Potential MC Questions 2013

1. The risk that cannot be eliminated by building diversified

portfolios is called: Market risk (systematic, nondiversifiable)
2. As the number of assets in a portfolio increases, the number of
correlations required for portfolio optimization: Increases
Exponentially
3. Which statement represents an inference that is not valid? If
stock prices follow a random walk, then the stock market
is efficient
4. Consider the results of an event study of target firm returns
around merger announcements. Which result would contradict
the efficient markets hypothesis? Target firm stock prices
decrease 5% in the five days after the announcement
5. With a rising yield curve, which bond has the highest yield to
maturity? A 10 year treasury with a 3% coupon
6. Which of the same set of bonds has the shortest duration? A five
year treasury with a 6% coupon
7. If the yield curve is flat, then according to the liquidity preference
theory of the term structure of interest rates, market participants
expect future short-term rates to be: Lower than todays short
term rates
8. If a stock has a large estimated alpha over the last three years,
according to the CAPM, then: adjusting for market
movements it did better than the market
9. Which statement about beta is true? A beta can be equal to 0
10.
The actual realized return for a portfolio of high-yield (or
Junk) bonds depends on: The price originally paid for the
bonds, the fraction of bonds that default, the recovery
rate in event of default

11.
Consider a bond with a maturity of five years, face value
of 1000 and an annual coupon rate of 2%, and a YTM of 4%. The
quoted price of the bond will: increase on average over the
next five years (coupon<YTM)
12.
If the general level of interest rates increases, what
statement about duration is true? The duration of zerocoupon bonds will not change
13.
About which input for the Black-Scholes options pricing
model is there the most uncertainty? The volatility (SD)
14.
If the correlation between two assets is -1 it is possible to
construct a portfolio with zero risk
15.
The net work of a bank with long-term assets and shortterm liabilities will decline if: the general level of interest
rates increases
16.
Using adjusted beta rather than estimated raw beta
makes sense if: Estimated betas exhibit regression towards
the mean
17.
Which of the following instruments has a region of
negative convexity? A callable corporate bond with a
coupon of 7%
18.
If you wrote call options on 100 shares of twitter, which of
the following actions would provide a hedge against you liability
as the option writer? Buying shares of twitter
Potential MC Questions 2008
1. According to the CAPM, a stock with a beta equal to 1 has: An
expected return equal to the expected return on the
market
2. Adjusted beta is sometimes used in practice because: A stock
with a very low beta for the estimation period is likely to
have a higher beta the next period, a stock with a very
high beta for the estimation period is likely to have a
lower beta the next period, Betas tend to regress toward
the mean

3. It is possible to beat the market return using patterns of past

stock prices if the correlation of returns between any two periods
is: sufficiently negative or positive
4. A perpetuity is a bond that pays a coupon indefitiniely and has
no face value. If a perpetuity pays a coupon C and the YTM is
Y then its duration is: (1+Y)/Y
5. Consider a bond with a face value of 1000 and an annual coupon
rate of 8%, and an applicable interest rate at 6%. It has five
years to maturity. The quoted price of the bond will: decrease
on average over the next five years
6. Convexity for bonds refers to the following property of bonds: A
given percentage point increase in YTM will have a
smaller percentage effect on bond price than a
percentage decrease in YTM of the same magnitude
7. Which finding would contradict an efficient market? The stock
price of target firms increases on average the two weeks
after a merger announcement
8. The applicable interest rate for a bond with ten years to maturity
and a 6% coupon increases from 3 to 4 percent. What happens to
the duration of the bond? It increases
9. The applicable interest rate for a zero coupon bond with ten
years to maturity increases from 3 to 4 percent. What happens to
the duration of this bond? It stays the same
10.
Which bond will experience the smaller change in value in
the preceding two questions? The ten year bond with a 6
percent coupon
11.
TIPS(treasury inflation protected securities) offer protection
against inflation by: Increasing both the face value of a
bond and the coupon based on CPI changes
12.
If a banks assets have a weighted duration of 5 years, and
it liabilities have a weighted duration of 1 year, a decrease in
interest rates by 1 percentage point will result in: an increase in
net worth

13.
Five year GM bonds currently have a YTM of 80%. This
yield: reflects the substantial probability that GM will not
be able to meet its promised obligations under the bonds
14.
A fallen angel is best defined as a bond issued: as
investment grade, but lowered to speculative grade
15.
An investor who expects declining interest rates would be
likely to purchase a bond that has a ZERO coupon and a LONG
term to maturity.
Efficient Market: Market price makes efficient use of all available
information. The market is not ignoring anything
Random Walk: A price where any given change is unrelated to any
previous change
Stock priced efficiently: Will follow a random walk because all
information is reflected in the current price, and only new information
affects its path
Bond Prices and Yields:
Coupon payments are made semi-annually
Paying out a coupon affects the value of a bond
TIPS pay out coupons and face value
Callable bonds allow the issuer to pay the bond off before
maturity
Convertible bonds allow the bondholder to covert the bond into
stock
Zero-Coupon Bond:
US t-bills and the components of STRIPS based on US treasury
bonds are zero coupon bonds
Convex relationship (slope becomes less negative)
A longer term to maturity will lower value
A higher yield lowers value
1000/(1+r)^10
Perpetuity:
100/r
Convex relationship (slope becomes less negative)
Value Y axis and Return X axis
Coupon Bond:
Provide flows to bondholders in two parts through a regular
coupon payment and a face value at maturity

40/(1+r) + 40/(1+r)^2 + 40/(1+r)^3 + . 40+1000/(1+r)^10

TIPS:
Par value is tied to CPI
When security matures, US treasury pays original principal or par
value which ever is greater
Pay a coupon every 6 months based on annual coupon rate
multiplied by the principal
Callable Bonds:
Can be redeemed by issuer by paying a call price, typically
higher than par value (allowed to do this after call protection
period has expired)
Which will have a higher price and lower yield: A callable bond or
a straight bond? Straight bond will. The price divergence will be
higher at low interest rates because the issuer will want to
redeem bonds if interest rates are low
Convertible Bonds:
Convert bonds to stocks
What is the effect of adding a conversion option to the price of a
bond? What is the effect on the bonds yield? It raises the price
and lowers the yield. If the stock goes up a lot in price, you will
get much more than the promised coupon payments and face
value.
Bond Prices Over time:
Zero-coupon bond with YTM of 5%. Whats the value of that bond
over time if it stays constant? What happens if it increases to 7%
after 5 years? If it stays the same, the bond in fact returns 5%
yield every year. If it increases to 7% the bond price drops, and
then under the new, constant 7% YTM returns 7% every year.
Default Premium: Bond Yield- RF yield (also known as credit
spread)
Credit Default Swaps: CDS buyer pays a Premium cost (S) per
period, and in the event of default by the issuer, receives an
amount to make up for losses in default. S=(1-R)*P
CDS spreads are quoted on corporate bonds as well as
sovereign debt
The duration of a zero-coupon bond is equal to its maturity
Convexity: refers to the curvature of the price yield relationship
Straight or Bullet bonds exhibit positive convexity