16. Diversification is most effective when security returns are:

a) negatively correlated

b) positively correlated

c) low

d) high

e) uncorrelated

17. An investor invests 40% of her wealth in a risky asset with an expected rate of return of 15% and a standard deviation of 20%. The rest of her wealth is invested in the risk-free asset, which yields 6%. What are the expected return and standard deviation of her portfolio?

a) E(R) = 8.0%, s = 12%

b) E(R) = 9.6%, s = 8%

c) E(R) = 9.6%, s = 12%

d) E(R) = 11.4%, s = 12%

18. No matter how large the number of stocks in the portfolio is, the risk that cannot be diversified away is the:

a) company-specific risk

b) unsystematic risk

c) systematic risk

d) unique risk

e) both a and b

19. Which of the following statements about the single index model (SIM) is correct?

a) The SIM requires more computations to solve for the mean-variance efficient set.

b) The SIM can decompose risk into its systematic component and unsystematic component.

c) The SIM claims that both the systematic and unsystematic risks can be diversified away.

d) The SIM assumes that a firm's specific news is dependent on another firm's specific news. Statements a and d are both correct.

20. Which of the following statements is false?

a) The single index model was developed to reduce the computational problems in calculating the efficient frontier.

b) The APT was developed as an alternative to the CAPM.

c) With the single index model, risk can be broken down into systematic and unsystematic components.

d) With large portfolios, systematic risk can be virtually eliminated.

e) The single index model assumes that returns are generated by a single factor and firm-specific factors.

21. Which of the following statements is true?

I. In a strong form efficient market, it is possible for fundamental analysts to earn abnormal returns consistently.

II. In a strong form efficient market, it is possible for technical analysts to earn abnormal returns consistently.

III. In a strong form efficient market, asset allocation is useless.

a) I only

b) I and II only

c) III only

d) I, II, and III

e) neither I, nor II, nor III

22. If the market is perfectly efficient, which of the following statements is false?

a) Prices will fluctuate randomly around their true value.

b) Security prices reflect all publicly available information.

c) Smaller firms tend to outperform larger firms on a risk-adjusted basis.

d) An average mutual fund does not outperform the market as a whole.

e) Both technical analysis and fundamental analysis are economically worthless.

23. A random walk occurs when:

a) stock prices respond slowly to new information

b) the stock price level is random

c) past information is useful in predicting future prices

d) stock price changes are random but predictable

e) future price changes are uncorrelated with past price changes

24. Which of the following statements is true?

a) According to the unbiased expectations hypothesis, the yield curve will be flat if expected future short-term rates exceed current short-term rates.

b) According to the unbiased expectations hypothesis, long-term rates are equal to expected future short-term rates.

c) According to the liquidity preference hypothesis, the term structure is usually downward sloping.

d) According to the market segmentations hypothesis, interest rates for long-maturity bonds are independent from interest rates for short-maturity bonds.

25. Which of the following is the best measure of a discount bonds total expected return?

a) current yield

b) yield to call

c) capital gains yield

d) yield to maturity

e) coupon yield

26. What is the duration of a 5-year zero-coupon bond?

a) 4.5

b) 5.0

c) 5.5

d) The answer cannot be determined without more information.

27. Which of the following is an income immunization strategy that selects only bonds whose coupon and principal payments occur exactly when cash is required?

a) cash matching strategy

b) duration matching strategy

c) horizon matching strategy

d) contingent immunization strategy

28. Which of the following is not a problem encountered when implementing DDMs?

a) Using DDMs to identify undervalued stocks is useful only if the mispricing of stocks is corrected in the market.

b) DDMs assume that the discount rate is constant over time.

c) Theoretical DDMs relate future cash flows to price, but future cash flows are unknown today.

d) DDMs have little practical value because they value stocks assuming infinite cash flows and investors investment horizons are always finite.

29. Sometimes when a company purchases a new asset, the full cost of the asset is not recorded on the companys income statement as an expense; instead, the asset is depreciated, and the cost of the asset is spread out over several years. Which basic accounting concept requires this treatment?

a) matching

b) historical cost

c) conservatism

d) consistency

30. The CAPM rewards which of the following types of risks?

a) Unique risks

b) Diversifiable risk

c) Systematic risk

d) Total risk

e) Firm-specific risks