Paper: Final Term Investment & Portfolio Management

Marks: 100

Time Allowed: 3 Hours

Note: Show calculations where required. Answers encircled and then erased will not
be given credit for.

PART 1: Multiple Choice Questions. (60)

1. Chapter 1 defines the nature of investments. Which of the following is NOT

considered an investment?
a) The commitment of funds to an asset held for the future.
b) Gold coins
c) Treasury notes
d) Renting an apartment

2. Which of the following is NOT a common reason why many people invest in financial
assets?

a) Save for retirement.

b) Save to buy a house or condominium.
c) Save for children’s education.
d) Help their stockbroker make commissions.

3. Which of the following is NOT a career field using an understanding of Investments?

a) Investment bankers
b) Bond salespeople
c) Chemical engineers
d) Registered representatives

4. Which of the following is the foundation for making investment decisions?

a) Buying the right investment products.
b) The trade-off between expected return and risk.
c) Making the most money.
d) Minimizing taxes, commissions and storage costs.

5. Which factor causes the greatest increase in the Final Rupees Wealth?

a) The amount invested per year.

b) The number of years invested.
c) The interest rate.
d) The final rupees wealth does not change.

6. Which of the following is considered an “investment,” but not a “marketable

security”?
a) Common stocks
b) An apartment building
c) Treasury bonds
d) Exchange Traded Funds

7. What is meant by the statement “investors are risk averse”?

a) Investors never invest in assets with even the smallest risk.
b) Investors invest in risky assets only if they expect a greater return.
c) All investors choose risky assets.
d) All investors will choose to invest in the same assets.

8. If investors are risk-averse, then what is meant by the term “risk tolerance”?
a) Risk tolerance is the opposite of risk-averse.
b) Risk tolerance refers to the degree of risk an investor is willing to accept with their
investments.
c) Risk tolerance is the same as risk-averse.
d) Risk tolerance is the same for all investors.

9. Among the following assets, which is the most risky?

a) Corporate bonds
b) Treasury bonds
c) Speculative puts & calls
d) Corporate equities

10. Which of the following is NOT part of security analysis?

a) Determining the factors that affect the value of the specific security.
b) Determining the expected future returns for the specific security.
c) Performing an asset-allocation matrix.
d) Determining the risk-return profile of the specific security as it relates to other
securities
11. Which of the following is NOT a contribution the Internet has made to the field of
Investments?
a) Investors can access information on companies and markets very easily.
b) Investors can place stock market orders quickly and inexpensively.
c) Individual investors now have access to information previously available only to
institutional investors.
d) Investors have much higher returns today because of the Internet.

12: While certain investors look for income-producing investments, most investors is
more concerned with total return investing. Total return is measured by:
a) Dividends
b) Coupon payments on bonds
c) Yield plus capital appreciation or depreciation
d) Capital appreciation or depreciation.

13: Why would an investor choose to invest in any risky asset?

a) Because they expect a return adequate to compensate them for the extra risk.
b) The government requires risky investments to provide higher returns.
c) Investors want very safe investments.
d) Risk and return move in opposite directions.

14: Which of the following is NOT a source of risk involved with investing in financial
assets?

a) Interest rate risk

b) Inflation risk
c) Investment risk
d) Liquidity risk

15: One of the most basic tenets of general investment philosophy is:

a) Past returns should always be extrapolated into the future.

b) Investors should purchase a security if its expected return compensates for its risk.
c) Realized returns are generally close to expected returns, in any short period.
d) The investments with higher expected returns are usually safer.

16: For U.S. investors, which of the following is a source of risk involved with
international investments, but not with domestic investments?

a) Inflation risk
b) Business risk
c) Exchange rate risk
d) Liquidity risk.
17: Which of the following is included in "market risk"?

a) Specific risk
b) Business risk
c) Interest rate risk
d) Financial risk

18: Formula shows us how to calculate Total Return TR = (CFt + PE -PB) / PB

Which part of the formula represents the yield?

a) CFt
b) CFt / Pb
c) PE -PB
d) (PE -PB) / PB

19: The total return on a treasury bond is measured by:

a) the present value of its coupon payments only

b) .interest rate risk
c) coupon payments plus capital gain or loss
d) dividends plus capital gain or loss

20: How does one calculate the “Cumulative Wealth Index”?

a) Add the total returns for each year and add to the starting amount.
b) Multiply the return relatives for each year, and multiply by the starting amount.
c) Adding the return relatives for each year, and add to the starting amount.
d) Multiply the total returns for each year, and multiply by the starting amount

21: Investments in non-Pakistani companies and funds expose investors to all of the
following risks EXCEPT:

a) Exchange rate risk

b) Country (political) risk.
c) Diversification risk
d) Market risk.

22: Which is of the following is an appropriate time to use the arithmetic mean, rather
than the geometric mean?

a) The arithmetic mean is a better measure of typical performance over a single period.
b) The geometric mean is a better measure of typical performance over a single period.
c) The geometric mean shows the compound average rate of growth over several periods.
d) The arithmetic mean does better at adjusting for inflation.
23: Which of the following best explains why analysts may want to adjust nominal
returns to real returns?

a) “Nominal returns” are returns in name only.

b) Only “real” returns are the actual returns the investor receives.
c) The investor receives money returns, but with inflation, the value of money falls.
d) Real and nominal returns are measuring the same thing.

24: Which is the best way to accurately calculate the inflation adjusted total return?

a) (1+ TR) / (1+inf) – 1

b) TR – inf
c) TR + inf
d) Cannot be determined.

25: Which of the following is NOT another way to express the concept of “risk”?

a) Dispersions of outcomes
b) Variability
c) The chance the actual outcome will differ from the expected outcome
d) The total return

26: Consider the following investments, each of which has a series of total returns over
time. Which series is likely to have the lowest variability?

a) A one-year treasury bill held to maturity.

b) Common stock
c) Mutual funds
d) Corporate bonds

27: The standard deviation of total returns can be calculated for all but which of the
following?

a) The series of total returns for a specific stock over a specified period in the past.
b) The series of total returns for a mutual fund over a specified period in the past.
c) The series of total returns for a specific stock over a specified period in the future.
d) The series of total returns for a portfolio of securities over a specified period in the
past.

28: All of the following are categories of a particular security’s risk premium EXCEPT:

a) Time premium between long term and short term treasury bonds.
b) Default premium between corporate bonds and treasury bonds.
c) Equity risk premium between a stock and a treasury security.
d) The risk-free rate of return.
29: Which of the following asset classes has demonstrated the greatest volatility over
time?
a) Large-cap stocks
b) Treasury bonds
c) Small-cap stocks
d) Treasury bills

30: What best explains the vast difference in cumulative wealth index for common stocks
versus Treasury bonds, over long periods?

a) Common stocks have much higher volatility, over a long period of time.
b) While common stocks have higher returns, it is the compounding of returns over time
that makes such a huge difference.
c) Treasury bonds are much safer than common stocks.
d) Common stocks have higher returns than Treasury bonds, over time.

31: Chapter 7 focuses on realized returns and standard deviations. Which of the
following is NOT a reason why investors are interested in past activity?

a) Realized (past) returns can help investors form expectations about expected (future)
returns.
b) Realized (past) returns are used directly to make decisions as to investment values.
c) Investors and portfolio managers want to measure the success of their past decisions.
d) Statistically, investors can use past data to form forecasts about the future.

32: An analyst has estimated what the rate of return on XYZ stock will be in various
states of the economy, as shown in the following table:

Economy Probability Return

Boom .1 30%
Good time .2 15%
Moderate .4 10%
Slow .2 0%
Recession .1 -20%
1.0

What is the expected rate of return for XYZ?

a) 8%
b) 10%
c) 12%
d) 15%
33: An analyst has estimated what the rate of return on XYZ stock will be in various
states of the economy, as shown in the following table:

Economy Probability Return

Boom .1 30%
Good time .2 15%
Moderate .4 10%
Slow .2 0%
Recession .1 -20%
1.0

:What is the variance of the rate of return on XYZ?

a) 151%
b) .0151
c) .1229
d) –

34: Sally has three investments, with the expected returns and portfolio proportions as
shown below:

Investment Proportion Expected

Return*
Treasuries 0.50 4%
Microsoft 0.30 7%
AT&T 0.20 6%
1.00
*this is a hypothetical example

What is the expected return for Sally’s entire portfolio?

a) 4%
b) 7%
c) 5.3%
d) 17%

35: Which of the following is NOT a measure of risk?

a) Standard deviation
b) Variation
c) Expected return
d) Dispersion
36: Which of the following is a true statement concerning portfolios?

a) The expected return of a portfolio is less than the weighted average of expected return
of its components. W
b) The variance of a portfolio is equal to the weighted average of the variance of its
components.
c) The variance of a portfolio is less than the weighted average of the variance of its
components.
d) The variance of a portfolio is more than the weighted average of the variance of its
components.

37: Which type of risk is reduced when assets are combined into portfolios?

a) Market risk
b) Systematic risk
c) Company-specific risk
d) Interest rate risk

38: Which of the following is likely to cause some of the covariance between pairs of
securities’ returns?

a) The effects of the economy, such as interest rates, affect both securities.
b) The unique events affecting the two companies are independent.
c) If the two companies are in different industries, both companies will respond
differently.
d) Both companies have high company-specific risk.

39: Consider a portfolio of Asset A and Asset B. Which level of correlation between the
returns of A and B will reduce the standard deviation of the portfolio the most?

a)  = +1.00
b) 
c) 
d) 

40: Which of the following best explains the difference between “correlation” and
“covariance??”

a) Correlation measures how the returns of two returns move together, but the covariance
is the square root of the variance.
b) Correlation can be any number, positive or negative; covariance is somewhere
between –1 and +1 only.
c) Covariance is a measure of how two variables move together, but correlation is
relative, dividing the covariance by the standard deviations of both the two variables.
d) Correlation is used to calculate the portfolio standard deviation, but covariance cannot
be used in investment theory

Pick out True and False: (20)

1. The trade-off between risk and reward is one of the most important topics in
investments.(T/F)

2. The field of Investments covers only marketable securities, not non-marketable

assets.(T/F)

3. Wealth should be evaluated and managed within the context of a portfolio, which
consists of the asset holdings of an investor.(T/F)

4. Investment bankers need security analysts to assist in the sale of new securities and in
the valuation of firms as possible merger or acquisition candidates.(T/F)

5. All investors should invest in stocks, because historically stocks have provided the
highest return of all financial assets.(T/F)

6. The first issue to understand in the study of Investments is the trade-off between risk
and return.(T/F)

7. All investors have the same degree of risk aversion.(T/F)

8. Investments are made on the basis of future (ex ante) returns, rather than past (ex post)
returns (T/F)

9. Even the best investors make mistakes.(T/F).

10: Investment decisions involve estimations of future returns. But future returns are
never knowable in advance, with certainty.(T/F)

11: A probability distribution shows all the possible outcomes, and the probability of
each outcome occurring.(T/F)
12: The normal distribution is an example of a discrete distribution.(T/F)

13: According to the Law of Large Numbers, the larger the sample size, the more likely it
is that the sample mean will be close to the population expected value.(T/F)

14: The expected return on a portfolio is the expected return of each asset, multiplied by
its weight in the portfolio.(T/F)

15: The standard deviation of a portfolio is the standard deviation of each asset,
multiplied by its weight in the portfolio.(T/F)

16: If we want to build a portfolio with two assets whose returns are statistically
independent, we need to find two assets whose firm-specific risks are completely
unrelated.(T/F)

17: “Don’t put all your eggs in one basket” is a popular saying, which expresses the
fundamental idea of diversification.(T/F)

18: Although tedious, working through the 31,125 co-variances of a 250-security

portfolio can be handled by a reasonably modern computer.(T/F)

19: The investments choices available to individual investors continue to change rapidly.
(T/F)

20: Direct investing allows investors to buy and sell securities themselves (T/F)
PART B: Solve any 4 of the following problems. All Carry Equal Marks. (40)

1: Calculate the total return for the following.

A: Assume that you purchased a 10% coupon bond at the price of 960 PKR and
sold one year later for 1020 PKR.

B: 100 shares of BAC & Co were purchased at 30 PKR and sold one year later for
26. A dividend of 2 Rupees per share was also received.

2: Calculate arithmetic and geometric mean from the following data.

(Hint: For G.M convert data into Return relatives)

YEAR Total Return (%age)

1990 -3.14
1991 30.00
1992 7.43
1993 9.94
1994 1.29
1995 37.11
1996 22.68
1997 33.10
1998 28.34
1999 20.88

3: Calculate the expected return for portfolio.

Consider the portfolio of three stocks G, H and I. with the expected returns of 12, 20
and 17 percent respectively. Assuming that the weights of portfolios are 40, 40 and
20 percent respectively.

4: Calculate the portfolio risk.

Assume that there are two stocks in a portfolio i.e. ABC and XYZ.

Expected return for ABC is 10.1% while standard deviation is 16.8%. For XYZ
expected return is 15.4 while the standard deviation is 27.8 %. The correlation
coefficient between the two is 0.19.

5: Four securities have following expected returns.

A: 12%. B: 15%. C: 22%. D: 30%.

Using the following conditions calculate the expected return for the portfolio.
1: The portfolio weights are 25% each.
2: Security A has a weight of 10% while the weight of the rest of securities remains
unknown.
3: A and B have a weight of 20 %.

*********************************GOOD LUCK**************************