) = (39% + 17% - 5%)/3 = 17%; E(RB) = (30% + 15% + 0%)/3 = 15%; E(RC) = (22% + 14% + 6%)/3 =
14%; E(RP) = -0.5(14%) + 0.5[(17% + 15%)/2]; -7.0% + 8.0% = 1.0%.

Bodie - Chapter 10 #28

Difficulty: Difficult
 
29. The risk that cannot be diversified away is 
A. firm-specific risk.
B. unique.
C. non-systematic risk.
D. market risk.
E. none of the above.

Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk
that can be eliminated from the portfolio by diversification.

Bodie - Chapter 07 #9
Difficulty: Easy
 

30. A "fairly priced" asset lies 

A. above the security market line.
B. on the security market line.
C. on the capital market line.
D. above the capital market line.
E. below the security market line.

Securities that lie on the SML earn exactly the expected return generated by the CAPM. Their prices are
proportional to their beta coefficients and they have alphas equal to zero.

Bodie - Chapter 09 #67

Difficulty: Easy
 

31. Studies of negative earnings surprises have shown that there is 

A. a negative abnormal return on the day negative earnings surprises are announced.
B. a positive drift in the stock price on the days following the earnings surprise announcement.
C. a negative drift in the stock price on the days following the earnings surprise announcement.
D. both A and B are true.
E. both A and C are true.

The market appears to adjust to earnings information gradually, resulting in a sustained period of abnormal
returns.

Bodie - Chapter 11 #25

Difficulty: Moderate
 
32. Cash flow matching on a multiperiod basis is referred to as a 
A. immunization.
B. contingent immunization.
C. dedication.
D. duration matching.
E. rebalancing.

Cash flow matching on a multiperiod basis is referred to as a dedication strategy.

Bodie - Chapter 16 #47

Difficulty: Easy
 

33. Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%, respectively. The
risk-free rate of return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities are ruled out, portfolio B
must have a beta of __________. 
A. 0.45
B. 1.00
C. 1.10
D. 1.22
E. none of the above

A: 14% = 7% + 0.7F; F = 10; B: 18% = 7% + 10b; b = 1.10.

Bodie - Chapter 10 #24

Difficulty: Moderate
 

34. Fama and French (1992) found that the stocks of firms within the highest decile of market/book ratios had
average monthly returns of _______ while the stocks of firms within the lowest decile of market/book ratios
had average monthly returns of ________. 
A. greater than 1%, greater than 1%
B. greater than 1%, less than 1%
C. less than 1%, greater than 1%
D. less than 1%, less than 1%
E. less than 0.5%, greater than 0.5%

This finding suggests either that low market-to-book ratio firms are relatively underpriced, or that the market-
to-book ratio is serving as a proxy for a risk factor that affects expected equilibrium returns.

Bodie - Chapter 11 #29

Difficulty: Moderate
 
35. Suppose you are doing a portfolio analysis that includes all of the stocks on the NYSE. Using a single-index
model rather than the Markowitz model _______ the number of inputs needed from _______ to ________. 
A. increases, about 1,400, more than 1.4 million
B. increases, about 10,000, more than 125,000
C. reduces, more than 125,000, about 10,000
D. reduces, more than 4 million, about 9,000
E. increases, about 150, more than 1,500

This example is discussed in the textbook. The main point for the students to remember is that the single-index
model drastically reduces the number of inputs required.

Bodie - Chapter 08 #55

Difficulty: Moderate
 

36. The duration of a perpetuity with a yield of 6% is 

A. 13.50 years.
B. 12.11 years.
C. 17.67 years.
D. cannot be determined.
E. none of the above.

D = 1.06/0.06 = 17.67 years.

Bodie - Chapter 16 #72

Difficulty: Easy
 

37. If a firm's beta was calculated as 0.8 in a regression equation, Merrill Lynch would state the adjusted beta at
a number 
A. less than 0.8 but greater than zero.
B. between 1.0 and 1.8.
C. between 0.8 and 1.0.
D. greater than 1.8.
E. zero or less.

Betas, on average, equal one; thus, betas over time regress toward the mean, or 1. Therefore, if historic betas are
less than 1, adjusted betas are between 1 and the calculated beta.

Bodie - Chapter 08 #21

Difficulty: Moderate
 
38. A Treasury bond due in one year has a yield of 4.6%; a Treasury bond due in 5 years has a yield of 5.6%. A
bond issued by Lucent Technologies due in 5 years has a yield of 8.9%; a bond issued by Mobil due in one year
has a yield of 6.2%. The default risk premiums on the bonds issued by Mobil and Lucent Technologies,
respectively, are: 
A. 1.6% and 3.3%
B. 0.5% and .7%
C. 3.3% and 1.6%
D. 0.7% and 0.5%
E. none of the above

Mobil: 6.2% - 4.6% = 1.6%; Lucent Technologies: 8.9% - 5.6% = 3.3%.

Bodie - Chapter 14 #32

Difficulty: Moderate
 

 Consider the following probability distribution for stocks C and D:

   

Bodie - Chapter 07
 

39. The expected rates of return of stocks C and D are _____ and _____, respectively. 
A. 4.4%; 9.5%.
B. 9.5%; 4.4%
C. 6.3%; 8.7%
D. 8.7%; 6.2%
E. none of the above

E(RC) = 0.30(7%) + 0.5(11%) + 0.20(-16%) = 4.4%; E(RD) = 0.30(-9%) + 0.5(14%) + 0.20(26%) = 9.5%.

Bodie - Chapter 07 #69

Difficulty: Easy
 
40. Given an optimal risky portfolio with expected return of 18% and standard deviation of 21% and a risk free
rate of 5%, what is the slope of the best feasible CAL? 
A. 0.64
B. 0.14
C. 0.62
D. 0.33
E. 0.36

Slope = (18 - 5)/21 = .6190

Bodie - Chapter 07 #50

Difficulty: Moderate
 

41. Indexing of bond portfolios is difficult because 

A. the number of bonds included in the major indexes is so large that it would be difficult to purchase them in
the proper proportions.
B. many bonds are thinly traded so it is difficult to purchase them at a fair market price.
C. the composition of bond indexes is constantly changing.
D. all of the above are true.
E. both A and B are true.

All of the above are true statements about bond indexes.

Bodie - Chapter 16 #30

Difficulty: Moderate
 

42. Which of the following factors did Chen, Roll and Ross not include in their multifactor model? 
A. Change in industrial production
B. Change in expected inflation
C. Change in unanticipated inflation
D. Excess return of long-term government bonds over T-bills
E. All of the above factors were included in their model.

Chen, Roll and Ross included the four listed factors as well as the excess return of long-term corporate bonds
over long-term government bonds in their model.

Bodie - Chapter 10 #59

Difficulty: Moderate
 
43. An investor invests 70 percent of his wealth in a risky asset with an expected rate of return of 0.11 and a
variance of 0.12 and 30 percent in a T-bill that pays 3 percent. His portfolio's expected return and standard
deviation are __________ and __________, respectively. 
A. 0.086; 0.242
B. 0.087; 0.267
C. 0.295; 0.123
D. 0.087; 0.182
E. none of the above

E(rP) = 0.7(11%) + 0.3(3%) = 8.6%; sP = 0.7(0.12)1/2 = 24.2%.

Bodie - Chapter 06 #55

Difficulty: Moderate
 

44. Which of the following are false about the interest-rate sensitivity of bonds?
I) Bond prices and yields are inversely related.
II) Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds.
III) Interest-rate risk is directly related to the bond's coupon rate.
IV) The sensitivity of a bond's price to a change in its yield to maturity is inversely related to the yield to
maturity at which the bond is currently selling. 
A. I
B. III
C. I, II, and IV
D. II, III, and IV
E. I, II, III, and IV

Number III is incorrect because interest-rate risk is inversely related to the bond's coupon rate.

Bodie - Chapter 16 #58

Difficulty: Moderate
 
45. The index model has been estimated for stocks A and B with the following results:
RA = 0.01 + 0.8RM + eA
RB = 0.02 + 1.2RM + eB
sM = 0.20 s(eA) = 0.20 s (eB) = 0.10
The standard deviation for stock A is __________. 
A. 0.0656
B. 0.0676
C. 0.2561
D. 0.2600
E. none of the above

sA = [(0.8)2(0.2)2 + (0.2)2]1/2 = 0.2561.

 

Bodie - Chapter 08 #47

Difficulty: Difficult
 

46. Diversifiable risk is also referred to as 

A. systematic risk, unique risk.
B. systematic risk, market risk.
C. unique risk, market risk.
D. unique risk, firm-specific risk.
E. none of the above.

Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk
that can be eliminated from the portfolio by diversification.

Bodie - Chapter 07 #4
Difficulty: Easy
 
47. A coupon bond pays annual interest, has a par value of $1,000, matures in 4 years, has a coupon rate of
10%, and has a yield to maturity of 12%. The current yield on this bond is ___________. 
A. 10.65%
B. 10.45%
C. 10.95%
D. 10.52%
E. none of the above

FV = 1000, n = 4, PMT = 100, i = 12, PV = 939.25; $100 / $939.25 = 10.65%.

Bodie - Chapter 14 #9
Difficulty: Moderate
 

48. Which of the following are investment superstars who have consistently shown superior performance?
I) Warren Buffet
II) Phoebe Buffet
III) Peter Lynch
IV) Merrill Lynch
V) Jimmy Buffet 
A. I, III, and IV
B. II, III, and IV
C. I and III
D. III and IV
E. I, III, IV, and V

Warren Buffet manages Berkshire Hathaway and Peter Lynch managed Fidelity's Magellan Fund. Phoebe Buffet
is a character on NBC's "Friends" and Jimmy Buffet is "Wasting Away in Margaritaville". Merrill Lynch isn't a
person.

Bodie - Chapter 11 #50

Difficulty: Moderate
 
49. Cumulative abnormal returns (CAR) 
A. are used in event studies.
B. are better measures of security returns due to firm-specific events than are abnormal returns (AR).
C. are cumulated over the period prior to the firm-specific event.
D. A and B.
E. A and C.

As leakage of information occurs, the accumulated abnormal returns that are abnormal returns summed over the
period of interest (around the event date) are better measures of the effect of firm-specific events.

Bodie - Chapter 11 #37

Difficulty: Moderate
 

50. In the mean-standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio,
P, is called ______________. 
A. the Security Market Line
B. the Capital Allocation Line
C. the Indifference Curve
D. the investor's utility line
E. none of the above

The Capital Allocation Line (CAL) illustrates the possible combinations of a risk-free asset and a risky asset
available to the investor.

Bodie - Chapter 06 #46

Difficulty: Moderate
 

51. A Treasury bill with a par value of $100,000 due one month from now is selling today for $99,010. The
effective annual yield is __________. 
A. 12.40%
B. 12.55%
C. 12.62%
D. 12.68%
E. none of the above

$990/$99,010 = 0.01; (1.01)12 - 1.0 = 12.68%.

Bodie - Chapter 14 #50

Difficulty: Moderate
 
 Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills.
The information below refers to these assets.

   

Bodie - Chapter 06
 

52. What are the proportions of Stocks A, B, and C, respectively in Bo's complete portfolio? 
A. 40%, 25%, 35%
B. 8%, 5%, 7%
C. 32%, 20%, 28%
D. 16%, 10%, 14%
E. 20%, 12.5%, 17.5%

Proportion in A = .8 * 40% = 32%; proportion in B = .8 * 25% = 20%; proportion in C = .8 * 35% = 28%.

Bodie - Chapter 06 #51

Difficulty: Moderate
 
53. Skewnes is a measure of ____________. 
A. how fat the tails of a distribution are
B. the downside risk of a distribution
C. the normality of a distribution
D. the dividend yield of the distribution
E. None of the above

Skewness is a measure of the normality of a distribution.

Bodie - Chapter 05 #69

Difficulty: Moderate
 

54. Consider the one-factor APT. The variance of returns on the factor portfolio is 9%. The beta of a well-
diversified portfolio on the factor is 1.25. The variance of returns on the well-diversified portfolio is
approximately __________. 
A. 3.6%
B. 6.0%
C. 7.3%
D. 14.1%
E. none of the above

s2P = (1.25)2(9%) = 14.06%.

Bodie - Chapter 10 #72

Difficulty: Moderate
 

55. In a multi-factor APT model, the coefficients on the macro factors are often called ______. 
A. systemic risk
B. firm-specific risk
C. idiosyncratic risk
D. factor betas
E. none of the above

The coefficients are called factor betas, factor sensitivities, or factor loadings.

Bodie - Chapter 10 #4
Difficulty: Easy
 
56. The expected return-beta relationship 
A. is the most familiar expression of the CAPM to practitioners.
B. refers to the way in which the covariance between the returns on a stock and returns on the market measures
the contribution of the stock to the variance of the market portfolio, which is beta.
C. assumes that investors hold well-diversified portfolios.
D. all of the above are true.
E. none of the above are true.

Statements A, B and C all describe the expected return-beta relationship.

Bodie - Chapter 09 #48

Difficulty: Moderate
 

57. The bond indenture includes 

A. the coupon rate of the bond.
B. the par value of the bond.
C. the maturity date of the bond.
D. all of the above.
E. none of the above.

The bond indenture includes the coupon rate, par value and maturity date of the bond as well as any other
contractual features.

Bodie - Chapter 14 #75

Difficulty: Easy
 

58. In a two-security minimum variance portfolio where the correlation between securities is greater than -1.0 
A. the security with the higher standard deviation will be weighted more heavily.
B. the security with the higher standard deviation will be weighted less heavily.
C. the two securities will be equally weighted.
D. the risk will be zero.
E. the return will be zero.

The security with the higher standard deviation will be weighted less heavily to produce minimum variance.
The return will not be zero; the risk will not be zero unless the correlation coefficient is -1.

Bodie - Chapter 07 #43

Difficulty: Difficult
 
 Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of
return is 6%. The following information is available about two well-diversified portfolios:

   

Bodie - Chapter 10
 

59. Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolio should be
___________. 
A. 3%
B. 4%
C. 5%
D. 6%
E. none of the above

See solution to previous problem.

Bodie - Chapter 10 #30

Difficulty: Difficult
 

60. When a distribution is negatively skewed, ____________. 

A. standard deviation overestimates risk
B. standard deviation correctly estimates risk
C. standard deviation underestimates risk
D. the tails are fatter than in a normal distribution
E. none of the above

When a distribution is negatively skewed standard deviation underestimates risk.

Bodie - Chapter 05 #72

Difficulty: Moderate
 
61. Your opinion is that security C has an expected rate of return of 0.106. It has a beta of 1.1. The risk-free rate
is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this
security is 
A. underpriced.
B. overpriced.
C. fairly priced.
D. cannot be determined from data provided.
E. none of the above.

4% + 1.1(10% - 4%) = 10.6%; therefore, the security is fairly priced.

Bodie - Chapter 09 #70

Difficulty: Moderate
 

62. Suppose the following equation best describes the evolution of b over time:
bt = 0.3 + 0.2bt-1
If a stock had a b of 0.8 last year, you would forecast the b to be _______ in the coming year. 
A. 0.46
B. 0.60
C. 0.70
D. 0.94
E. none of the above

0.3 + 0.2(0.8) = 0.46.

Bodie - Chapter 08 #69

Difficulty: Easy
 

63. A convertible bond has a par value of $1,000 and a current market value of $850. The current price of the
issuing firm's stock is $27 and the conversion ratio is 30 shares. The bond's conversion premium is _________. 
A. $40
B. $150
C. $190
D. $200
E. none of the above

$850 - $810 = $40.

Bodie - Chapter 14 #55

Difficulty: Moderate
 
64. Ceteris paribus, the duration of a bond is positively correlated with the bond's 
A. time to maturity.
B. coupon rate.
C. yield to maturity.
D. all of the above.
E. none of the above.

Duration is negatively correlated with coupon rate and yield to maturity.

Bodie - Chapter 16 #2
Difficulty: Moderate
 

65. A coupon bond that pays interest of $90 annually has a par value of $1,000, matures in 9 years, and is
selling today at a $66 discount from par value. The yield to maturity on this bond is __________. 
A. 9.00%
B. 10.15%
C. 11.25%
D. 12.32%
E. none of the above

FV = 1000, PMT = 90, n = 9, PV = -934, i = 10.15%

Bodie - Chapter 14 #29

Difficulty: Easy
 

66. Suppose the following equation best describes the evolution of b over time:
bt = 0.25 + 0.75bt-1
If a stock had a b of 0.6 last year, you would forecast the b to be _______ in the coming year. 
A. 0.45
B. 0.60
C. 0.70
D. 0.75
E. none of the above

0.25 + 0.75(0.6) = 0.70.

Bodie - Chapter 08 #39

Difficulty: Easy
 
67. Barber and Odean (2001) report that women trade __________ frequently than men. 
A. less
B. less in down markets
C. more in up markets
D. more
E. none of the above

Barber and Odean (2001) report that men trade more frequently than women.

Bodie - Chapter 12 #50

Difficulty: Moderate
 

68. Patell and Woflson (1984) report that most of the stock price response to corporate dividend or earnings
announcements occurs within ____________ of the announcement. 
A. 10 minutes
B. 45 minutes
C. 2 hours
D. 4 hours
E. 2 trading days

the correct answer is 2 hours.

Bodie - Chapter 11 #62

Difficulty: Moderate
 

69. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 4%. What is your
approximate annual real rate of return if the rate of inflation was 2% over the year? 
A. 4%.
B. 2%.
C. 6%.
D. 3%.
E. none of the above.

4% - 2% = 2%.

Bodie - Chapter 05 #39

Difficulty: Easy
 
70. GARCH models were pioneered by 
A. Robert Engle
B. Bodie, Kane, and Marcus
C. William Sharpe
D. Michael Jensen
E. Fama and French

GARCH models were pioneered by Robert Engle.

Bodie - Chapter 13 #54

Difficulty: Moderate
 

71. Which of the following statements is true about models that attempt to measure the empirical performance
of the CAPM? 
A. The conventional CAPM works better than the conditional CAPM with human capital.
B. The conventional CAPM works about the same as the conditional CAPM with human capital.
C. The conditional CAPM with human capital yields a better fit for empirical returns than the conventional
CAPM.
D. Adding firm size to the model specification dramatically improves the fit.
E. Adding firm size to the model specification worsens the fit.

The results are presented in Table 13.2.

Bodie - Chapter 13 #35

Difficulty: Moderate
 

72. Which one of the following par value 12% coupon bonds experiences a price change of $23 when the
market yield changes by 50 basis points? 
A. The bond with a duration of 6 years.
B. The bond with a duration of 5 years.
C. The bond with a duration of 2.7 years.
D. The bond with a duration of 5.15 years.
E. None of the above.

DP/P = -D X [D(1+y) / (1+y)]; -.023 = -D X [.005 / 1.12]; D = 5.15.

Bodie - Chapter 16 #25

Difficulty: Difficult
 
73. Which Excel tool can be used to find the points along an efficient frontier? 
A. Regression
B. Solver
C. Scenarios
D. Goal Seek
E. Data Analysis

Even if the student isn't familiar with Excel's Solver tool, he should recognize it from the discussion in the text.

Bodie - Chapter 07 #57

Difficulty: Moderate
 

74. The Dow theory posits that the three forces that simultaneously affect stock prices are ____________.
I) primary trend
II) intermediate trend
III) momentum trend
IV) minor trend
V) contrarian trend 
A. I, II, and III
B. II, III, and IV
C. III, IV and V
D. I, II, and IV
E. I, III, and V

The Dow theory posits that the three forces that simultaneously affect stock prices are primary trend,
intermediate trend, and minor trend.

Bodie - Chapter 12 #23

Difficulty: Moderate
 
75. Consider a bond selling at par with modified duration of 12 years and convexity of 265. A 1 percent
decrease in yield would cause the price to increase by 12%, according to the duration rule. What would be the
percentage price change according to the duration-with-convexity rule? 
A. 21.2%
B. 25.4%
C. 17.0%
D. 13.3%
E. none of the above.

DP/P = -D*Dy + (1/2) * Convexity * (Dy)2; = -12 * -.01 + (1/2) * 265 * (.01)2 = .12 + .01325 = .13325 or
(13.3%)
 

Bodie - Chapter 16 #81

Difficulty: Difficult
 

76. 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 above

An investor's indifference curves are parallel, and thus cannot intersect and have positive slopes. The highest
indifference curve (the one in the most northwestern position) offers the greatest utility. Indifference curves of
investors with similar risk-return trade-offs might intersect.

Bodie - Chapter 06 #6
Difficulty: Moderate
 
77. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect CAT with a
beta of 1.0 to offer a rate of return of 11 percent, you should 
A. buy stock X because it is overpriced.
B. sell short stock X because it is overpriced.
C. sell stock short X because it is underpriced.
D. buy stock X because it is underpriced.
E. none of the above, as the stock is fairly priced.

11% = 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is fairly priced.

Bodie - Chapter 09 #40

Difficulty: Moderate
 

78. When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio, 
A. the portfolio standard deviation will be greater than the weighted average of the individual security standard
deviations.
B. the portfolio standard deviation will be less than the weighted average of the individual security standard
deviations.
C. the portfolio standard deviation will be equal to the weighted average of the individual security standard
deviations.
D. the portfolio standard deviation will always be equal to the securities' covariance.
E. none of the above are true.

Whenever two securities are less than perfectly positively correlated, the standard deviation of the portfolio of
the two assets will be less than the weighted average of the two securities' standard deviations. There is some
benefit to diversification in this case.

Bodie - Chapter 07 #47

Difficulty: Moderate
 
79. The duration of a coupon bond 
A. does not change after the bond is issued.
B. can accurately predict the price change of the bond for any interest rate change.
C. will decrease as the yield to maturity decreases.
D. all of the above are true.
E. none of the above are true.

Duration changes as interest rates and time to maturity change, can only predict price changes accurately for
small interest rate changes, and increases as the yield to maturity decreases.

Bodie - Chapter 16 #29

Difficulty: Easy
 

80. The duration of a 20-year zero-coupon bond is 

A. equal to smaller than 20.
B. larger than 20.
C. smaller than 20.
D. equal to that of a 20-year 10% coupon bond
E. none of the above.

Duration of a zero-coupon bonds equals the bond's maturity.

Bodie - Chapter 16 #70

Difficulty: Easy
 

81. The utility score an investor assigns to a particular portfolio, other things equal, 
A. will decrease as the rate of return increases.
B. will decrease as the standard deviation increases.
C. will decrease as the variance increases.
D. will increase as the variance increases.
E. will increase as the rate of return increases.

Utility is enhanced by higher expected returns and diminished by higher risk.

Bodie - Chapter 06 #21

Difficulty: Easy
 
82. Early tests of the CAPM involved 
A. establishing sample data.
B. estimating the security characteristic line.
C. estimating the security market line.
D. all of the above.
E. none of the above.

These three basic steps, establishing sample data, estimating security characteristic lines and estimating the
security market line, were all necessary to test the implications of the CAPM.

Bodie - Chapter 13 #28

Difficulty: Easy
 

83. A reward-to-volatility ratio is useful in: 

A. measuring the standard deviation of returns.
B. understanding how returns increase relative to risk increases.
C. analyzing returns on variable rate bonds.
D. assessing the effects of inflation.
E. none of the above.

B is the only choice relevant to the reward-to-volatility ratio (risk and return).

Bodie - Chapter 06 #41

Difficulty: Moderate
 

84. Subordination clauses in bond indentures 

A. may restrict the amount of additional borrowing the firm can undertake.
B. are sometimes referred to as "me-first" rules.
C. provide higher priority to senior creditors in the event of bankruptcy.
D. all of the above are true.
E. both B and C are true.

All of the statements correctly describe subordination clauses.

Bodie - Chapter 14 #84

Difficulty: Easy
 
85. Studies by Chan, Karceski, and Lakonishok (2003) and La Porta, Lakonishok, Shleifer, and Vishny (1997)
report that 
A. the value premium is a manifestation of market irrationality.
B. the value premium is a rational risk premia.
C. the value premium is a statistical artifact found only in the U.S.
D. all of the above
E. none of the above

Studies by Chan, Karceski, and Lakonishok (2003) and La Porta, Lakonishok, Shleifer, and Vishny (1997)
report that the value premium is a manifestation of market irrationality.

Bodie - Chapter 13 #50

Difficulty: Moderate
 

 Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10%
and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%.

Bodie - Chapter 07
 

86. Which of the following portfolio(s) is (are) most efficient? 

A. 45 percent in A and 55 percent in B.
B. 65 percent in A and 35 percent in B.
C. 35 percent in A and 65 percent in B.
D. A and B are both efficient.
E. A and C are both efficient.

The Portfolio E(Rp), sp, and Reward/volatility ratios are 45A/55B: 8.9%, 0.6%, 14.83; 65A/35B: 9.3%, 6.2%,
1.5; 35A/65B: 8.7%, 2.2%, 3.95. Both A and B are efficient according to the mean-variance criterion. A has a
much higher Reward/volatility ratio.

Bodie - Chapter 07 #32

Difficulty: Difficult
 
87. A coupon bond is reported as having an ask price of 108% of the $1,000 par value in the Wall Street Journal.
If the last interest payment was made one months ago and the coupon rate is 9%, the invoice price of the bond
will be ____________. 
A. $1,087.50
B. $1,110.10
C. $1,150.00
D. $1,160.25
E. none of the above

$1,080 + $7.5 (accrued interest) = $1,087.50.

Bodie - Chapter 14 #21

Difficulty: Moderate
 

88. If a 7.75% coupon bond is trading for $1019.00, it has a current yield of ____________ percent. 
A. 7.38
B. 6.64
C. 7.25
D. 7.61
E. 7.18

77.50/1019 = 7.605.

Bodie - Chapter 14 #5
Difficulty: Easy
 

89. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 40
stocks in order to construct a mean-variance efficient portfolio constrained by 40 investments. They will need to
calculate _____________ expected returns and ___________ variances of returns. 
A. 100, 100
B. 40, 40
C. 4950, 100
D. 4950, 4950
E. none of the above

The expected returns of each of the 40 securities must be calculated. In addition, the 40 variances around these
returns must be calculated.

Bodie - Chapter 08 #62

Difficulty: Moderate
 
90. One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does this mean? 
A. They plan for one identical holding period.
B. They are price-takers who can't affect market prices through their trades.
C. They are mean-variance optimizers.
D. They have the same economic view of the world.
E. They pay no taxes or transactions costs.

Myopic behavior is shortsighted, with no concern for medium-term or long-term implications.

Bodie - Chapter 09 #63

Difficulty: Moderate
 

91. The CAPM is not testable unless 

A. the exact composition of the true market portfolio is known and used in the tests.
B. all individual assets are included in the market proxy.
C. the market proxy and the true market portfolio are highly negatively correlated.
D. A and B.
E. B and C.

A and B must be true for the CAPM to be tested; however, the exact composition of the true market portfolio
cannot be known, thus the CAPM probably can never be tested.

Bodie - Chapter 13 #25

Difficulty: Easy
 

92. The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight, during
the peak of the citrus harvest. In an efficient market one would expect the price of Florida Orange's stock to 
A. drop immediately.
B. remain unchanged.
C. increase immediately.
D. gradually decline for the next several weeks.
E. gradually increase for the next several weeks.

In an efficient market the price of the stock should drop immediately when the bad news is announced. If later
news changes the perceived impact to Florida Orange, the price may once again adjust quickly to the new
information. A gradual change is a violation of the EMH.

Bodie - Chapter 11 #41

Difficulty: Moderate
 
93. Your opinion is that security A has an expected rate of return of 0.145. It has a beta of 1.5. The risk-free rate
is 0.04 and the market expected rate of return is 0.11. According to the Capital Asset Pricing Model, this
security is 
A. underpriced.
B. overpriced.
C. fairly priced.
D. cannot be determined from data provided.
E. none of the above.

14.5% = 4% + 1.5(11% - 4%) = 14.5%; therefore, the security is fairly priced.

Bodie - Chapter 09 #69

Difficulty: Moderate
 

94. Single men trade far more often than women. This is due to greater ________ among men. 
A. framing
B. regret avoidance
C. overconfidence
D. conservatism
E. none of the above

Single men trade far more often than women. This is due to greater overconfidence among men.

Bodie - Chapter 12 #8
Difficulty: Moderate
 
95. Duration is important in bond portfolio management because
I) it can be used in immunization strategies.
II) it provides a gauge of the effective average maturity of the portfolio.
III) it is related to the interest rate sensitivity of the portfolio.
IV) it is a good predictor of interest rate changes. 
A. I and II
B. I and III
C. III and IV
D. I, II, and III
E. I, II, III, and IV

Duration can be used to calculate the approximate effect of interest rate changes on prices, but is not used to
forecast interest rates.

Bodie - Chapter 16 #61

Difficulty: Moderate
 

96. Which statement is not true regarding the market portfolio? 

A. It includes all publicly traded financial assets.
B. It lies on the efficient frontier.
C. All securities in the market portfolio are held in proportion to their market values.
D. It is the tangency point between the capital market line and the indifference curve.
E. All of the above are true.

The tangency point between the capital market line and the indifference curve is the optimal portfolio for a
particular investor.

Bodie - Chapter 09 #10

Difficulty: Moderate
 
97. "Bracket Creep" happens when 
A. tax liabilities are based on real income and there is a negative inflation rate.
B. tax liabilities are based on real income and there is a positive inflation rate.
C. tax liabilities are based on nominal income and there is a negative inflation rate.
D. tax liabilities are based on nominal income and there is a positive inflation rate.
E. too many peculiar people make their way into the highest tax bracket.

A positive inflation rate typically leads to higher nominal income. Higher nominal income means people will
have higher tax liabilities and in some cases will put them in higher tax brackets. This can happen even when
real income has declined.

Bodie - Chapter 05 #30

Difficulty: Moderate
 

98. Work by Amihud and Mendelson (1986,1991) 

A. argues that investors will demand a rate of return premium to invest in less liquid stocks.
B. may help explain the small firm effect.
C. may be related to the neglected firm effect.
D. B and C.
E. A, B, and C.

Lack of liquidity may affect the returns of small and neglected firms; however the theory does not explain why
the abnormal returns are concentrated in January.

Bodie - Chapter 11 #28

Difficulty: Moderate
 

 You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with 2 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.

Bodie - Chapter 06
 
99. What would be the dollar values of your positions in X and Y, respectively, if you decide to hold 40%
percent of your money in the risky portfolio and 60% in T-bills? 
A. $240; $360
B. $360; $240
C. $100; $240
D. $240; $160
E. Cannot be determined

$400(0.6) = $240 in X; $400(0.4) = $160 in Y.

Bodie - Chapter 06 #39

Difficulty: Moderate
 

100. Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of 1.3. The risk-free rate
is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this
security is 
A. underpriced.
B. overpriced.
C. fairly priced.
D. cannot be determined from data provided.
E. none of the above.

13.75% - 4% + 1.3(11.5% - 4%) = 0.0%; therefore, the security is fairly priced.

Bodie - Chapter 09 #29

Difficulty: Moderate
 
Test02 Summary

Category #  of  Question

s
Bodie - Chapter 05 5
Bodie - Chapter 06 12
Bodie - Chapter 07 12
Bodie - Chapter 08 10
Bodie - Chapter 09 10
Bodie - Chapter 10 12
Bodie - Chapter 11 10
Bodie - Chapter 12 5
Bodie - Chapter 13 5
Bodie - Chapter 14 15
Bodie - Chapter 16 10
Difficulty: Difficult 10
Difficulty: Easy 29
Difficulty: Moderate 61