IP- Work book

Investment Planning and Asset Management Workbook CFP Level 1 - Module 2 - Investment Planning and Asset Management - Workbook Page 1

Chapter-5 Investment Theory 1. Human mind frequently makes random judgmental errors. This trait may be dealt with by programming individual decision process. This Characteristic is used in ____. a) averaging b) arbitraging c) Systematic Investment Plan d) Hedging (Ans - c) 2. Rational investors will form portfolios to eliminate systematic risk. a) True b) False (And - b) 3. Calculate the expected rate of return of the portfolio given the following information: Risk-free rate of interest: 8% Expected return of market portfolio: 18% Standard Deviation of asset: 2.8% Market Standard Deviation: 2.4% Correlation co-efficient of portfolio with market 0.8 a) 17.7% b) 17.33% c) 18.7% d) 16.33% ( Ans – b) Beta = [r * SD (stock)] / SD (market) = (0.8 * 2.8) / 2.4 = 0.933. Use CAPM: ERp = 8% + [(18% - 8%) * 0.933] = 17.33%) CFP Level 1 - Module 2 - Investment Planning and Asset Management - Workbook Page 2

4. If expected return of a security, as per the Capital Asset Pricing Model, is greater than the actual return of the security then in terms of performance the security would be treated as: a) Outperforming b) Underperforming c) Performing at par with the Market d) None of the Above (Ans - b) 5. The Capital Asset Pricing Model (CAPM) predicts the required rate of return on a stock as: a) The difference between the risk-free rate and the market risk premium b) The sum of the risk-free rate and the market risk premium c) The sum of the risk-free rate and the beta of the stock d) The sum of the risk free rate and the product of beta of the stock and market risk premium (Ans - d) 6. The efficient market hypothesis which contradicts the market timing approach says that ______. a) It is impossible to time the market as historical data is hard to get b) It is impossible to time the market due to trends that is shows c) It is impossible to time the market as market behavior is random d) It is impossible to time the market as there is efficiency in settlement (Ans - c) 7. Calculate return of the portfolio with a 15% risk given that the risk free rate is 7%, return of the market is 15% and risk of the market is 7%. a) 16.80% b) 15.33% c) 17.95% d) 23.00% (Ans - d) CFP Level 1 - Module 2 - Investment Planning and Asset Management - Workbook Page 3

8. Rakesh has a portfolio with 23 different equities. The portfolio beta is 1.50. By what percentage should the Market move so that the expected return from his portfolio is 20% using the Capital Asset Pricing Model? (Assume risk free rate to be 6%). a) 14.80% b) 15.33% c) 17.00% d) 16.50% (Ans - b) 9. The CAPM is a model that: a) Determines the geometric return of a security. b) Determines time-weighted return c) Explain return in terms of risk. d) Explains systematic risk (Ans - (c) Explain return in terms of risk. 10. __________________ is an investment strategy focused on the needs of the investor rather than the constant tracking of the markets, and is thought to remove the influence of emotion from investment strategies. a) liquidity expectation timing b) portfolio optimization c) strategic asset allocation d) tactical asset allocation (Ans-(c) Strategic Asset Allocation) 11 Which of the following is/are not a method(s) to evaluate the attractiveness of investments? I. Net present value. II. Internal rate of return. III. Sum of digits. CFP Level 1 - Module 2 - Investment Planning and Asset Management - Workbook Page 4

IV. Payback period. a) I b) I, II c) III d) III, IV (Ans - (c) III. Sum of digits 12. What is Modern Portfolio Theory? a) Modern Portfolio Theory (MPT) argues that it's possible to design an ideal portfolio that will provide the investor maximum returns by taking on the optimal amount of risk. b) MPT was developed by economist Harry Markowitz in the 1950s; his theories surround the importance of portfolios, risk, diversification and the connections between different kinds of securities. c) MPT advocates diversification of securities and asset classes. d) All of the above (Ans - d) 13. Which of the following is not true about assumptions of MPT? a) Investors are rational, and want to realize the best possible utility (satisfaction) of their investments. b) Investors prefer the highest level of risk, and for a given level of risk, want the maximum possible return. c) When making decisions, investors consider only risk and return. d) Expected return, risk and covariance are fixed through time, and known to investors (Ans - b) As per MPT, investors prefer lowest level of risk) 14. How do we choose between efficient portfolios? a) Most investors desire to achieve the highest satisfaction (utility) from their portfolio. b) This means there is no one perfect or best portfolio. c) Instead, each investor will find his or her optimal portfolio along the efficient frontier by determining the amount of risk to assume relative to the return the person needs or wants. d) In this context, there may be more than one optimal portfolio for a given investor, depending on the goal(s) the investor has for the portfolio. e) All the above are true (Ans - e) CFP Level 1 - Module 2 - Investment Planning and Asset Management - Workbook Page 5

15. Hoe does Arbitrage Pricing Theory explain itself? a) The key point behind APT is a logical statement that security returns are not based on one single factor of the market, rather it is influenced by multiple macro-economic factors where sensitivities to each factor is represented by a factor specific beta coefficient. b) The APT model proposes that there exists a linear relationship between the return on asset and the number of risk factors. c) APT assumes that a security’s long run return is “directly related to its sensitivities to unanticipated changes in the four macroeconomic variables – (i) inflation, (ii) industrial production, (iii) risk premium, and (iv) the scope of the term structure of interest rates. d) All the above are true (Ans - d) 16. Which of the following three forms of efficiency given by efficient market hypothesis is true? a) Weak form assumes that current stock prices reflect all available (current and historical) stock market information. b) Semi-Strong form assumes that new information available to the public is immediately factored into stock prices, and can be used by investors. The market then regains equilibrium. If true, the semi-strong form effectively discounts fundamental analysis. c) Strong form assumes current stock prices fully reflect all public and nonpublic (including insider) information (i.e., a perfect market). d) All the above are true (Ans - d) 17. Which of the following about Random walk theory is true? a) One has no reason to do Fundamental Analysis b) One has no reason to do Technical Analysis. c) The only way to get better investment returns than provided by the market is to accept greater risk (i.e., it is impossible to outperform the market). d) All the above are true 18. What is the Time-premium? a) It is the compensation or reward for waiting as the current consumption of money value is sacrificed for the present or proposed to the future. b) It is the compensation for the loss in value of the money. This compensation should be at least equal to the returns on risk free assets as this is the minimum expected return that one can have from his investment. CFP Level 1 - Module 2 - Investment Planning and Asset Management - Workbook Page 6

c) The risk free assets are however, subject to interest rate risk and inflation risk. They are free from default risk. d) All the above are true (Ans - d) 19. Which of the following is not true about Risk- premium? a) It is the reward for assuming risk by the risk-averse investors. b) His desire for return increases with the increased quantum of risk assumed by him. c) The risk premium is nothing but the compensation over and above the risk involved in riskless assets. d) The risk premium decreases with the increase in risk. e) In other words, higher the risk higher the return; lower the risk lower the return. f) All are true (Ans - d) 20. The Beta of a market portfolio is: a) -1 b) 0 c) 1 d) None of the above (Ans - c) CFP Level 1 - Module 2 - Investment Planning and Asset Management - Workbook Page 7