Principles of Investments Exam Practice
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Course Introduction
Principles of Investments introduces students to the fundamental concepts, theories, and practices involved in investment decision-making and portfolio management. The course covers various types of investment vehicles such as stocks, bonds, mutual funds, and alternative assets, along with the markets in which they operate. Students learn the principles of risk and return, valuation techniques, asset allocation, diversification, and the basics of security analysis. Emphasis is placed on both the theoretical framework and practical application, providing the analytical tools needed to understand investment strategies, evaluate investment opportunities, and make informed financial decisions.
Recommended Textbook
Fundamentals of Investments 6th Edition by
Bradford D. Jordan
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Chapter 1: A Brief History of Risk and Return
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Sample Questions
Q1) If you multiply the number of shares of outstanding stock for a firm by the price per share, you are computing the firm's:
A) equity ratio.
B) total book value.
C) market share.
D) market capitalization.
E) time value.
Answer: D
Q2) Over the past five years, Northern Railway stock had annual returns of 11, 15, -5, 8.5, and 18 percent, respectively. What is the variance of these returns?
A) .00548
B) .00685
C) .00790
D) .01370
E) .02740
Answer: C
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Chapter 2: The Investment Process
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Sample Questions
Q1) Sarah has a brokerage account with Jeff, who is a money manager with Downtown Brokers. Sarah pays an all-inclusive annual fee to the firm and Jeff manages her funds. She pays no trading costs or commissions. Which one of the following best describes this type of account?
A) wrap
B) cash
C) margin
D) mutual
E) advisory
Answer: A
Q2) You purchased 700 shares of stock for $54.30 a share. The initial margin requirement is 75 percent and the maintenance margin is 35 percent. What is the maximum percentage decrease that can occur in the stock price before you receive a margin call?
A) 35 percent
B) 38 percent
C) 48 percent
D) 57 percent
E) 62 percent
Answer: E
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Chapter 3: Overview of Security Types
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Sample Questions
Q1) Which one of the following statements related to common stock is correct?
A) Corporations are required to pay annual dividends to its common stockholders.
B) Corporations have the right to discontinue paying dividends.
C) Corporations pay dividends at the discretion of the firm's president.
D) Common stock is a form of corporate debt.
E) Common stock has a pre-defined liquidation value.
Answer: B
Q2) You own 500 shares of ZZ Industries stock which you purchased for $28.60 a share. You would like to have the right to sell your shares for $30 a share. What will be the cost to obtain this right?
A) $0.40
B) $0.90
C) $5.00
D) $396.00
E) $900.00
Answer: C
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Chapter 4: Mutual Funds
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Sample Questions
Q1) Which one of the following types of bond funds tends to have the highest level of risk?
A) short-term government
B) intermediate-term corporate
C) treasury
D) high-yield
E) single-state municipal
Q2) An investment company that issues a fixed number of shares which can only be resold in the open stock market is called a(n) _____ fund.
A) hedge
B) closed-end
C) open-end
D) public
E) market
Q3) To determine the actual objective of a fund, you should primarily refer to the:
A) fund's objective statement.
B) fund's prospectus.
C) portfolio holdings.
D) sales literature.
E) portfolio manager's comments in the annual report.
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Chapter 5: The Stock Market
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Q1) Trevor currently owns 545,000 shares of ABC stock. He will sell those shares for $17.10 a share. He is also willing to purchase additional shares for $17.07 a share. Trevor is a securities:
A) broker.
B) representative.
C) underwriter.
D) floor broker.
E) dealer.
Q2) When the issuer assumes the risk for any shares the underwriters cannot sell, the underwriting is known as a _____ underwriting.
A) Dutch auction
B) partial
C) firm commitment
D) best efforts
E) pro-rata
Q3) Explain the NYSE uptick rule and the current controversy pertaining to that rule.
Q4) Describe some of the recent changes in the structure and operations of the NYSE.
Q5) Describe the primary advantage and disadvantage of a limit sell order.
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Chapter 6: Common Stock Valuation
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Sample Questions
Q1) The retention ratio is the:
A) net income divided by total equity.
B) percentage of net income paid out to shareholders.
C) net income divided by the number of shares outstanding.
D) percentage of net income held by a firm for future growth.
E) inverse of the dividend payout ratio.
Q2) What is beta?
A) a rate of return measure
B) the return on a stock relative to the overall market
C) the rate of dividend growth
D) the percentage of net income paid out as a dividend
E) measure of a stock's risk relative to the stock market average
Q3) The model used to value a stock that pays a dividend which increases at a constant rate forever is referred to as which one of the following? Assume the growth rate is less than the discount rate.
A) diminishing valuation growth model
B) increasing valuation growth model
C) constant perpetual growth model
D) irregular growth perpetual model
E) two-stage growth model
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Chapter 7: Stock Price Behavior and Market Efficiency
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Sample Questions
Q1) Which of the following sources of information are used by informed traders?
I. financial statements
II. inside information
III. internet reports
IV. analysts reports
A) I and IV only
B) II and III only
C) III and IV only
D) I, III, and IV only
E) I, II, III, and IV
Q2) Efficient markets tend to exist:
A) only when all investors are rational.
B) anytime market volume exceeds the average trading volume.
C) only when market volatility is low.
D) when rational arbitrage traders dominate irrational traders.
E) when arbitrage trading is prohibited.
Q3) What are some of the key lessons to be learned from historical stock market crashes?
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Chapter 8: Behavioral Finance and the Psychology of Investing
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Sample Questions
Q1) According to Dow theory, which one of the following is the primary means of eliminating secondary market trends?
A) corrections
B) confirmations
C) continuations
D) conversions
E) coordinated trades
Q2) Loss aversion is defined as:
A) the inability to mentally acknowledge a loss on a security.
B) selling any security for less than the price paid to acquire it.
C) selling a security as soon as it has increased significantly in value.
D) the reluctance to sell a security after it has decreased in value.
E) the tendency to quickly sell any investment that has decreased in value.
Q3) The belief that information you hold is superior to information held by other investors best describes:
A) over-confidence
B) the snakebite effect
C) the illusion of knowledge
D) the clustering illusion
E) loss aversion
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Chapter 9: Interest Rates
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Sample Questions
Q1) A $5,000 face value STRIPS matures in 7 years and is currently quoted at a price of 64.238. What is the yield-to-maturity?
A) 3.21 percent
B) 3.38 percent
C) 4.87 percent
D) 6.42 percent
E) 6.76 percent
Q2) Which of the following will increase the price of a money market instrument computed using a discount yield?
I. increase in discount yield
II. decrease in discount yield
III. increase in days to maturity
IV. decrease in days to maturity
A) I only
B) I and III only
C) I and IV only
D) II and III only
E) II and IV only
Q3) Write a short paragraph comparing a bank discount rate to a bond equivalent rate.
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Chapter 10: Bond Prices and Yields
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Sample Questions
Q1) You own a 7 percent, semiannual coupon bond that matures in 8 years. The par value is $1,000 and the current yield to maturity is 7.6 percent. What will the percentage change in the price of your bond be if the yield to maturity suddenly increases by 75 basis points?
A) -4.37 percent
B) -4.49 percent
C) -4.54 percent
D) -4.61 percent
E) -4.77 percent
Q2) Alex purchased a $1,000 par value bond one year ago at a price of $1,008. At the time of purchase, the bond had 14 years to maturity and a 6 percent, semiannual coupon. Today, the bond has a yield to maturity of 6.5 percent. What is his realized yield as of today?
A) 0.43 percent
B) 0.86 percent
C) 1.29 percent
D) 1.72 percent
E) 2.60 percent
Q3) Identify and briefly explain four of Malkiel's five theorems.
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Page 12
Chapter 11: Diversification and Risky Asset Allocation
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Sample Questions
Q1) Which one of the following is a collection of possible risk-return combinations available from portfolios consisting of individual assets?
A) minimum variance set
B) financial frontier
C) efficient portfolio
D) allocated set
E) investment opportunity set
Q2) A group of stocks and bonds held by an investor is called which one of the following?
A) weights
B) grouping
C) basket
D) portfolio
E) bundle
Q3) Explain the primary goal of portfolio diversification as it relates to asset allocation and correlation.
Q4) Foreign securities are generally considered to be more risky than domestic securities. Given this assumption, explain how adding foreign securities into a domestic portfolio can affect the Markowitz efficient portfolios.
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Page 13
Chapter 12: Return, Risk, and the Security Market Line
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Q1) A portfolio consists of two stocks and has a beta of 1.07. The first stock has a beta of 1.48 and comprises 38 percent of the portfolio. What is the beta of the second stock?
A) .41
B) .66
C) .82
D) 1.28
E) 1.35
Q2) Which of the following will affect the beta value of an individual security?
I. interval of time frequency used for the data sample
II. length of the time period used for the data sample
III. particular time period selected for the sampling
IV. choice of index used as the measure of the market
A) I and II only
B) I and III only
C) II and IV only
D) II, III, and IV only
E) I, II, III, and IV
Q3) Identify and describe each of the three components of a security's expected return according to the capital asset pricing model.
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Page 14
Chapter 13: Performance Evaluation and Risk Management
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Sample Questions
Q1) A stock has an annual standard deviation of 14.1 percent and an expected annual return of 11.5 percent. What is the smallest expected loss for the next 6 months given a probability of 2.5 percent?
A) -8.90 percent
B) -13.79 percent
C) -14.57 percent
D) -15.38 percent
E) -16.67 percent
Q2) The one-year standard deviation of your portfolio is 16.4 percent. What is the two-year standard deviation?
A) 17.47 percent
B) 19.23 percent
C) 23.19 percent
D) 25.41 percent
E) 27.20 percent
Q3) Explain the similarities and differences between the Sharpe and Treynor ratios. Also, explain the most appropriate application for each.
Q4) Explain a key advantage and a key disadvantage of Jensen's alpha.
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Chapter 14: Futures Contracts
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Sample Questions
Q1) Which one of the following statements is correct concerning an inverted futures market?
A) The basis will be negative.
B) The basis will equal zero.
C) The cash price will equal the futures price.
D) The cash price will exceed the futures price.
E) Arbitrage opportunities must exist.
Q2) The 4-month futures price on a non-dividend-paying stock is $23.60. The risk-free rate is 2.25 percent and the market rate is 10.45 percent. What is the spot rate for this stock if spot-futures parity exists?
A) $23.39
B) $23.43
C) $23.51
D) $23.64
E) $23.78
Q3) You are a wheat farmer with a crop that will be ready to harvest in approximately three months. How can you hedge this crop and what are the advantages and disadvantages of doing so?
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Chapter 15: Stock Options
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Sample Questions
Q1) A decrease in which one of the following will increase the intrinsic value of a put option?
A) strike price
B) exercise price
C) option premium
D) time value
E) underlying stock price
Q2) A cash-settled option is defined as an option which does which one of the following?
A) requires a cash deposit upon purchase
B) has a foreign currency as its underlying asset
C) has the U.S. dollar at its underlying asset
D) entails a cash payment to the holder upon exercise
E) offers the option to either deliver the underlying asset or a cash payment
Q3) Which one of the following represents an arbitrage opportunity?
A) stock price of $18 and strike price of $20
B) call price of $0.40 and put price of $0.40
C) PCP-implied put price of $0.30 and call price of $0.28
D) PCP-implied put price of $0.30 and put market price of $0.31
E) PCP-implied call price of $0.20 and a put market price of $0.22
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Chapter 16: Option Valuation
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Q1) All else constant, which one of the following situations will produce the highest call price given a strike price of $27.50?
A) $25 stock price; 15 percent standard deviation
B) $25 stock price; 30 percent standard deviation
C) $30 stock price; 15 percent standard deviation
D) $30 stock price; 30 percent standard deviation
E) Insufficient information is provided to answer this question.
Q2) You have determined that you need -1,698 call options to hedge your stock portfolio. What should you do based on this information?
A) buy 17 call option contracts
B) buy 1,698 call option contracts
C) write 17 call option contracts
D) write 170 call option contracts
E) write 1,698 call option contracts
Q3) Draw a graph with the option price on the vertical axis and the time to expiration on the horizontal axis. Illustrate how put and call option prices vary as the time to expiration increases.
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Chapter 17: Projecting Cash Flow and Earnings
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Q1) Better Products just filed its quarterly report with the SEC. This report is referred to as which one of the following?
A) 10F
B) 10K
C) 10Q
D) EDGAR 10
E) 10FD
Q2) Smith's Corner Market had annual sales of $425,300 and total assets of $366,000. What is the return on assets if the profit margin is 11 percent?
A) 8.2 percent
B) 9.8 percent
C) 10.6 percent
D) 11.0 percent
E) 12.8 percent
Q3) Why is the expected rate of sales growth so critical to pro forma statements?
Q4) What value does the Statement of Cash Flows add to the financial statements of a firm?
Q5) Explain the role the external financing need plays in the future growth outlook for a firm.
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Chapter 18: Corporate Bonds
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Q1) A firm has outstanding common stock valued at $67 a share. The firm also has convertible bonds which have a $1,000 par value, a 7.5 percent, semi-annual coupon, and a time to maturity of 11 years. The bonds have a conversion ratio of 15. Comparable, non-convertible bonds have a yield to maturity of 8.2 percent. What is the intrinsic value of this bond?
A) $949.90
B) $957.37
C) $975.83
D) $1,005.00
E) $1,360.76
Q2) Which one of the following features of corporate bonds has the greatest appeal to pension fund investors?
A) call provision
B) convertible provision
C) zero repayment risk
D) prospectus availability
E) predictable cash flows
Q3) How is the minimal value for a convertible bond determined?
Q4) Why do corporations, rather than individuals, tend to be the largest holders of preferred stock?
Page 20
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Chapter 19: Government Bonds
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Sample Questions
Q1) You just purchased a 5-year STRIPS security that was created from a 30-year T-bond. How many payments will you receive?
A) 1
B) 10
C) 11
D) 60
E) 61
Q2) Which of the following features apply to T-bills?
I. original maturities of 4, 13, or 26 weeks
II. minimum face value of $10,000
III. sold at a discount
IV. semiannual interest payments
A) IV only
B) I and III only
C) I and IV only
D) II and III only
E) II and IV only
Q3) Explain how the imputed interest is computed on a U. S. Treasury bill.
Q4) What is the advantage of purchasing a STRIPS over a Treasury note?
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Chapter 20: Mortgage-Backed Securities
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Sample Questions
Q1) Ten years ago, you borrowed $165,000 for 25 years at 7.5 percent interest. What is the current principal balance, assuming payments are made monthly?
A) $112,200
B) $131,534
C) $138,314
D) $140,362
E) $147,414
Q2) Four years ago, you borrowed $250,000 for 20 years at 8 percent. Payments are made monthly. How much interest have you paid thus far?
A) $74,222
B) $75,756
C) $75,909
D) $76,456
E) $77,121
Q3) Explain what a reverse mortgage is, how it works, and who it is intended to help.
Q4) What are the advantages and the disadvantages of a homeowner selecting a 30-year mortgage rather than a 20-year mortgage?
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