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1. Which of the following statements is CORRECT? (Points : 5)

a. The beta of a portfolio of stocks is always smaller than the betas of any

of the individual stocks.

b. If you found a stock with a zero historical beta and held it as the only

stock in your portfolio, you would by definition have a riskless

portfolio.

c. The beta coefficient of a stock is normally found by regressing past

returns on a stock against past market returns. One could also construct

a scatter diagram of returns on the stock versus those on the market,

estimate the slope of the line of best fit, and use it as beta. However,

this historical beta may differ from the beta that exists in the future.

d. The beta of a portfolio of stocks is always larger than the betas of any

of the individual stocks.

e. It is theoretically possible for a stock to have a beta of 1.0. If a

stock did have a beta of 1.0, then, at least in theory, its required rate

of return would be equal to the risk-free (default-free) rate of return,

r

2. Which of the following statements is NOT CORRECT? (Points : 5)

If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.

All else equal, bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities.

If a bond is selling at its par value, its current yield equals its yield to maturity.

If a bond is selling at a premium, its current yield will be greater than its yield to maturity.

All else equal, bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons.

3. Which of the following statements is CORRECT? (Points : 5)

a. If a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity.

b. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.

c. On an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest.

d. If a coupon bond is selling at par, its current yield equals its yield to maturity.

e. The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to maturity than Bond B.

4. Which of the following statements is CORRECT? (Points : 5)

Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued.

Most sinking funds require the issuer to provide funds to a trustee, who saves the money so that it will be available to pay off bondholders when the bonds mature.

A sinking fund provision makes a bond more risky to investors at the time of issuance.

Sinking fund provisions never require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time.

If interest rates have increased since a company issued bonds with a sinking fund, the company is less likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price.

5. Which of the following statements best describes what you should expect to happen if you randomly select stocks and add them to your portfolio? (Points : 5)

a. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

b. Adding more such stocks will increase the portfolio's expected rate of return.

c. Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk.

e. Adding more such stocks will have no effect on the portfolio's risk.

e. Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.

6. A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is NOT CORRECT? (Points : 5)

a. The bond's expected capital gains yield is positive.

b. The bond's yield to maturity is 9%.

c. The bond's current yield is 9%.

d. If the bond's yield to maturity remains constant, the bond will continue to sell at par.

e. The bond's current yield exceeds its capital gains yield.

7. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. a. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stock is zero. Assuming the market is in equilibrium, which of the following statements is CORRECT? (Points : 5)

a. Portfolio P's expected return is greater than the expected return on Stock B.

b. Portfolio P's expected return is equal to the expected return on Stock A.

c. Portfolio P's expected return is less than the expected return on Stock B.

d. Portfolio P's expected return is equal to the expected return on Stock B.

e. Portfolio P's expected return is greater than the expected return on Stock C.

8. Which of the following statements is CORRECT? (Points : 5)

a. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.

b. Liquidity premiums are generally higher on Treasury than corporate bonds.

c. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.

d. Default risk premiums are generally lower on corporate than on Treasury bonds.

e. Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

9. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT? (Points : 5)

a. Portfolio P has a standard deviation of 20%.

b. The required return on Portfolio P is equal to the market risk premium (rM - rRF).

c. Portfolio P has a beta of 0.7.

d. Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.

e. Portfolio P has the same required return as the market (rM).

10. A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT? (Points : 5)

The bond sells at a price below par.

The bond has a current yield greater than 8%.

The bond sells at a discount.

The bond's required rate of return is less than 7.5%.

If the yield to maturity remains constant, the price of the bond will decline over time.

11. Which of the following statements is CORRECT? (Points : 5)

a. A zero coupon bond's current yield is equal to its yield to maturity.

b. If a bond's yield to maturity exceeds its coupon rate, the bond will sell at par.

c. All else equal, if a bond's yield to maturity increases, its price will fall.

d. If a bond's yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.

e. All else equal, if a bond's yield to maturity increases, its current yield will fall.

12. Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price? (Points : 5)

a. An 8-year bond with a 9% coupon.

b. A 1-year bond with a 15% coupon.

c. A 3-year bond with a 10% coupon.

d. A 10-year zero coupon bond.

e. A 10-year bond with a 10% coupon.

13. Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio? (Points : 5)

a. The combined portfolios expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.

b. The combined portfolio's beta will be equal to a simple average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.

c. The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.

d. The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.

e. The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.

14. Which of the following statements is CORRECT? (Points : 5)

a. If a coupon bond is selling at par, its current yield equals its yield to maturity.

b. If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.

c. If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.

d. If a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium.

e. If a coupon bond is selling at a premium, its current yield equals its yield to maturity.

15. A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Both bonds have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT? (Points : 5)

a. The prices of both bonds will decrease by the same amount.

b. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.

c. The prices of both bonds would increase by the same amount.

d. One bond's price would increase, while the other bond's price would decrease.

e. The prices of the two bonds would remain constant.

16. Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is CORRECT? (Points : 5)

a. The portfolio's beta is less than 1.2.

b. The portfolio's expected return is 15%.

c. The portfolio's standard deviation is greater than 20%.

d. The portfolio's beta is greater than 1.2.

e. The portfolio's standard deviation is 20%.

17. A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0 and a perfect positive correlation with the market. Potential new Stocks A and B both have expected returns of 15%, and both are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice matter? (Points : 5)

a. Either A or B, i.e., the investor should be indifferent between the two.

b. Stock A.

c. Stock B.

d. Neither A nor B, as neither has a return sufficient to compensate for risk.

e. Add A, since its beta must be lower.

18. A 12-year bond has an annual coupon rate of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT? (Points : 5)

a. If market interest rates decline, the price of the bond will also decline.

b. The bond is currently selling at a price below its par value.

c. If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.

d. The bond should currently be selling at its par value.

e. If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today.

19. Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par? (Points : 5)

a. Adding additional restrictive covenants that limit management's actions.

b. Adding a call provision.

c. The rating agencies change the bond's rating from Baa to Aaa.

d. Making the bond a first mortgage bond rather than a debenture.

e. Adding a sinking fund.

20. Which of the following statements is CORRECT? (Points : 5)

a. All else equal, senior debt generally has a lower yield to maturity than subordinated

debt.

b. An indenture is a bond that is less risky than a mortgage bond.

c. The expected return on a corporate bond will generally exceed the bond's yield to maturity.

d. If a bond's coupon rate exceeds its yield to maturity, then its expected return to investors exceeds the yield to maturity.

e. Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated.

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