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Question 1 of 10
1. Question
Which of the following statements is true regarding range?
I. Range is the difference in the highest return of the portfolio and the lowest return of the portfolio
II. This look at a portfolio’s performance allows the investor or adviser to statistically evaluate the range of the included securities
III. If there is a large range, there may or may not be a problem with the portfolio that needs to be addressed, depending on the investors’ profit
IV. A large range may also be a sign of negative correlation in the portfolio, whereas a smaller range tends to indicate positive correlationCorrect
Range
Range is the difference in the highest return of the portfolio and the lowest return of the portfolio. It covers all numbers in between. This look at a portfolio’s performance allows the investor or adviser to statistically evaluate the range of the included securities. If there is a large range, there may or may not be a problem with the portfolio that needs to be addressed, depending on the investors’ time horizon and risk appetite. A large range may also be a sign of negative correlation in the portfolio, whereas a smaller range tends to indicate positive correlation. Both of the scenarios can be problematic or show that an investor’s strategy is working, again dependent upon time horizon and risk appetite.Incorrect
Range
Range is the difference in the highest return of the portfolio and the lowest return of the portfolio. It covers all numbers in between. This look at a portfolio’s performance allows the investor or adviser to statistically evaluate the range of the included securities. If there is a large range, there may or may not be a problem with the portfolio that needs to be addressed, depending on the investors’ time horizon and risk appetite. A large range may also be a sign of negative correlation in the portfolio, whereas a smaller range tends to indicate positive correlation. Both of the scenarios can be problematic or show that an investor’s strategy is working, again dependent upon time horizon and risk appetite. -
Question 2 of 10
2. Question
Which of the following statements is true regarding standard deviation?
I. Standard deviation measures the distance each of the returns in the portfolio falls from the mean
II. The further spread the data is, the lower the measure of standard deviation
III. A higher standard deviation then indicates a low degree of volatility and thus profit
IV. Standard deviation may also apply to an individual security by measuring its historical mean performance against the historical returns making up the meanCorrect
Standard deviation
Standard deviation measures the distance each of the returns in the portfolio falls from the mean. The further spread the data is, the higher the measure of standard deviation. A higher standard deviation then indicates a high degree of volatility and thus risk. It is a very useful metric in determining the suitability of an investment for a client, risk averse or otherwise. Standard deviation may also apply to an individual security by measuring its historical mean performance against the historical returns making up the mean. In this case, too, a higher standard deviation represents a higher amount of volatility and risk.Incorrect
Standard deviation
Standard deviation measures the distance each of the returns in the portfolio falls from the mean. The further spread the data is, the higher the measure of standard deviation. A higher standard deviation then indicates a high degree of volatility and thus risk. It is a very useful metric in determining the suitability of an investment for a client, risk averse or otherwise. Standard deviation may also apply to an individual security by measuring its historical mean performance against the historical returns making up the mean. In this case, too, a higher standard deviation represents a higher amount of volatility and risk. -
Question 3 of 10
3. Question
Which of the following statements is true regarding financial ratios?
I. Financial ratios are a comparison of two specific pieces of numerical data from a given company’s loss
II. They are often used to quantify data and allow a more valuable comparison of data between companies
III. Financial ratios are very useful when used to compare data from the financial statements of companies that vary greatly in size
IV. A ratio comparing two companies’ debt to cash won’t be much easier to interpret than simply looking at the numbers on the financial statementsCorrect
Financial ratios
Financial ratios are a comparison of two specific pieces of numerical data from a given company’s financial statement. They are often used to quantify data and allow a more valuable comparison of data between companies. Financial ratios are very useful when used to compare data from the financial statements of companies that vary greatly in size. A ratio comparing two companies’ debt to cash will be much easier to interpret than simply looking at the numbers on the financial statements. This is also very useful when comparing the performance of an individual company to the entire industry to which the company belongs.Incorrect
Financial ratios
Financial ratios are a comparison of two specific pieces of numerical data from a given company’s financial statement. They are often used to quantify data and allow a more valuable comparison of data between companies. Financial ratios are very useful when used to compare data from the financial statements of companies that vary greatly in size. A ratio comparing two companies’ debt to cash will be much easier to interpret than simply looking at the numbers on the financial statements. This is also very useful when comparing the performance of an individual company to the entire industry to which the company belongs. -
Question 4 of 10
4. Question
Which of the following statements is true regarding interest rate risk?
I. Interest rate risk describes the possibility that interest rates will increase over time
II. Since decreasing interest rates provide an increase in the value of fixed-income assets, interest rate risk does not describe the downward movement of interest rates
III. An investment with a long duration will be more susceptible to interest rate risk due to the greater likelihood of interest rate movement during the lifetime of the investment compared to a long-duration investment
IV. Because interest rates are benchmarked to the Federal Reserve Rate, a decrease in rates at the Federal Reserve affects the fixed assets market as a wholeCorrect
Interest rate risk
Interest rate risk describes the possibility that interest rates will increase over time. Since decreasing interest rates provide an increase in the value of fixed-income assets, interest rate risk does not describe the downward movement of interest rates. When interest rates move up, the value of fixed-income assets decreases. An investment with a long duration will be more susceptible to interest rate risk due to the greater likelihood of interest rate movement during the lifetime of the investment compared to a short-duration investment. Because interest rates are benchmarked to the Federal Reserve Rate, an increase in rates at the Federal Reserve affects the fixed assets market as a whole. Individual investors do not hold sway over the Federal Reserve, making systematic risk unavoidable. It may not be eliminated completely, but may be reduced through diversification.Incorrect
Interest rate risk
Interest rate risk describes the possibility that interest rates will increase over time. Since decreasing interest rates provide an increase in the value of fixed-income assets, interest rate risk does not describe the downward movement of interest rates. When interest rates move up, the value of fixed-income assets decreases. An investment with a long duration will be more susceptible to interest rate risk due to the greater likelihood of interest rate movement during the lifetime of the investment compared to a short-duration investment. Because interest rates are benchmarked to the Federal Reserve Rate, an increase in rates at the Federal Reserve affects the fixed assets market as a whole. Individual investors do not hold sway over the Federal Reserve, making systematic risk unavoidable. It may not be eliminated completely, but may be reduced through diversification. -
Question 5 of 10
5. Question
Which of the following statements is true regarding inflation risk?
I. Inflation risk, also known as purchasing power risk, is the risk that the value of the goods that a dollar will purchase will decrease with time
II. Inflation is one of the reasons that investing is popular among those saving for business and profit
III. If a saver merely stored the money in a safe until retirement, inflation will have eaten away a large portion of the value of the savings
IV. A strong economy will result in some amount of inflation, and often terrible economies can lead to hyperinflation or deflationCorrect
Inflation risk
Inflation risk, also known as purchasing power risk, is the risk that the value of the goods that a dollar will purchase will decrease with time. Inflation is one of the reasons that investing is popular among those saving for retirement. If a saver merely stored the money in a safe until retirement, inflation will have eaten away a large portion of the value of the savings. The reason that inflation is unavoidable (thus systematic) is that it is always present, regardless of economic conditions. A strong economy will result in some amount of inflation, and often terrible economies can lead to hyperinflation or deflation. Deflation is simply negative inflation, and does not occur often enough and will not last long enough to be considered a viable investment strategy.Incorrect
Inflation risk
Inflation risk, also known as purchasing power risk, is the risk that the value of the goods that a dollar will purchase will decrease with time. Inflation is one of the reasons that investing is popular among those saving for retirement. If a saver merely stored the money in a safe until retirement, inflation will have eaten away a large portion of the value of the savings. The reason that inflation is unavoidable (thus systematic) is that it is always present, regardless of economic conditions. A strong economy will result in some amount of inflation, and often terrible economies can lead to hyperinflation or deflation. Deflation is simply negative inflation, and does not occur often enough and will not last long enough to be considered a viable investment strategy. -
Question 6 of 10
6. Question
Which of the following statements is true regarding fixed-income market?
Correct
Fixed-income market
The fixed-income market is the most susceptible to inflation risk due to the more stable nature of the investment. Investors who wish to reduce inflation risk associated with the fixed-income market usually invest in Treasury Inflation Protected Securities, or TIPS. As the name suggests, TIPS are fixed securities issued by the United States government. They are “inflation protected” because the par value of the issue is linked to the Consumer Price Index, or CPI. The CPI is a measure of the current rate of inflation. As the CPI rises, the par value of TIPS rises. This allows investors to combat a portion of the inflation rate risk they have accepted by investing in fixed-income markets.Incorrect
Fixed-income market
The fixed-income market is the most susceptible to inflation risk due to the more stable nature of the investment. Investors who wish to reduce inflation risk associated with the fixed-income market usually invest in Treasury Inflation Protected Securities, or TIPS. As the name suggests, TIPS are fixed securities issued by the United States government. They are “inflation protected” because the par value of the issue is linked to the Consumer Price Index, or CPI. The CPI is a measure of the current rate of inflation. As the CPI rises, the par value of TIPS rises. This allows investors to combat a portion of the inflation rate risk they have accepted by investing in fixed-income markets. -
Question 7 of 10
7. Question
Which of the following statements is true regarding unsystematic risk?
Correct
Unsystematic risk
Unsystematic risk, also known as nonsystematic risk, describes the risk inherent in a single security. Unsystematic risk, unlike systematic risk, can often be negated through diversification and other hedging strategies. Examples of unsystematic risk include, but are not limited to, natural disasters, poor management of a firm, a product shortage due to poor logistics, et cetera. Investors may diversify against the risk of a hurricane hurting their investment in an offshore oil company by also investing funds allocated to the energy sector in an oil company that operates in the plains.Incorrect
Unsystematic risk
Unsystematic risk, also known as nonsystematic risk, describes the risk inherent in a single security. Unsystematic risk, unlike systematic risk, can often be negated through diversification and other hedging strategies. Examples of unsystematic risk include, but are not limited to, natural disasters, poor management of a firm, a product shortage due to poor logistics, et cetera. Investors may diversify against the risk of a hurricane hurting their investment in an offshore oil company by also investing funds allocated to the energy sector in an oil company that operates in the plains. -
Question 8 of 10
8. Question
Which of the following statements is false regarding opportunity cost?
Correct
Opportunity cost
Opportunity cost refers to returns that are given up in favor of pursuing another investment. Since capital invested in a security was invested at the expense of not investing in another security, the return of the alternative investment not chosen is considered the opportunity cost. Investors in low-risk Treasury bills (considered the “risk-free” investment) experience the opportunity cost of higher returns that may be gained from other, riskier investments. To those investors, the lack of risk is worth the opportunity cost. Investors must determine if the opportunity cost is worth the benefits received by choosing an alternative investment. This is a determination that must be made with every investment, and as the value of the investment rises, the importance of properly evaluating the opportunity cost rises with it.Incorrect
Opportunity cost
Opportunity cost refers to returns that are given up in favor of pursuing another investment. Since capital invested in a security was invested at the expense of not investing in another security, the return of the alternative investment not chosen is considered the opportunity cost. Investors in low-risk Treasury bills (considered the “risk-free” investment) experience the opportunity cost of higher returns that may be gained from other, riskier investments. To those investors, the lack of risk is worth the opportunity cost. Investors must determine if the opportunity cost is worth the benefits received by choosing an alternative investment. This is a determination that must be made with every investment, and as the value of the investment rises, the importance of properly evaluating the opportunity cost rises with it. -
Question 9 of 10
9. Question
Which of the following statements is true regarding capital structure?
Correct
Capital structure
Capital structure refers to the way in which a firm has chosen to finance its operations. This structure is a mix of debt issues and equity issues. Capital structure is often analyzed using the debt-to-equity ratio. The more debt a company uses to finance its operations, the riskier the company is, but this can also lead to higher returns for investors, as the firm may use debt to invest in ventures in which it may not otherwise have had access. Investors should demand higher returns from companies with high debt-to-equity ratios.Incorrect
Capital structure
Capital structure refers to the way in which a firm has chosen to finance its operations. This structure is a mix of debt issues and equity issues. Capital structure is often analyzed using the debt-to-equity ratio. The more debt a company uses to finance its operations, the riskier the company is, but this can also lead to higher returns for investors, as the firm may use debt to invest in ventures in which it may not otherwise have had access. Investors should demand higher returns from companies with high debt-to-equity ratios. -
Question 10 of 10
10. Question
Which of the following statements is true regarding discounted cash flows in the valuation of fixed-income securities?
Correct
Discounted cash flows in the valuation of fixed-income securities
Discounted cash flow is used to valuate any security by discounting future cash flows (usually using inflation as the discount rate) and assigning the investment a present value. Using discounted cash flows to value equities can be problematic, since cash flows from equities tend to be uncertain. The discounted cash flows method of valuation is particularly useful, however, when attempting to value securities from the fixed-income sector. Since the par value of the investment is known, and the coupon of the fixed security is constant, the resulting present value calculation often provides relevant and predictable results. The drawback to using the discounted cash flows method is that the discount rate may be inaccurate in times of volatile rates of inflation.Incorrect
Discounted cash flows in the valuation of fixed-income securities
Discounted cash flow is used to valuate any security by discounting future cash flows (usually using inflation as the discount rate) and assigning the investment a present value. Using discounted cash flows to value equities can be problematic, since cash flows from equities tend to be uncertain. The discounted cash flows method of valuation is particularly useful, however, when attempting to value securities from the fixed-income sector. Since the par value of the investment is known, and the coupon of the fixed security is constant, the resulting present value calculation often provides relevant and predictable results. The drawback to using the discounted cash flows method is that the discount rate may be inaccurate in times of volatile rates of inflation.