Multiple Choice Questions
1. To _____ means to mitigate a financial risk.
A. invest
B. speculate
C. hedge
D. renege
Answer: C. hedge
2. In a defined benefit pension plan, the _____ bears all of the fund's investment performance
risk.
A. employer
B. employee
C. fund manager
D. government
Answer: A. employer
3. In a defined contribution pension plan, the _____ bears all of the fund's investment
performance risk.
A. employer
B. employee
C. fund manager
D. government
Answer: B. employee
4. My pension plan will pay me a yearly retirement amount equal to 2% of my highest annual
salary for each year of service. I must have ___________.
A. a defined benefit plan
B. a defined contribution plan
C. an endowment fund
D. a variable annuity
Answer: A. a defined benefit plan
5. A ______ insurance policy provides death benefits, with no buildup of cash value.
A. whole-life
B. universal life
C. variable life
D. term life
Answer: D. term life
6. If the maturity of a bank's assets is much longer than the maturity of its liabilities and it
wants to limit its interest rate risk, the bank may _________.
A. prefer to invest in long-term bonds in its asset portfolio
B. prefer to invest in equities in its asset portfolio
C. prefer to invest in variable-rate assets
D. decide to increase its fixed-rate mortgage holdings
Answer: C. prefer to invest in variable-rate assets
7. You are thinking of investing in one of two assets. Asset A has higher systematic risk than
asset B. You can be sure that asset A's _______ return will be higher than asset B's, but you
can't be sure if asset A's _______ return will be higher than asset B's.
A. realized; expected
B. real; nominal
C. expected; realized
D. nominal; expected
Answer: C. expected; realized
8. A mutual fund may not hold more than ______ of the shares of any publicly traded
company.
A. 5%
B. 10%
C. 25%
D. 50%
Answer: A. 5%
9. Which one of the following would be considered a "cash equivalent" investment?
A. Treasury bills
B. Common stock
C. Corporate bonds
D. Real estate
Answer: A. Treasury bills
10. For a bank, the difference between the interest rate charged to borrowers and the interest
rate paid on liabilities is called the __________.
A. insurance premium
B. interest rate spread
C. risk premium
D. term premium
Answer: B. interest rate spread
11. Price volatility is greatest on which one of the following investments?
A. Commercial paper
B. 20-year zero-coupon bonds
C. Treasury notes
D. Treasury bills
Answer: B. 20-year zero-coupon bonds
12. A portfolio manager indexes part of a portfolio and actively manages the rest of the
portfolio. This is called a _________ strategy.
A. passive-aggressive
B. passive core
C. passively active
D. balanced fund
Answer: B. passive core
13. The major asset most people have during their early working years is their ________.
A. home
B. stock portfolio
C. earning power derived from their skills
D. bond portfolio
Answer: C. earning power derived from their skills
14. At the early stage of an individual's working career, his or her retirement portfolio should
probably consist mostly of _______.
A. annuities
B. stocks
C. bonds
D. commodities
Answer: B. stocks
15. If an investor wants to invest 100% of her portfolio in safe assets but does not want to
manage her portfolio, she should invest in __________.
A. a money market fund
B. a growth stock fund
C. several different money market instruments
D. several different stocks
Answer: A. a money market fund
16. Just 2 months after you put money into an investment, its price falls 25%. Assuming that
none of the investment fundamentals have changed, which of the following actions would
evidence the greatest risk tolerance?
A. You sell to avoid further worry and buy something else.
B. You do nothing and wait for the investment to come back.
C. You buy more, thinking that if it was a good investment before, now it's not only good but
cheap too.
D. You sue your financial adviser.
Answer: C. You buy more, thinking that if it was a good investment before, now it's not only
good but cheap too.
17. To become a CFA, you must do all of the following except which one?
A. Pass three exams designed to ensure that you have sufficient knowledge of investments.
B. Obtain 3 years of work experience in money management.
C. Become a member of a local Society of the Financial Analysts Federation.
D. Divest all your own stock holdings to eliminate any potential conflicts of interest with
client recommendations.
Answer: D. Divest all your own stock holdings to eliminate any potential conflicts of interest
with client recommendations.
18. Which of the following is not one of the main areas covered in the examinations that must
be taken in order to achieve the designation of Chartered Financial Analyst?
A. Investment management ethics
B. Securities analysis
C. Securities marketing techniques
D. Portfolio management
Answer: C. Securities marketing techniques
19. As the typical investor ages, the composition of his wealth usually switches from
primarily _______ to primarily _______.
A. human capital; financial capital
B. financial capital; human capital
C. intellectual capital; physical capital
D. investable capital; noninvestable capital
Answer: A. human capital; financial capital
20. The two most important factors in describing an individual's or organization's investment
objectives are ________________.
A. income level and age
B. income level and risk tolerance
C. age and risk tolerance
D. return requirement and risk tolerance
Answer: D. return requirement and risk tolerance
21. The term hedge refers to an investment that is used ________________.
A. primarily for tax-loss selling purposes
B. to mitigate specific financial risks
C. to conceal one's true investment strategy from other market participants
D. primarily to defer capital losses
Answer: B. to mitigate specific financial risks
22. The price of your investment increases 20% one month after you buy it. You do not
believe that the stock's prospects have changed. Which one of the following actions would
indicate the lowest amount of risk aversion?
A. You hang on to the stock, anticipating that it will go higher.
B. You buy more stock, anticipating that it will go higher.
C. You sell all of your stock holdings immediately.
D. You sell half of your stock holdings and invest the proceeds in other areas of your
portfolio.
Answer: B. You buy more stock, anticipating that it will go higher.
23. An individual is on the game show Squeal or No Squeal, and she has a choice between
receiving a certain gain of $100,000 and receiving a 50% chance of winning $200,000 or
zero. If she takes the gamble instead of the certain $100,000, she is acting
____________________.
A. like a person who is risk-neutral
B. like a person who is risk averse
C. like a person who is a risk lover
D. irrationally
Answer: C. like a person who is a risk lover
24. Which of the following typically strives to earn a return on their investments that exceeds
the actuarially determined rate of return?
A. Banks
B. Thrifts
C. Mutual funds
D. Pension funds
Answer: D. Pension funds
25. If an individual confers legal title to property to another person or institution to manage
the property on their behalf, the individual has created ___________.
A. a personal trust
B. a charitable trust
C. an endowment fund
D. a mutual fund
Answer: A. a personal trust
26. Personal trusts are typically allowed to engage in which of the following investment
activities?
I. Buying and selling futures contracts.
II. Short-selling securities.
III. Purchasing and writing options.
IV. Buying stock on margin.
A. I only
B. II and III only
C. II and IV only
D. None of the given activities are allowed.
Answer: D. None of the given activities are allowed.
27. If a defined benefit pension fund's actual rate of return is _____ than the actuarial assumed
rate, then the ___________.
A. greater; employees will benefit
B. greater; firm's shareholders will benefit
C. lower; employees will benefit
D. lower; firm's shareholders will benefit
Answer: B. greater; firm's shareholders will benefit
28. An employee has an average wage of $60,000 and has worked for the firm for 25 years.
The defined benefit pension plan pays retirees 2.5% of the average wage times the years of
service. The employee can expect to receive _______ per year upon retirement.
A. $18,000
B. $37,500
C. $45,325
D. $55,250
Answer: B. $37,500
(.025)($60,000)(25) = $37,500
29. Life insurance companies try to hedge the risks inherent in whole-life insurance policies
by investing in __________.
A. long-term bonds
B. money market mutual funds
C. savings accounts
D. short-term commercial paper
Answer: A. long-term bonds
30. A pension fund will owe $10 million to retirees in 6 years. An actuary assumes an 8% rate
of return on the funds invested in the pension plan. If the pension plan receives annual
contributions from the company sponsor, how much must the company pay each year to fully
fund the pension liability?
A. $1,212,587
B. $1,363,154
C. $1,533,333
D. $1,666,667
Answer: B. $1,363,154
31. The risk that a downturn in the market may substantially reduce your investment principal
is called _______.
A. purchasing power risk
B. interest rate risk
C. market risk
D. liquidity risk
Answer: C. market risk
32. The possibility that you are too conservative and your money doesn't grow fast enough to
keep pace with inflation is called ________.
A. purchasing power risk
B. liquidity risk
C. timing risk
D. market risk
Answer: A. purchasing power risk
33. A pension fund will owe $15 million to retirees in 20 years. An actuary assumes a 6% rate
of return on the funds invested in the pension plan, but the fund actually earns 8%. The
pension plan receives annual contributions from the company sponsor. If the 8% rate of return
is expected to continue, by how much can the company reduce its pension payments per year?
A. $65,437
B. $79,985
C. $89,462
D. $95,320
Answer: B. $79,985
34. Many defined benefit pension plans have a target rate of return on investment that is equal
to the ____________.
A. firm's return on equity
B. plan's assumed actuarial rate of return
C. economic inflation rate because wages often increase with inflation
D. estimated stock market return
Answer: B. plan's assumed actuarial rate of return
35. _______ is a life insurance policy that provides a death benefit and a fixed-rate taxdeferred savings plan.
A. Term life
B. Whole life
C. Variable life
D. Universal life
Answer: B. Whole life
36. Empirical evidence confirms that investors become __________ as they approach
retirement.
A. greedier
B. less interested in investments
C. more risk averse
D. more risk tolerant
Answer: C. more risk averse
37. _______ is a life insurance policy that will provide a death benefit only and has no
savings plan.
A. Term life
B. Whole life
C. Variable life
D. Universal life
Answer: A. Term life
38. Of the following, the investment time horizon is typically the shortest for __________.
A. banks
B. endowment funds
C. life insurance companies
D. pension funds
Answer: A. banks
39. A passive asset allocation strategy involves _________.
A. investing in the stock of companies that are price takers
B. maintaining approximately the same proportions of a portfolio in each asset class over time
C. varying the proportions of a portfolio in each asset class in response to changing market
conditions
D. selecting individual securities in different sectors that are believed to be undervalued
Answer: B. maintaining approximately the same proportions of a portfolio in each asset class
over time
40. An active asset allocation strategy involves _________.
A. investing in the stock of companies that are price takers
B. maintaining approximately the same proportions of a portfolio in each asset class over time
C. varying the proportions of a portfolio in each asset class in response to changing market
conditions
D. selecting individual securities in different sectors that are believed to be undervalued
Answer: C. varying the proportions of a portfolio in each asset class in response to changing
market conditions
41. Endowment funds are held by __________.
A. financial intermediaries
B. individuals
C. profit-oriented firms
D. nonprofit institutions
Answer: D. nonprofit institutions
42. Which one of the following is a life insurance policy that will provide a fixed death
benefit and allows the policyholder to choose where to invest the policy's cash value?
A. Term life
B. Whole life
C. Variable life
D. Industrial life
Answer: C. Variable life
43. Under a "passive core" portfolio management strategy, a manager would ___________.
A. index the entire portfolio
B. index part of the portfolio and actively manage the rest
C. delegate the management of core segments of the portfolio to other managers
D. actively manage the entire portfolio
Answer: B. index part of the portfolio and actively manage the rest
44. Of the following, the most flexible type of life insurance policy from the policyholder's
perspective is probably a ___________ policy.
A. term life
B. whole life
C. variable life
D. universal life
Answer: D. universal life
45. The amount of risk an individual should take depends on his or her:
I. Return requirements
II. Risk tolerance
III. Time horizon
A. I only
B. I and II only
C. II and III only
D. I, II, and III
Answer: D. I, II, and III
46. Earnings on variable life and universal life insurance policies are ___________.
A. never taxed
B. taxed only at the capital gains tax rate
C. not taxed until the money is withdrawn
D. not taxed at the federal level but are taxed at the state level
Answer: C. not taxed until the money is withdrawn
47. When a company sets up a defined contribution pension plan, the __________ bears all
the risk and the __________ receives all the return from the plan's assets.
A. employee; employee
B. employee; employer
C. employer; employee
D. employer; employer
Answer: A. employee; employee
48. Suppose that the pretax holding-period returns on two stocks are the same. Stock A has a
high dividend payout policy and stock B has a low dividend payout policy. If you are a hightax rate individual and do not intend to sell the stocks during the holding period, __________.
A. stock A will have a higher after-tax holding-period return than stock B
B. the after-tax holding period returns on stocks A and B will be the same
C. stock B will have a higher after-tax holding-period return than stock A
D. The answer cannot be determined from the information given.
Answer: C. stock B will have a higher after-tax holding-period return than stock A
49. The objectives of personal trusts normally are __________ in scope than those of
individual investors, and personal trust managers typically are __________ than individual
investors.
A. broader; more risk averse
B. broader; less risk averse
C. more limited; more risk averse
D. more limited; less risk averse
Answer: C. more limited; more risk averse
50. The prudent investor rule requires __________.
A. executives of companies to avoid investing in options of companies they work for
B. executives of companies to disclose their transactions in stocks of companies they work for
C. professional investors who manage money for others to avoid all risky investments
D. professional investors who manage money for others to constrain their investments to
those that would be approved by a prudent investor
Answer: D. professional investors who manage money for others to constrain their
investments to those that would be approved by a prudent investor
51. The prudent investor rule is an example of a regulation designed to ensure appropriate
_____________ by money managers.
A. fiduciary responsibility
B. fiscal responsibility
C. monetary responsibility
D. marketing procedures
Answer: A. fiduciary responsibility
52. An investor has a long time horizon and desires to earn the market rate of return.
However, the investor will need to withdraw funds each year from her investment portfolio.
The biggest constraint a planner would face with this client is a ___________ constraint.
A. tax
B. risk-tolerance
C. liquidity
D. social
Answer: C. liquidity
53. When used in the context of investment decision making, the term liquidity refers to
_____________.
A. the ease and speed with which an asset can be sold at any value possible
B. the ease and speed with which an asset can be sold without having to discount the value
C. an aspect of monetary policy
D. the proportion of short-term to long-term investments held in an investor's portfolio
Answer: B. the ease and speed with which an asset can be sold without having to discount the
value
54. The term investment horizon refers to __________.
A. the proportion of short-term to long-term investments held in an investor's portfolio
B. the planned liquidation date of an investment
C. the average maturity date of investments held in a portfolio
D. the maturity date of the longest investment in the portfolio
Answer: B. the planned liquidation date of an investment
55. The choice of an active portfolio management strategy rather than a passive strategy
assumes ___________.
A. the ability to continuously adjust the portfolio to provide superior returns
B. asset allocation involving only domestic securities
C. stable economic conditions over the short term
D. the ability to minimize trading costs
Answer: A. the ability to continuously adjust the portfolio to provide superior returns
56. Conservative investors are likely to want to invest in __________ mutual funds, while
risk-tolerant investors are likely to want to invest in __________.
A. income; high growth
B. income; moderate growth
C. moderate-growth; high growth
D. high-growth; moderate growth
Answer: A. income; high growth
57. The first step any investor should take before beginning to invest is to __________.
A. establish investment objectives
B. develop a list of investment managers with superior records to interview
C. establish asset allocation guidelines
D. decide between active management and passive management
Answer: A. establish investment objectives
58. Which of the following is the least likely to be included in the portfolio management
process?
A. Monitoring market conditions and relative values
B. Monitoring investor circumstances
C. Identifying investor constraints and preferences
D. Organizing the investment management process itself
Answer: D. Organizing the investment management process itself
59. A clearly understood investment policy statement is not critical for which one of the
following?
I. Mutual funds
II. Individuals
III. Defined benefit pension funds
A. II only
B. III only
C. I only
D. None of these options (A policy statement is necessary for all three.)
Answer: D. None of these options (A policy statement is necessary for all three.)
60. An investor refuses to invest in any firm that produces alcohol or tobacco. This is an
example of a ___________ constraint.
A. return requirement
B. risk-tolerance
C. liquidity
D. social
Answer: D. social
61. Under the provisions of a typical defined benefit pension plan, the employer is responsible
for _____________.
A. investing in conservative fixed-income assets
B. paying benefits to retired employees
C. counseling employees in the selection of asset classes
D. paying employees the market rate of return on employee contributions
Answer: B. paying benefits to retired employees
62. A life insurance firm wants to minimize its interest rate risk, and it is planning on paying
out $250,000 in 5 years. Which one of the following investments best matches its goal?
A. High-yield utility stocks
B. 5-year zero-coupon bonds
C. 10-year coupon bonds
D. Money market investments rolled over as needed
Answer: B. 5-year zero-coupon bonds
63. An institutional investor will have to pay off a maturing bond issue in 3 years. The
institution has 10,000 bonds outstanding, each with a $1,000 par value. The institutional
money manager is reevaluating the fund's total portfolio of $100 million at this time. She is
bullish on stocks and wants to put the most she can into the stock market, but she cannot risk
being unable to pay off the bonds. Three-year zero-coupon bonds are available paying 6%
interest. What percentage of the total $100 million portfolio can she put in stocks and still
ensure meeting the bond payments?
A. 87.4%
B. 88.5%
C. 90%
D. 91.6%
Answer: D. 91.6%
64. An investor with high risk aversion will likely prefer which of the following risk and
return combinations?
A. Expected return = 12%, historical standard deviation = 17%
B. Expected return = 14%, historical standard deviation = 19%
C. Expected return = 16%, historical standard deviation = 21%
D. Expected return = 18%, historical standard deviation = 23%
Answer: A. Expected return = 12%, historical standard deviation = 17%
65. An investor with low risk aversion will likely prefer which of the following risk and return
combinations?
A. Expected return = 11%, historical standard deviation = 12%
B. Expected return = 12%, historical standard deviation = 14%
C. Expected return = 14%, historical standard deviation = 18%
D. Expected return = 17%, historical standard deviation = 21%
Answer: D. Expected return = 17%, historical standard deviation = 21%
66. Medfield College's $10 million endowment fund is not allowed to spend any contributed
capital or any capital gains. The fund may spend only investment earnings. The fund is
expected to need between $500,000 and $1,000,000 to pay for new lab equipment for the
science building. Which of the following is (are) true?
I. The fund should have a target rate of return of at least 10%.
II. The limitations on spending require that the fund limit its considerations to growth stocks.
III. The requirement to spend money out of the fund this year provides a liquidity constraint
that may reduce the fund's rate of return.
A. I only
B. II only
C. I and III only
D. I, II, and III
Answer: C. I and III only
67. An investor is looking at different retirement investment choices, and he is willing to
accept one with upside potential even if that means sacrificing certainty. Which of the
following will he most likely select?
A. Fixed annuity
B. Defined benefit plan
C. Defined contribution plan
D. Bonds invested in a retirement plan
Answer: C. Defined contribution plan
68. Both a wife and her husband work in the airline industry. They are in their 40s, and they
have a high tax bracket and are concerned about their after-tax rate of return. A meeting with
their financial planner reveals that they are primarily focused on long-term capital gains and
will need at least a 9% to 11% average rate of return to meet their retirement goals. They
desire a diversified portfolio, and liquidity is not currently a major concern. Which of the
following asset allocations seems to best fit their situation?
A. 10% money market; 40% long-term bonds; 10% commodities; 40% high-dividend-paying
stocks
B. 0% money market; 60% long-term bonds; 40% stocks
C. 10% money market; 30% long-term bonds; 10% commodities; 50% high-dividend-paying
stocks
D. 5% money market; 30% long-term bonds; 5% commodities; 60% stocks, most with low
dividends and high growth prospects
Answer: D. 5% money market; 30% long-term bonds; 5% commodities; 60% stocks, most
with low dividends and high growth prospects
69. A family will retire in a few years. They have a high tax bracket and are concerned about
their after-tax rate of return. A meeting with their financial planner reveals that they are
primarily focused on safety of principal and will need a 6% to 8% average rate of return on
their portfolio. They desire a diversified portfolio, and liquidity is likely to be a concern due
to health reasons. Which of the following asset allocations seems to best fit this family's
situation?
A. 10% money market; 50% intermediate-term bonds; 40% blue chip stocks, many with high
dividend yields
B. 0% money market; 60% intermediate-term bonds; 40% stocks
C. 10% money market; 30% intermediate-term bonds; 60% high-dividend-paying stocks
D. 5% money market; 35% intermediate-term bonds; 60% stocks, most with low dividends
Answer: A. 10% money market; 50% intermediate-term bonds; 40% blue chip stocks, many
with high dividend yields
70. Your sister, an avid outdoors person, works in the airline industry, and she has come to
you (the financial guru) for investment advice. She is looking into purchasing stocks she
knows something about. She is considering purchasing stock in Boeing, Lockheed Martin,
United Technologies (maker of aircraft engines), and Cabela's Sporting Goods. Based only on
the information given, which stock should you recommend for her?
A. Boeing
B. Lockheed Martin
C. United Technologies
D. Cabela's
Answer: D. Cabela's
71. In 1937 the Eli Lilly family donated millions of dollars in stock to fund a not-for-profit
charitable organization. Such organizations are typically called _________________.
A. annuities
B. endowments
C. mutual funds
D. personal trusts
Answer: B. endowments
72. Which one of the following institutions typically has the longest investment horizon?
A. Mutual funds
B. Pension funds
C. Property and casualty insurers
D. Banks
Answer: B. Pension funds
73. For which one of the following institutions is liquidity usually the most important?
A. Mutual funds
B. Pension funds
C. Life insurers
D. Banks
Answer: D. Banks
74. One of the major functions of the investment committee is to ________________.
A. determine security selection of each portfolio operated by the investment company
B. translate the objectives and constraints of the investment company into an asset universe
C. determine the percentages of each security in the total investment company portfolio
D. calculate and report the overall rate of return to investment company constituents
Answer: B. translate the objectives and constraints of the investment company into an asset
universe
75. For an investor concerned with maximizing liquidity, which of the following investments
should be avoided?
A. Real estate
B. Bonds
C. Domestic stocks
D. International stocks
Answer: A. Real estate
76. The asset universe is the _____________________.
A. set of investments in which an investment company can legally invest
B. existing set of assets the investment company currently owns in one or more of its
portfolios
C. list of assets approved by the investment committee that may be placed into the investment
company's portfolio
D. market portfolio of all available risky assets
Answer: C. list of assets approved by the investment committee that may be placed into the
investment company's portfolio
77. Go Global Investment Management has an asset allocation strategy of 60% U.S.
investments and 40% global investments. Within the United States, Go Global has allocated
70% of its portfolio to equities and 30% to bonds. Go Global now holds 3% of its U.S. equity
portfolio in the stock of Wally World. Internationally, Go Global has allocated 55% to
equities and 45% to bonds. About what percentage of Go Global's total portfolio is invested in
Wally World?
A. 1%
B. 1.26%
C. 1.5%
D. 1.77%
Answer: B. 1.26%
(60%)(70%)(3%) = 1.26%
78. Major functions of the investment committee include all but which one of the following?
A. Engage in security selection for each portfolio managed
B. Broadly determine the overall asset allocation of the investment company
C. Determine the asset-class weights for each portfolio
D. Determine the asset universe
Answer: A. Engage in security selection for each portfolio managed
79. A portfolio consists of three index funds: an equity index, a bond index, and an
international index. The portfolio manager changes the weights periodically according to
forecasts for each sector. This is an example of __________.
A. a passively managed core with an actively managed component
B. a totally passively managed fund
C. passive asset allocation with active security selection
D. active asset allocation with passive security selection
Answer: D. active asset allocation with passive security selection
80. A portfolio consists of three index funds: an equity index accounting for 40% of the total
portfolio, a bond index accounting for 30% of the total portfolio, and an international index
accounting for 30% of the total portfolio. After each quarter the portfolio manager buys and
sells some of each sector to preserve the original weights for each sector. This is an example
of ____________.
A. a passively managed core with an actively managed component
B. a totally passively managed fund
C. passive asset allocation with active security selection
D. active asset allocation with passive security selection
Answer: B. a totally passively managed fund
81. One way that life insurance firms can hedge the risk created by offering whole-life
insurance policies is by ________________.
A. holding long-term bonds
B. holding equities
C. holding short-term bonds
D. exercising its right to terminate the policy
Answer: A. holding long-term bonds
Test Bank for Essentials of Investments
Zvi Bodie, Alex Kane, Alan Marcus
9780078034695, 9789389957877, 9781264140251, 9781260316148, 9780073382401, 9780078034695, 9781260013924, 9780077835422
