AAMS Module Quizzes (1-10) Test Questions with Complete Answers, A+

Which of the following is a key element that all investment policy statements should contain? - cORRECT sOLUTION An investment policy statement should include statements regarding acceptable investment vehicles, the portfolio's asset allocation, and the client's risk tolerance level. The asset management process can be used to adjust to changes in a client's financial situation by - cORRECT sOLUTION helping the client to ignore market "noise." The asset management process is designed to help the client ignore market noise and respond only to significant events (major changes in personal situations and discontinuous changes in the markets). Sara White bought a stock that has subsequently dropped 50%. She plans to hold on to the stock in the hopes of getting back to even. What investor mistake is Sara most likely making? - cORRECT sOLUTION loss aversion Loss aversion is the reluctance to take losses and is associated with a "get-even-itis" mentality. The investment policy statement would most likely need to be changed if which of the following occurred? - cORRECT sOLUTION The investment policy statement would most likely need to be changed if a client experienced a major event in his or her life. Examples of such changes would include inheriting a large amount of money, divorcing a spouse, and taking an early retirement from his or her company. Who bears the main responsibility for decision making in an investment policy statement? - cORRECT sOLUTION the client Which behavioral mistake is defined as a misunderstanding that an investor has in relating nominal rates of return to real (inflation-adjusted) rates of return? - cORRECT sOLUTION money illusion Money illusion is a misunderstanding that an investor has in relating nominal rates of return to real (inflation-adjusted) rates of return. Which of the following is not an example of a discontinuous change? - cORRECT sOLUTION receiving a 10% raise at work Discontinuous changes represent a significant departure from a trend or pattern. Bonds fell in price on news of higher interest rates. To which one of the following risks are the bonds most likely to be subject? - cORRECT sOLUTION interest rate risk Interest rate risk centers on the inverse relationship of interest rate changes and bond prices, so, in this situation, if interest rates go up, the price of George's bonds go down. If international stocks were added to a portfolio of U.S. stocks, which one of the following risks would specifically be added to the portfolio? - cORRECT sOLUTION exchange rate risk International stocks specifically add exchange rate risk to a portfolio since their value is affected by changes in the values of foreign currencies relative to that of the U.S. dollar. Which of the following are characteristics of the Sharpe ratio? - cORRECT sOLUTION It adjusts the return for variability by using standard deviation as the measure of risk Jensen's Alpha - cORRECT sOLUTION 1. it assumes that the portfolio being evaluated is well diversified 2. both alpha and beta appear in the formula for the ratio 3. it indicates by how much the realized return differs from the return required by the capital asset pricing model (CAPM) Treynor Ratio - cORRECT sOLUTION it assumes that the portfolio being evaluated is well diversified A measure of a security's systematic risk is - cORRECT sOLUTION beta. Beta measures the degree to which a security moves with the market or systematic risk. Measurement of total risk - cORRECT sOLUTION standard deviation Assume a growth stock mutual fund has a beta of 1.3. If the stock market increases by 9%, you would expect this mutual fund to - cORRECT sOLUTION increase by 11.7%. You would expect any fund with a beta of 1.3 to increase by 11.7% (1.3 × 9%). The risk-free rate is 1.25%, the market rate of return is 8%, the standard deviation of XYZ stock is 20, and the beta of XYZ stock is 1.10. Using the capital asset pricing model in conjunction with this information, what is the expected return of XYZ stock? - cORRECT sOLUTION 8.68% CAPM is the risk-free rate plus beta times excess return, or Rs = 1.25% + (8% - 1.25%) 1.1 = 8.68%. Which one of the following lists the investments in order of least risk to most risk? - cORRECT sOLUTION Treasury securities, high-grade convertibles, REITs, collectibles Ranked from least risk to most risk in the investment pyramid are Treasury securities, high-grade convertibles, REITs, and collectibles. Which one of the following statements is correct? - cORRECT sOLUTION Jensen's alpha may be used by itself to judge an investment. Beta is the risk measure for the Jensen's alpha, but the Sharpe ratio uses standard deviation as its risk measure. Therefore, the reliability of beta is relevant for Jensen's alpha. Jensen's alpha can be used by itself to judge an investment; the Sharpe ratio must be used in comparison with another Sharpe ratio in judging an investment. A negative reading for Jensen's alpha indicates the investment did not perform as well as expected given the risk taken. For example, an alpha reading of -1 means the investment underperformed by 1% compared to what it was expected to return. Accordingly, a negative alpha does not necessarily mean the investment lost money. The Treynor ratio uses beta as its measure of risk. negative alpha means - cORRECT sOLUTION the fund underperformed the benchmark (does NOT mean that it's a negative return, it's just LOWER than the benchmark) Assume each of the asset classes below has the following correlation to long-term government bonds: Treasury bills: 0.67 Corporate bonds: 0.81 Large stocks: 0.37 Small stocks: 0.12 Which one of the following correctly states the impact of diversification on a portfolio of long-term government bonds? - cORRECT sOLUTION Small stocks provide more diversification than large stocks. Because the correlations of small stocks to long-term government bonds are less than that of large stocks (even though both are positive), small stocks provide more diversification than large stocks. Gary Stevens would like to know the weighted beta coefficient for his portfolio. He owns 100 shares of ACE common stock with a beta of 1.1 and total current market value of $5,000; 400 shares of BDF common stock with a beta of .70 and total current market value of $8,000; and 200 shares of GIK common stock with a beta of 1.5 and total current market value of $10,000.What is the overall weighted beta coefficient for Gary's portfolio? - cORRECT sOLUTION This can be done long-hand, using the following steps:$5,000 + $8,000 + $10,000 = $23,000 total value of the portfolio([$5,000/$23,000] x 1.1) + ([$8,000/$23,000] x 0.7) + ([$10,000/$23,000] x 1.5) = 1.13478 = 1.13 The higher the standard deviation of an investment in relation to its rate of return, - cORRECT sOLUTION the greater the level of risk for a given rate of return. The greater the dispersion of returns around an average rate of return, the greater will be the standard deviation and, consequently, the higher the level of risk for a given rate of return. During the past year, the portfolio of your largest client had a return of 10% and a beta of 1.1. During the same year, the average T-bill rate was 1.25%. What is the Treynor ratio for the performance of this portfolio? - cORRECT sOLUTION .0796 The Treynor ratio divides the excess return (return - risk-free rate) by the beta—in this case, (.10 - .0125) ÷ 1.1 = .0796. The risk-adjusted ratio that can be used by itself (without comparison to something else) is the - cORRECT sOLUTION Jensen's alpha. The Jensen ("alpha") compares a portfolio's actual return with the return that could be expected based on the risk incurred in managing that portfolio, and therefore can be used by itself.