Financial Economics
Final Exam
Course Introduction
Financial Economics explores the fundamental principles that govern the functioning of financial markets and institutions, and examines how economic theory applies to financial decision-making. The course covers the valuation of assets, risk and return, portfolio theory, the functioning of capital markets, and the role of financial intermediaries. Students will analyze how market information, interest rates, and economic policies impact prices and resource allocation in financial markets. Topics such as derivatives, financial crises, and behavioral finance may also be introduced, providing students with a comprehensive foundation for understanding the economic forces that shape financial systems globally.
Recommended Textbook Investments 11th Edition by Zvi Bodie
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28 Chapters
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Page 2
Chapter 1: The Investment Environment
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Sample Questions
Q1) Commercial banks differ from other businesses in that both their assets and their liabilities are mostly
A) illiquid.
B) financial.
C) real.
D) owned by the government.
E) regulated.
Answer: B
Q2) _________ financial asset(s).
A) Buildings are
B) Land is a
C) Derivatives are
D) U.S. agency bonds are
E) Derivatives and U.S. agency bonds are
Answer: E
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Page 3
Chapter 2: Asset Classes and Financial Instruments
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Sample Questions
Q1) Which of the following securities is a money market instrument?
A) Treasury note
B) Treasury bond
C) Municipal bond
D) Commercial paper
E) Mortgage security
Answer: D
Q2) Suppose an investor is considering a corporate bond with a 7.17% before-tax yield and a municipal bond with a 5.93% before-tax yield. At what marginal tax rate would the investor be indifferent between investing in the corporate and investing in the muni?
A) 15.4%
B) 23.7%
C) 39.5%
D) 17.3%
E) 12.4%
Answer: D
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Chapter 3: How Securities Are Traded
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Sample Questions
Q1) You want to buy 100 shares of Hotstock Inc. at the best possible price as quickly as possible. You would most likely place a
A) stop-loss order.
B) stop-buy order.
C) market order.
D) limit-sell order.
E) limit-buy order.
Answer: C
Q2) Which of the following orders instructs the broker to buy at or above a specified price?
A) Limit-buy order
B) Discretionary order
C) Limit-sell order
D) Stop-buy order
E) Market order
Answer: D
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5
Chapter 4: Mutual Funds and Other Investment Companies
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Sample Questions
Q1) A mutual fund had average daily assets of $4.0 billion in 2016. The fund sold $1.5 billion worth of stock and purchased $1.6 billion worth of stock during the year. The fund's turnover ratio is
A) 37.5%.
B) 22%.
C) 15%.
D) 45%.
E) 20%.
Q2) A mutual fund had NAV per share of $26.25 on January 1, 2016. On December 31 of the same year, the fund's rate of return for the year was 16.4%. Income distributions were $1.27, and the fund had capital gain distributions of $1.85. Without considering taxes and transactions costs, what ending NAV would you calculate?
A) $27.44
B) $33.88
C) $24.69
D) $42.03
E) $16.62
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Chapter 5: Risk, Return, and the Historical Record
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Sample Questions
Q1) Over the past year, you earned a nominal rate of interest of 3.6% on your money. The inflation rate was 3.1% over the same period. The exact actual growth rate of your purchasing power was
A) 3.6%.
B) 3.1%.
C) 0.48%.
D) 6.7%.
Q2) You purchased a share of CSCO stock for $20. One year later, you received $2 as a dividend and sold the share for $31. What was your holding-period return?
A) 45%
B) 50%
C) 60%
D) 40%
E) None of the options are correct.
Q3) Other things equal, an increase in the government budget deficit
A) drives the interest rate down.
B) drives the interest rate up.
C) might not have any effect on interest rates.
D) increases business prospects.
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Page 7
Chapter 6: Capital Allocation to Risky Assets
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Sample Questions
Q1) A reward-to-volatility ratio is useful in
A) measuring the standard deviation of returns.
B) understanding how returns increase relative to risk increases.
C) analyzing returns on variable-rate bonds.
D) assessing the effects of inflation.
E) None of the options are correct.
Q2) Which of the following statements is(are) true? I) Risk-averse investors reject investments that are fair games.
II. Risk-neutral investors judge risky investments only by the expected returns.
III. Risk-averse investors judge investments only by their riskiness.
IV. Risk-loving investors will not engage in fair games.
A) I only
B) II only
C) I and II only
D) II and III only
E) II, III, and IV only
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Chapter 7: Optimal Risky Portfolios
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Sample Questions
Q1) Market risk is also referred to as
A) systematic risk or diversifiable risk.
B) systematic risk or nondiversifiable risk.
C) unique risk or nondiversifiable risk.
D) unique risk or diversifiable risk.
Q2) A two-asset portfolio with a standard deviation of zero can be formed when
A) the assets have a correlation coefficient less than zero.
B) the assets have a correlation coefficient equal to zero.
C) the assets have a correlation coefficient greater than zero.
D) the assets have a correlation coefficient equal to one.
E) the assets have a correlation coefficient equal to negative one.
Q3) In a two-security minimum variance portfolio where the correlation between securities is greater than 1.0,
A) the security with the higher standard deviation will be weighted more heavily.
B) the security with the higher standard deviation will be weighted less heavily.
C) the two securities will be equally weighted.
D) the risk will be zero.
E) the return will be zero.
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9
Chapter 8: Index Models
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Sample Questions
Q1) A single-index model uses __________ as a proxy for the systematic risk factor.
A) a market index, such as the S&P 500
B) the current account deficit
C) the growth rate in GNP
D) the unemployment rate.
Q2) An analyst estimates the index model for a stock using regression analysis involving total returns. The estimated intercept in the regression equation is 6% and the is 0.5. The risk-free rate of return is 12%. The true of the stock is
A) 0%.
B) 3%.
C) 6%.
D) 9%.
Q3) The beta of Exxon stock has been estimated as 1.6 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of A) 1.20.
B) 1.32.
C) 1.13.
D) 1.40.
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Page 10
Chapter 9: The Capital Asset Pricing Model
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Sample Questions
Q1) The capital asset pricing model assumes
A) all investors are rational.
B) all investors have the same holding period.
C) investors have heterogeneous expectations.
D) all investors are rational and have the same holding period.
E) all investors are rational, have the same holding period, and have heterogeneous expectations.
Q2) In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is A) unique risk.
B) systematic risk.
C) standard deviation of returns.
D) variance of returns.
Q3) According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function Of
A) beta risk.
B) unsystematic risk.
C) unique risk.
D) reinvestment risk.
E) None of the options are correct.
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Page 11
Chapter 10: Arbitrage Pricing Theory and Multifactor Models of
Risk and Return
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Sample Questions
Q1) Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%. Portfolio B has a beta of 0.4 and an expected return of 13%. The risk-free rate of return is 5%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in portfolio A) A; A
B) A; B
C) B; A
D) B; B
Q2) Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%, respectively. The risk-free rate of return is 10%. Stock A has an expected return of 19% and a beta on factor 1 of 0.8. Stock A has a beta on factor 2 of A) 1.33.
B) 1.50.
C) 1.67.
D) 2.00.
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Page 12
Chapter 11: The Efficient Market Hypothesis
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Sample Questions
Q1) Which of the following are used by technical analysts to determine proper stock prices? I) Trendlines II) Earnings
III. Dividend prospects
IV. Expectations of future interest rates
V. Resistance levels
A) I and V
B) I, II, and III
C) II, III, and IV
D) II, IV, and V
E) All of the items are used by fundamental analysts.
Q2) Banz (1981) found that, on average, the risk-adjusted returns of small firms
A) were higher than the risk-adjusted returns of large firms.
B) were the same as the risk-adjusted returns of large firms.
C) were lower than the risk-adjusted returns of large firms.
D) were unrelated to the risk-adjusted returns of large firms.
E) were negative.
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13
Chapter 12: Behavioral Finance and Technical Analysis
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Sample Questions
Q1) The premise of behavioral finance is that
A) conventional financial theory ignores how real people make decisions and that people make a difference.
B) conventional financial theory considers how emotional people make decisions, but the market is driven by rational utility maximizing investors.
C) conventional financial theory should ignore how the average person makes decisions because the market is driven by investors who are much more sophisticated than the average person.
D) conventional financial theory considers how emotional people make decisions, but the market is driven by rational utility maximizing investors and should ignore how the average person makes decisions because the market is driven by investors who are much more sophisticated than the average person.
E) None of the options are correct.
Q2) Barber and Odean (2001) report that women __________ men.
A) earn higher returns than B) earn lower returns than C) earn about the same returns as D) generate higher trading costs than
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14
Chapter 13: Empirical Evidence on Security Returns
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Sample Questions
Q1) Petkova and Zhang (2005) examine the relationship between beta and the market risk premium and find
A) a countercyclical beta is negative in good economies and positive in bad economies.
B) the beta of the HML portfolio is negative in good economies and positive in bad economies.
C) a cyclical beta is positive in good economies and negative in bad economies.
D) the beta of the HML portfolio is positive in good economies and negative in bad economies.
E) a countercyclical beta and the beta of the HML portfolio are negative in good economies and positive in bad economies.
Q2) An extension of the Fama French three factor model includes a fourth factor to measure
A) default spread.
B) term spread.
C) momentum.
D) industrial production.
E) inflation.
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Page 15
Chapter 14: Bond Prices and Yields
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Sample Questions
Q1) The current yield on a bond is equal to
A) annual interest payment divided by the current market price.
B) the yield to maturity.
C) annual interest divided by the par value.
D) the internal rate of return.
E) None of the options are correct.
Q2) A coupon bond pays annual interest, has a par value of $1,000, matures in four years, has a coupon rate of 10%, and has a yield to maturity of 12%. The current yield on this bond is
A) 10.65%.
B) 10.45%.
C) 10.95%.
D) 10.52%.
E) None of the options are correct.
Q3) A CDS is a
A) command duty supervisor.
B) collateralized debt security.
C) commercial debt servicer.
D) collateralized debenture security.
E) credit default swap.
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Chapter 15: The Term Structure of Interest Rates
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Sample Questions
Q1) According to the expectations theory, what is the expected forward rate in the third year? The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000. \(\begin{array}{cc}
\text { Maturity }\\
\text { (Years) } & \text { Price } \\
1 & \$ 925.15 \\
2 & 862.57 \\
3 & 788.66 \\
4 & 711.00
\end{array}\)
A) 7.23%
B) 9.37%
C) 9.00%
D) 10.9%
Q2) Which of the following are possible explanations for the term structure of interest rates?
A) The expectations theory
B) The liquidity preference theory
C) Modern portfolio theory
D) The expectations theory and the liquidity preference theory
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Chapter 16: Managing Bond Portfolios
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Sample Questions
Q1) A 7%, 14-year bond has a yield to maturity of 6% and duration of 7 years. If the market yield changes by 44 basis points, how much change will there be in the bond's price?
A) 1.85%
B) 2.91%
C) 3.27%
D) 6.44%
Q2) Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's
A) term to maturity is higher.
B) coupon rate is higher.
C) yield to maturity is higher.
D) All of the options are correct.
E) None of the options are correct.
Q3) The duration of a 5-year zero-coupon bond is
A) smaller than 5.
B) larger than 5.
C) equal to 5.
D) equal to that of a 5-year 10% coupon bond.
E) None of the options are correct.
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Page 18
Chapter 17: Macroeconomic and Industry Analysis
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Sample Questions
Q1) Two firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30¢ per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 50¢ per coat hanger. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy enters a recession, the total revenue of firm C will be
A) -$1,680,000.
B) $1,400,000.
C) $2,000,000.
D) $0.
E) None of the options are correct.
Q2) Assume the U.S. government was to decide to increase the budget field. Holding all else constant, this will cause ______ to decrease.
A) interest rates
B) government borrowing
C) unemployment
D) -interest rates and government borrowing
E) None of the options are correct.
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Chapter 18: Equity Valuation Models
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Sample Questions
Q1) Paper Express Company has a balance sheet which lists $85 million in assets, $40 million in liabilities, and $45 million in common shareholders'equity. It has 1,400,000 common shares outstanding. The replacement cost of the assets is $115 million. The market share price is $90. What is Paper Express's market value per share?
A) $1.68
B) $2.60
C) $32.14
D) $60.71
E) None of the options are correct.
Q2) High Tech Chip Company is expected to have EPS in the coming year of $2.50. The expected ROE is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 70%, the growth rate of dividends should be A) 5.00%.
B) 6.25%.
C) 6.60%.
D) 7.50%.
E) 8.75%.
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Chapter 19: Financial Statement Analysis
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Q1) Which of the following are issues when dealing with the financial statements of international firms? I) Many countries allow firms to set aside larger contingency reserves than the amounts allowed for U.S. firms.
II) Many firms outside the U.S. use accelerated depreciation methods for reporting purposes, whereas most U.S. firms use straight-line depreciation for reporting purposes.
III) Intangibles, such as goodwill, may be amortized over different periods or may be expensed rather than capitalized.
IV) There is no way to reconcile the financial statements of non-U.S. firms to GAAP.
A) I and II
B) II and IV
C) I, II, and III
D) I, III, and IV
E) I, II, III, and IV
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21
Chapter 20: Options Markets: Introduction
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Sample Questions
Q1) To adjust for stock splits
A) the exercise price of the option is reduced by the factor of the split, and the number of options held is increased by that factor.
B) the exercise price of the option is increased by the factor of the split, and the number of options held is reduced by that factor.
C) the exercise price of the option is reduced by the factor of the split, and the number of options held is reduced by that factor.
D) the exercise price of the option is increased by the factor of the split, and the number of options held is increased by that factor.
Q2) You purchase one June 70 put contract for a put premium of $4. What is the maximum profit that you could gain from this strategy?
A) $7,000
B) $400
C) $7,400
D) $6,600
E) None of the options are correct.
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Chapter 21: Option Valuation
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Q1) Other things equal, the price of a stock call option is negatively correlated with which of the following factors?
A) The stock price
B) The time to expiration
C) The stock volatility
D) The exercise price
E) The stock price, time to expiration, and stock volatility
Q2) Which of the inputs in the Black-Scholes option pricing model are directly observable?
A) The price of the underlying security
B) The risk-free rate of interest
C) The time to expiration
D) The variance of returns of the underlying asset return
E) The price of the underlying security, risk-free rate of interest, and time to expiration
Q3) The elasticity of a stock put option is always
A) positive.
B) smaller than one.
C) negative.
D) infinite.
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Page 23
Chapter 22: Futures Markets
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Sample Questions
Q1) An investor with a long position in Treasury notes futures will profit if A) interest rates decline.
B) interest rates increase.
C) the prices of Treasury notes decrease.
D) the price of the S&P 500 Index increases.
E) None of the options are correct.
Q2) Agricultural futures contracts are actively traded on A) rice.
B) sugar.
C) canola.
D) rice and sugar.
E) All of the options are correct.
Q3) Financial futures contracts are actively traded on the following indices except A) the S&P 500 Index.
B) the New York Stock Exchange Index.
C) the Nikkei Index.
D) the Dow Jones Industrial Index.
E) All are actively traded.
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Chapter 23: Futures, Swaps, and Risk Management
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Q1) Which one of the following stock index futures has a multiplier of 10 euros times the index?
A) CAC 40
B) Hang Seng
C) Nikkei
D) DAX-30
E) CAC 40 and Hang Seng
Q2) Consider the following: \[\begin{array} { l l } &\text { CF Now }\\
\text { Risk-free rate in the United States } & 0.04 / \text { Cear } \\
\text { Risk-free rate in Australia } & 0.03 / \text { year } \\
\text { Spot exchange rate } & 1.67 \mathrm {~A} \$ / \$
\end{array}\] What should be the proper futures price for a 1-year contract?
A) 1.703 A$/$
B) 1.654 A$/$
C) 1.638 A$/$
D) 1.778 A$/$
E) 1.686 A$/$
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Chapter 24: Portfolio Performance Evaluation
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Q1) The M-squared measure considers
A) only the return when evaluating mutual funds.
B) the risk-adjusted return when evaluating mutual funds.
C) only the total risk when evaluating mutual funds.
D) only the market risk when evaluating mutual funds.
E) None of the options are correct.
Q2) Studies of style analysis have found that ________ of fund returns can be explained by asset allocation alone.
A) between 50% and 70%
B) less than 10%
C) between 40 and 50%
D) between 75% and 90%
E) over 90%
Q3) The M<sup>2</sup> measure was developed by
A) Merton and Miller.
B) Miller and Miller.
C) Modigliani and Miller.
D) Modigliani and Modigliani.
E) the M&M Mars Company.
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Page 26
Chapter 25: International Diversification
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Q1) The interest rate on a 1-year Canadian security is 8%. The current exchange rate is C$ = US $0.78. The 1-year forward rate is C$ = US $0.76. The return (denominated in U.S. $) that a U.S. investor can earn by investing in the Canadian security is
A) 3.59%.
B) 4.00%.
C) 5.23%.
D) 8.46%.
E) None of the options are correct.
Q2) The interplay between interest rate differentials and exchange rates, such that each adjusts until the foreign exchange market and the money market reach equilibrium, is called the
A) Purchasing Power Parity Theory.
B) Balance of Payments.
C) Interest Rate Parity Theory.
D) None of the options are correct.
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Chapter 26: Hedge Funds
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Q1) Pairs trading is associated with
A) triangular arbitrage.
B) statistical arbitrage.
C) data mining.
D) triangular arbitrage and data mining.
E) statistical arbitrage and data mining.
Q2) Hedge funds are ______ transparent than mutual funds because of ______ strict SEC regulation on hedge funds.
A) more; more
B) more; less
C) less; less
D) less; more
Q3) Sadka (2010) shows that exposure to unexpected declines in ________ is an important determinant of average hedge fund returns, and that the spreads in average returns across funds with the highest and lowest ________ may be as much as 6% annually.
A) market risk; systematic risk
B) market liquidity; liquidity risk
C) unsystematic risk; unique risk
D) default risk; default risk
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Chapter 27: The Theory of Active Portfolio Management
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Q1) The beta of an active portfolio is 1.20. The standard deviation of the returns on the market index is 20%. The nonsystematic variance of the active portfolio is 1%. The standard deviation of the returns on the active portfolio Is
A) 3.84%.
B) 5.84%.
C) 19.60%.
D) 24.17%.
E) 26.0%.
Q2) Benchmark risk
A) is inevitable and is never a significant issue in practice. B) is inevitable and is always a significant issue in practice.
C) cannot be constrained to keep a Treynor-Black portfolio within reasonable weights. D) can be constrained to keep a Treynor-Black portfolio within reasonable weights.
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Chapter 28: Investment Policy and the Framework of the
Cfa Institute
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Q1) Genny Webb is 27 years old and has accumulated $7,500 in her self directed defined contribution pension plan. Each year she contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she will live to age 90. The plan allows for two types of investments. One offers a 3% risk free real rate of return. The other offers an expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk free investment and 80% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments. Her salary will grow at the same rate as inflation. How much does Genny currently have in the safe account; how much in the risky account?
A) $1,500; $6,000
B) $3,000; $4,500
C) $2,000; $5,500
D) $4,800; $2,700
E) $3,500; $3,500
Q2) Target date retirement funds
A) are funds of funds diversified across stocks and bonds.
B) are inappropriate for most investors.
C) have very high fees.
D) function much like hedge funds.
Page 30
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