Question 1.1. List 3 reasons for diversifying a portfolio via international investing
Broadening the range of risk-return choices
Higher returns on foreign securities especially in high growth markets
Reduction of portfolio risk since foreign securities usually have a lower correlation with U.S. Securities
Question 2.2. What is the risk factor associated with international investing that potentially can also be viewed as a benefit [and hence, a 4th reason to invest internationally -- see question #1]. IF this factor is trending favorably for your investment portfolio, briefly explain why it is a benefit.
Question 3.3. On a risk/return basis, rank order the following asset classes from lowest to highest based on the following data.
(a) Small stocks: E(r) = 18.15% and standard deviation = 36.94%;
(b) Large stocks: E(r) = 11.50% and standard deviation = 20.14%;
(c) US Treasury bonds: E(r) = 5.45% and standard deviation = 8.06%;
How would this rank order change if the return for each class [i.e., the E(r)] were each reduced by a 3% inflation factor?
If inflation reduces returns by 3%:
Question 4.4. If the Beta coefficient for a publicly traded company is 1.25, and the average market return for the stock is 12%, and the interest yield on 10-year US Treasury Bonds is 4%, what is the required rate of return?
Question 5.5.
Select any type of company (e.g., your employer or the company for your current event project) and set up the equation for calculating the required or expected rate of return using the APT (Arbitrage Pricing Theory) model. Use your own estimates for the weighting of each factor, so that the equation accurately generates a required or expected rate of return that is mathematically correct. [Helpful hint: do not spend too much time or "overthink" this problem as this merely a hypothetical exercise to measure your comprehension on how the APT model can be applied in real world situations.] ALSO you are not called upon to calculate an E(r) but to set up the equation with the appropriate weighting factors only.
If for example we are considering a stock where the factors affecting the return are growth in monthly production (IP), Change in Expected Inflation (EI), as well as Unanticipated Inflation (UI).
Question 6.6. If a company decides to increase its ratio of total debt / total assets from 30% to 50% as a means of increasing its return on equity (ROE), and it is able to maintain a 7.5% return on assets (ROA), what is the return on equity (ROE) with the two different total debt/total asset ratios? (Points : 4)
Question 7.7. In an earlier problem you were asked to calculate the Return on Equity based on changes to the financial leverage or debt level. What is the critical underlying assumption that enables a firm to increase Return on Equity via increased financial leverage or higher debt?
Question 8.8. In the context of Time Value of Money, what is the most dynamic or important variable used in valuation? Explain.
Interest Rates are the most volatile variable used in the valuation. This is because of the Interest Rate Risk where interest rates are almost constants in the short-term, yet might change considerably in the long run
Question 9.9. In the context of Time Value of Money, the Horizon or Terminal Value for the NU Coffee Company is given as$150,000, its most recent annual cash flow was $30,000 and its long-term growth rate is 3%. What is the required rate of return? (Points : 4)
Question 11.11. A company forecasts free cash flow of $50 million in five years. It expects the free cash flow to grow at a constant rate of 6 percent thereafter. If the weighted average cost of capital is 12 percent, what is the terminal value, to the nearest million?
$53 million
$501 million
$600 million
$833 million
$883 million
Question 12.12. List the 4 decisions involved or constructing an investment strategy.
1) What asset classes should be considered for investment?
2) What policy weights should be assigned to each eligible asset class?
3) What are the allowable allocation ranges based on policy weights?
4) What specific securities or funds should be purchased for the portfolio?
Question 13.13. In addition to measuring profitability, efficiency and risk, the specific uses of financial ratios in the areas of investment cited by the textbook are Liquidity, Solvency, and ___________________.
Question 14.14. Which of the active management strategies in the fundamental analysis category is most suitable for structuring an investment portfolio? Selecting individual stocks to buy or sell?
The most suitable for structuring an investment portfolio is the Valuation Analysis. The most suitable for selecting individual stocks to buy or sell would be The top down and bottom up.
Question 15.15. Low Price/Book, low P/E and consumer & services are characteristics associated with value stocks.
True
False
Question 16.16. The textbook graphically depicts the Capital Asset Pricing Model (CAPM) with a Security Market Line (SML) in which the systematic risk (represented by the Beta coefficient) is the horizontal axis and the vertical axis is the expected or required rate of return. The value or number where the SML intersects the vertical axis is the risk free rate.
Based on this information, a change in investors' attitudes toward risk will cause a change in the market risk premium, and cause a change in the slope of the Security Market Line.
True
False
Question 17.17.
Asset allocation and sector rotation are examples of "Top Down" investment strategy.
True
False
Question 18.18.
Which of the following ratios is NOT a financial leverage ratio?
Long Term Debt divided by Total Assets
Total Debt divided by Shareholder's Equity
Current Assets divided by Current Liabilities
Long Term Debt divided by Total Capital
Shareholder's Equity divided by Total Capital
Question 19.19. The standard deviation and variance are "absolute" measures of dispersion, while the coefficient of variation is a "relative" measure of dispersion.
True
False
Question 20.20. The APT [Arbitrage Pricing Theory] model posits that the most significant factors influencing the required rate of return are:
Inflation, Industrial/economic growth
Industrial/economic growth, systematic risk, inflation, risk premiums, risk free rate and random error term
Industrial/economic growth, inflation, risk free rate, risk premiums and random error term
Industrial/economic growth, inflation, risk free rate and random error term
Industrial/economic growth, inflation, risk free rate and risk premiums
Question 21.21. Using the Capital Asset Pricing Model, the required rate of return for an individual stock is equal to:
Risk free rate plus market risk premium plus the Beta coefficient
Risk free rate plus market risk premium times the Beta coefficient
Risk free rate minus market risk premium times the Beta coefficient
Risk free rate times the market risk premium minus the Beta coefficient