FIN 4504 | FIN4504 Final Exam: Investments
Updated and Latest Questions and Correct
Answers with Rationale - Florida State University
1. A stock has a beta of 1.2, the risk-free rate is 3%, and the expected return on the market is
10%. According to the Capital Asset Pricing Model (CAPM), what is the expected return of the
stock?
A. 8.4%
B. 12.0%
C. 15.0%
D. 11.4%
Correct Answer: D
Explanation: The Capital Asset Pricing Model uses the formula expected return equals
risk-free rate plus beta times market risk premium. In this case, the calculation is 3% plus
1.2 multiplied by the 7% market risk premium. This results in a total expected return of
11.4% for the security. The model assumes that investors are only compensated for
systematic risk which cannot be diversified away. It provides a linear relationship between
the risk of an asset and its required rate of return.
2. Which form of the Efficient Market Hypothesis (EMH) states that stock prices reflect all
information that can be derived by examining market trading data such as history of past
prices and volume?
A. Strong-form efficiency
B. Weak-form efficiency
C. Semi-strong-form efficiency
D. Technical-form efficiency
Correct Answer: B
Explanation: Weak-form efficiency implies that past price and volume data are already
incorporated into current stock prices. This means that technical analysis cannot
consistently produce superior investment returns over time. Investors cannot profit by
looking at historical trends because the market reacts instantly to new data. Semi-strong
and strong forms include additional layers of public and private information respectively.
Understanding these levels helps portfolio managers decide between active and passive
investment strategies.
,3. An investor is considering two assets with a correlation coefficient of -1.0. What is the
primary benefit of combining these two assets in a portfolio?
A. Complete elimination of risk if proportions are correct
B. Perfect elimination of all systematic risk
C. Maximization of the expected return regardless of risk
D. Reduction of the risk-free rate of return
Correct Answer: A
Explanation: A correlation coefficient of -1.0 indicates that two assets move in perfectly
opposite directions. By combining these assets in specific proportions, an investor can
create a risk-free portfolio. This is the ultimate goal of diversification within a two-asset
framework to minimize variance. However, it is important to note that finding perfectly
negatively correlated assets is rare in real markets. This theoretical concept underscores
the power of non-perfect correlation in reducing unsystematic portfolio risk.
4. Using the Constant Growth Dividend Discount Model, what is the value of a stock that just
paid a $2.00 dividend, has a growth rate of 5%, and a required return of 10%?
A. $40.00
B. $20.00
C. $42.00
D. $44.10
Correct Answer: C
Explanation: The Gordon Growth Model calculates the price as the next year’s dividend
divided by the difference between required return and growth. Since the dividend just paid
was $2.00, the expected dividend is $2.10 after applying the 5% growth. Dividing $2.10 by
0.05 results in an intrinsic value of $42.00 per share. This model is highly sensitive to
changes in the estimated growth rate and required rate of return. It is best suited for
mature companies with stable and predictable dividend payout histories.
5. Which of the following measures is defined as the ratio of the portfolio’s risk premium to
its standard deviation?
A. Sharpe Ratio
B. Treynor Ratio
C. Jensen’s Alpha
D. Information Ratio
Correct Answer: A
, Explanation: The Sharpe Ratio measures the reward-to-volatility trade-off by using total
risk in the denominator. It is calculated by subtracting the risk-free rate from the portfolio
return and dividing by the standard deviation. A higher Sharpe Ratio indicates better risk-
adjusted performance for the investor. Unlike the Treynor Ratio, it accounts for both
systematic and unsystematic risk components. It is widely used to compare the
performance of diversified portfolios against a benchmark.
6. If a bond’s yield to maturity (YTM) is greater than its coupon rate, the bond is trading at:
A. A premium
B. A discount
C. Par value
D. Face value
Correct Answer: B
Explanation: When the required market yield exceeds the coupon rate, the bond’s price
must fall below its face value. This occurs because the fixed interest payments are less
attractive than current market rates. Investors pay less for the bond to compensate for the
lower periodic interest income received. As the bond approaches maturity, its price will
gradually pull toward its par value. This relationship between price and yield is a
fundamental principle of fixed-income security valuation.
7. In the context of the Fama-French Three-Factor Model, what are the two additional factors
added to the market risk premium?
A. Size and Book-to-Market Ratio
B. Momentum and Liquidity
C. Inflation and GDP Growth
D. Industry Beta and Dividend Yield
Correct Answer: A
Explanation: The Fama-French model expands on CAPM by adding size and value risk
factors to the equation. The SMB factor represents Small Minus Big market capitalization
stocks to capture size effects. The HML factor stands for High Minus Low book-to-market
ratios to capture value effects. Research suggests that small-cap and value stocks tend to
outperform the market over the long term. This model provides a more comprehensive
explanation of stock returns than the single-factor CAPM.
8. Which investment strategy involves shifting the portfolio’s asset allocation based on short-
term market forecasts?
A. Strategic Asset Allocation
B. Buy and Hold Strategy
Updated and Latest Questions and Correct
Answers with Rationale - Florida State University
1. A stock has a beta of 1.2, the risk-free rate is 3%, and the expected return on the market is
10%. According to the Capital Asset Pricing Model (CAPM), what is the expected return of the
stock?
A. 8.4%
B. 12.0%
C. 15.0%
D. 11.4%
Correct Answer: D
Explanation: The Capital Asset Pricing Model uses the formula expected return equals
risk-free rate plus beta times market risk premium. In this case, the calculation is 3% plus
1.2 multiplied by the 7% market risk premium. This results in a total expected return of
11.4% for the security. The model assumes that investors are only compensated for
systematic risk which cannot be diversified away. It provides a linear relationship between
the risk of an asset and its required rate of return.
2. Which form of the Efficient Market Hypothesis (EMH) states that stock prices reflect all
information that can be derived by examining market trading data such as history of past
prices and volume?
A. Strong-form efficiency
B. Weak-form efficiency
C. Semi-strong-form efficiency
D. Technical-form efficiency
Correct Answer: B
Explanation: Weak-form efficiency implies that past price and volume data are already
incorporated into current stock prices. This means that technical analysis cannot
consistently produce superior investment returns over time. Investors cannot profit by
looking at historical trends because the market reacts instantly to new data. Semi-strong
and strong forms include additional layers of public and private information respectively.
Understanding these levels helps portfolio managers decide between active and passive
investment strategies.
,3. An investor is considering two assets with a correlation coefficient of -1.0. What is the
primary benefit of combining these two assets in a portfolio?
A. Complete elimination of risk if proportions are correct
B. Perfect elimination of all systematic risk
C. Maximization of the expected return regardless of risk
D. Reduction of the risk-free rate of return
Correct Answer: A
Explanation: A correlation coefficient of -1.0 indicates that two assets move in perfectly
opposite directions. By combining these assets in specific proportions, an investor can
create a risk-free portfolio. This is the ultimate goal of diversification within a two-asset
framework to minimize variance. However, it is important to note that finding perfectly
negatively correlated assets is rare in real markets. This theoretical concept underscores
the power of non-perfect correlation in reducing unsystematic portfolio risk.
4. Using the Constant Growth Dividend Discount Model, what is the value of a stock that just
paid a $2.00 dividend, has a growth rate of 5%, and a required return of 10%?
A. $40.00
B. $20.00
C. $42.00
D. $44.10
Correct Answer: C
Explanation: The Gordon Growth Model calculates the price as the next year’s dividend
divided by the difference between required return and growth. Since the dividend just paid
was $2.00, the expected dividend is $2.10 after applying the 5% growth. Dividing $2.10 by
0.05 results in an intrinsic value of $42.00 per share. This model is highly sensitive to
changes in the estimated growth rate and required rate of return. It is best suited for
mature companies with stable and predictable dividend payout histories.
5. Which of the following measures is defined as the ratio of the portfolio’s risk premium to
its standard deviation?
A. Sharpe Ratio
B. Treynor Ratio
C. Jensen’s Alpha
D. Information Ratio
Correct Answer: A
, Explanation: The Sharpe Ratio measures the reward-to-volatility trade-off by using total
risk in the denominator. It is calculated by subtracting the risk-free rate from the portfolio
return and dividing by the standard deviation. A higher Sharpe Ratio indicates better risk-
adjusted performance for the investor. Unlike the Treynor Ratio, it accounts for both
systematic and unsystematic risk components. It is widely used to compare the
performance of diversified portfolios against a benchmark.
6. If a bond’s yield to maturity (YTM) is greater than its coupon rate, the bond is trading at:
A. A premium
B. A discount
C. Par value
D. Face value
Correct Answer: B
Explanation: When the required market yield exceeds the coupon rate, the bond’s price
must fall below its face value. This occurs because the fixed interest payments are less
attractive than current market rates. Investors pay less for the bond to compensate for the
lower periodic interest income received. As the bond approaches maturity, its price will
gradually pull toward its par value. This relationship between price and yield is a
fundamental principle of fixed-income security valuation.
7. In the context of the Fama-French Three-Factor Model, what are the two additional factors
added to the market risk premium?
A. Size and Book-to-Market Ratio
B. Momentum and Liquidity
C. Inflation and GDP Growth
D. Industry Beta and Dividend Yield
Correct Answer: A
Explanation: The Fama-French model expands on CAPM by adding size and value risk
factors to the equation. The SMB factor represents Small Minus Big market capitalization
stocks to capture size effects. The HML factor stands for High Minus Low book-to-market
ratios to capture value effects. Research suggests that small-cap and value stocks tend to
outperform the market over the long term. This model provides a more comprehensive
explanation of stock returns than the single-factor CAPM.
8. Which investment strategy involves shifting the portfolio’s asset allocation based on short-
term market forecasts?
A. Strategic Asset Allocation
B. Buy and Hold Strategy
