FIN 4504 | FIN4504 Exam 4: Investments Updated
and Latest Questions and Correct Answers with
Rationale - Florida State University
1. According to the semi-strong form of the Efficient Market Hypothesis (EMH), which of the
following information is already reflected in stock prices?
A. Only past historical price and volume data.
B. All information, including private and confidential internal data.
C. Only information available to corporate insiders.
D. All publicly available information including financial statements and news.
Correct Answer: D
Explanation: The semi-strong form of market efficiency posits that all publicly available
information is fully reflected in security prices. This means that neither technical analysis
nor fundamental analysis can consistently produce excess returns. If a market is semi-
strong efficient, prices adjust rapidly to new public announcements like earnings reports.
Investors in these markets are often better off using passive strategies to minimize
transaction costs. Research usually supports this hypothesis for developed markets like the
NYSE.
2. An investor refuses to sell a stock that has dropped 30% in value because they do not want
to realize the loss, despite better opportunities elsewhere. This is an example of:
A. Mental Accounting
B. Overconfidence Bias
C. Representativeness Heuristic
D. The Disposition Effect
Correct Answer: D
Explanation: The disposition effect describes the tendency of investors to hold onto losing
investments too long while selling winners too quickly. This behavior is rooted in loss
aversion, where the psychological pain of a loss is stronger than the joy of a gain. Rational
economic theory suggests that past costs should not influence future investment decisions.
By failing to sell losers, investors often face higher opportunity costs and unfavorable tax
consequences. Behavioral finance identifies this as a common hurdle for retail and
professional traders alike.
3. Which investment strategy involves buying a stock and simultaneously buying a put option
on that same stock?
A. Covered Call
,B. Protective Put
C. Long Straddle
D. Bull Spread
Correct Answer: B
Explanation: A protective put is a risk management strategy used to limit potential losses
on a stock position. By purchasing a put option, the investor establishes a minimum price at
which they can sell the asset. This strategy functions like an insurance policy against a
significant decline in the market value of the stock. While it protects the downside, the
investor still retains the ability to profit from any upward price movement. The primary
cost of this strategy is the premium paid for the put option.
4. If a bond has a duration of 8 years and market interest rates increase by 1%, what is the
approximate change in the bond’s price?
A. It will increase by approximately 8%.
B. It will decrease by approximately 1%.
C. It will stay the same.
D. It will decrease by approximately 8%.
Correct Answer: D
Explanation: Duration measures the sensitivity of a bond’s price to changes in interest
rates. There is an inverse relationship between interest rate movements and bond prices.
For every 1% change in rates, the price changes approximately by the percentage of the
duration in the opposite direction. In this scenario, an 8-year duration leads to an 8% drop
when rates rise by 1%. This calculation is essential for managing interest rate risk within
fixed income portfolios.
5. In the context of futures contracts, the process of ‘marking-to-market’ refers to:
A. The physical delivery of the underlying asset at expiration.
B. The initial margin required to open a new futures position.
C. The daily settlement of gains and losses based on the closing price.
D. The negotiation of the contract price between the buyer and seller.
Correct Answer: C
Explanation: Marking-to-market is the daily process where gains and losses are settled in
a futures account. Each day, the clearinghouse adjusts the trader’s account balance based
on the change in the contract’s price. This mechanism prevents the accumulation of large
losses and reduces the risk of default. If the account balance falls below the maintenance
, margin, the trader receives a margin call. It ensures that the financial integrity of the
futures exchange is maintained at all times.
6. An investor believes they can consistently beat the market because they possess superior
analytical skills, despite evidence to the contrary. This behavior is known as:
A. Overconfidence Bias
B. Confirmation Bias
C. Framing Effect
D. Anchoring Bias
Correct Answer: A
Explanation: Overconfidence bias leads individuals to overestimate their knowledge and
their ability to predict future events. In the investment world, this often results in excessive
trading and higher transaction costs. Many investors mistakenly believe they have an
informational edge over other market participants. Empirical studies show that
overconfident traders tend to underperform the broader market averages. Recognizing this
bias is a critical step in developing a disciplined and objective investment process.
7. The ‘January Effect’ is a market anomaly where stock prices, particularly of small-cap firms,
tend to rise in the first month of the year. This is often attributed to:
A. Tax-loss harvesting at the end of December followed by reinvestment.
B. A general increase in consumer spending during the holidays.
C. Companies releasing their annual reports earlier than expected.
D. Federal Reserve interest rate cuts that typically occur in January.
Correct Answer: A
Explanation: The January Effect is a well-documented seasonal anomaly in the equity
markets. It is largely driven by investors selling losing stocks in December to realize capital
losses for tax purposes. Once the new year begins, these investors often repurchase shares,
driving up demand and prices. This effect is most pronounced in small-cap stocks which
are more sensitive to shifts in trading volume. However, the magnitude of this anomaly has
diminished over time as more investors attempt to exploit it.
8. A ‘covered call’ strategy consists of:
A. Buying a call option and selling a put option.
B. Selling a call option without owning the underlying stock.
C. Buying a stock and buying a call option.
D. Selling a call option while holding the underlying stock.
and Latest Questions and Correct Answers with
Rationale - Florida State University
1. According to the semi-strong form of the Efficient Market Hypothesis (EMH), which of the
following information is already reflected in stock prices?
A. Only past historical price and volume data.
B. All information, including private and confidential internal data.
C. Only information available to corporate insiders.
D. All publicly available information including financial statements and news.
Correct Answer: D
Explanation: The semi-strong form of market efficiency posits that all publicly available
information is fully reflected in security prices. This means that neither technical analysis
nor fundamental analysis can consistently produce excess returns. If a market is semi-
strong efficient, prices adjust rapidly to new public announcements like earnings reports.
Investors in these markets are often better off using passive strategies to minimize
transaction costs. Research usually supports this hypothesis for developed markets like the
NYSE.
2. An investor refuses to sell a stock that has dropped 30% in value because they do not want
to realize the loss, despite better opportunities elsewhere. This is an example of:
A. Mental Accounting
B. Overconfidence Bias
C. Representativeness Heuristic
D. The Disposition Effect
Correct Answer: D
Explanation: The disposition effect describes the tendency of investors to hold onto losing
investments too long while selling winners too quickly. This behavior is rooted in loss
aversion, where the psychological pain of a loss is stronger than the joy of a gain. Rational
economic theory suggests that past costs should not influence future investment decisions.
By failing to sell losers, investors often face higher opportunity costs and unfavorable tax
consequences. Behavioral finance identifies this as a common hurdle for retail and
professional traders alike.
3. Which investment strategy involves buying a stock and simultaneously buying a put option
on that same stock?
A. Covered Call
,B. Protective Put
C. Long Straddle
D. Bull Spread
Correct Answer: B
Explanation: A protective put is a risk management strategy used to limit potential losses
on a stock position. By purchasing a put option, the investor establishes a minimum price at
which they can sell the asset. This strategy functions like an insurance policy against a
significant decline in the market value of the stock. While it protects the downside, the
investor still retains the ability to profit from any upward price movement. The primary
cost of this strategy is the premium paid for the put option.
4. If a bond has a duration of 8 years and market interest rates increase by 1%, what is the
approximate change in the bond’s price?
A. It will increase by approximately 8%.
B. It will decrease by approximately 1%.
C. It will stay the same.
D. It will decrease by approximately 8%.
Correct Answer: D
Explanation: Duration measures the sensitivity of a bond’s price to changes in interest
rates. There is an inverse relationship between interest rate movements and bond prices.
For every 1% change in rates, the price changes approximately by the percentage of the
duration in the opposite direction. In this scenario, an 8-year duration leads to an 8% drop
when rates rise by 1%. This calculation is essential for managing interest rate risk within
fixed income portfolios.
5. In the context of futures contracts, the process of ‘marking-to-market’ refers to:
A. The physical delivery of the underlying asset at expiration.
B. The initial margin required to open a new futures position.
C. The daily settlement of gains and losses based on the closing price.
D. The negotiation of the contract price between the buyer and seller.
Correct Answer: C
Explanation: Marking-to-market is the daily process where gains and losses are settled in
a futures account. Each day, the clearinghouse adjusts the trader’s account balance based
on the change in the contract’s price. This mechanism prevents the accumulation of large
losses and reduces the risk of default. If the account balance falls below the maintenance
, margin, the trader receives a margin call. It ensures that the financial integrity of the
futures exchange is maintained at all times.
6. An investor believes they can consistently beat the market because they possess superior
analytical skills, despite evidence to the contrary. This behavior is known as:
A. Overconfidence Bias
B. Confirmation Bias
C. Framing Effect
D. Anchoring Bias
Correct Answer: A
Explanation: Overconfidence bias leads individuals to overestimate their knowledge and
their ability to predict future events. In the investment world, this often results in excessive
trading and higher transaction costs. Many investors mistakenly believe they have an
informational edge over other market participants. Empirical studies show that
overconfident traders tend to underperform the broader market averages. Recognizing this
bias is a critical step in developing a disciplined and objective investment process.
7. The ‘January Effect’ is a market anomaly where stock prices, particularly of small-cap firms,
tend to rise in the first month of the year. This is often attributed to:
A. Tax-loss harvesting at the end of December followed by reinvestment.
B. A general increase in consumer spending during the holidays.
C. Companies releasing their annual reports earlier than expected.
D. Federal Reserve interest rate cuts that typically occur in January.
Correct Answer: A
Explanation: The January Effect is a well-documented seasonal anomaly in the equity
markets. It is largely driven by investors selling losing stocks in December to realize capital
losses for tax purposes. Once the new year begins, these investors often repurchase shares,
driving up demand and prices. This effect is most pronounced in small-cap stocks which
are more sensitive to shifts in trading volume. However, the magnitude of this anomaly has
diminished over time as more investors attempt to exploit it.
8. A ‘covered call’ strategy consists of:
A. Buying a call option and selling a put option.
B. Selling a call option without owning the underlying stock.
C. Buying a stock and buying a call option.
D. Selling a call option while holding the underlying stock.
