CHAPTER 3—SELECTING INVESTMENTS IN A GLOBAL MARKET

TRUE/FALSE

1. The U.S. equity and bond markets have grown in terms of their relative size of the world equity and
bond market.

ANS: F PTS: 1

2. Diversification with foreign securities can help reduce portfolio risk.

ANS: T PTS: 1

3. The total domestic return on German bonds is the return that would be experienced by an U.S. investor
who owned German bonds.

ANS: F PTS: 1

4. If the exchange rate effect for Japanese bonds is negative, it means that the domestic rate of return will
be greater than the U.S. dollar return.

ANS: T PTS: 1

5. A U.S. investor who ignores foreign markets reduces overall number of investment choices.

ANS: T PTS: 1

6. Treasury bills are long-term investments that make regular interest and principal payments.

ANS: F PTS: 1

7. A debenture is an option issued by a corporation that gives the holder the right to acquire common
stock from the issuing firm at a specified price within a designated period of time.

ANS: F PTS: 1

8. Income bonds are considered as safe as debentures because they pay higher rates of interest.

ANS: F PTS: 1

9. A Eurobond is an international bond denominated in a currency other than that of the United States.

ANS: F PTS: 1

10. Warrants are options often issued in connection with the sale of fixed income securities.

ANS: T PTS: 1

11. A call option is usually issued in conjunction with convertible bonds.

ANS: F PTS: 1
12. Yields on money market funds are often lower than yields available to individuals investing in CD's
because of the fees involved.

ANS: F PTS: 1

13. Municipal bond nominal yields are generally below comparable taxable bond yields.

ANS: T PTS: 1

14. REITS are investment companies that invest in high-quality money market instruments such as
Treasury bills, high-grade commercial paper, and large CD's.

ANS: F PTS: 1

15. It is very important when diversifying that the correlation between rates of return for various countries
be high and very stable over time.

ANS: F PTS: 1

16. The decrease in the standard deviation of returns after adding 40 to 50 securities within a country is
known as domestic diversification.

ANS: T PTS: 1

17. Government agency securities are issued by local government entities as either general obligation or
revenue bonds.

ANS: F PTS: 1

18. Subordinated bondholders have claim to the assets of the firm only after the firm has satisfied the
claims of all senior secured and debenture bondholders.

ANS: T PTS: 1

MULTIPLE CHOICE

1. An investor who purchases a put option:

a. Has the right to buy a given stock at a specified price during a designated time period.
b. Has the right to sell a given stock at a specified price during a designated time period.
c. Has the obligation to buy a given stock at a specified price during a designated time
period.
d. Has the obligation to sell a given stock at a specified price during a designated time
period.
e. None of the above.
ANS: B PTS: 1

2. If you are considering investing in German stocks as a means to reduce the risk of your portfolio, the
initial factor that you should examine is:
a. The average rate of return of the portfolio when you combine U.S. and German stocks.
b. The standard deviation of the German stocks.
c. The standard deviation of the German stocks compared to the standard deviation of U.S.
stocks.
 d. The correlation between the rates of return for German stocks and U.S. stocks.
e. The coefficient of variation (CV) of rates of return for German stocks versus the CV of
rates of return for U.S. stocks.
ANS: D PTS: 1

3. All of the following are considered fixed income investments except

a. Corporate bonds.
b. Preferred stock.
c. Treasury bills, notes, and bonds.
d. Money market mutual funds.
e. Certificates of deposit (CDs).
ANS: D PTS: 1

4. Capital market instruments include all of the following except

a. U.S. Treasury notes and bonds.
b. U.S Treasury bills.
c. U.S. government agency securities.
d. Municipal bonds.
e. Corporate bonds.
ANS: B PTS: 1

5. The original maturity of a United States Treasury note is

a. Zero years to five years.
b. Six months to ten years.
c. One year or less.
d. One year to ten years.
e. Over ten years.
ANS: D PTS: 1

6. The original maturity of a United States Treasury bill is

a. Zero years to five years.
b. Six months to ten years.
c. One year or less.
d. One year to ten years.
e. Over ten years.
ANS: C PTS: 1

7. The original maturity of a United States Treasury bond is

a. Zero years to five years.
b. Six months to ten years.
c. One year or less.
d. One year to ten years.
e. Over ten years.
ANS: E PTS: 1

8. Which of the following is not an U.S. government agency?

a. Federal National Mortgage Association
b. Federal Home Loan Bank
c. Government National Mortgage Association
d. Government Employees Insurance Company
 e. Federal Housing Administration
ANS: D PTS: 1

9. The legal document setting forth the obligations of a bond's issuer is called
a. A debenture.
b. A warrant.
c. An indenture.
d. The preemptive right.
e. A trustee deed.
ANS: C PTS: 1

10. All of the following are considered fixed income securities except
a. Debentures.
b. Eurobonds.
c. Preferred stock.
d. Mutual funds.
e. Yankee bonds.
ANS: D PTS: 1

11. The purchase and sale of commodities for current delivery and consumption is known as dealing in the
____ market.
a. Futures
b. Spot
c. Money
d. Capital
e. Options
ANS: B PTS: 1

12. An investor who purchases a call option:

a. Has the right to buy a given stock at a specified price during a designated time period.
b. Has the right to sell a given stock at a specified price during a designated time period.
c. Has the obligation to buy a given stock at a specified price during a designated time
period.
d. Has the obligation to sell a given stock at a specified price during a designated time
period.
e. None of the above.
ANS: A PTS: 1

13. If this year is consistent with historical trends you would expect the return for small capitalization
stocks to be
a. Below common stocks and above long-term government bonds.
b. Below common stocks and below long-term government bonds.
c. Above last year's return on the same stocks.
d. Above common stock, long-term government, and corporate bonds.
e. The least variable among long-term bonds and common stocks.
ANS: D PTS: 1

14. The correlation between U.S. equities and U.S. government bonds is
a. Strongly positive.
b. Weakly Positive.
 c. Strongly Negative.
d. Weakly Negative.
e. Indeterminate.
ANS: B PTS: 1

15. The best way to directly acquire the shares of a foreign company is through
a. International mutual funds.
b. Global mutual funds.
c. American Depository Receipts.
d. Investment in U.S. companies operating internationally.
e. Eurobonds.
ANS: C PTS: 1

16. Which of the following would be considered a low liquidity investment?

a. Warrants
b. Call options
c. Zero coupon bonds
d. Balanced mutual funds
e. Diamonds
ANS: E PTS: 1

17. An agreement that provides for the future delivery or receipt of an asset at a specified date for a
specified price is a
a. Eurobonds contract.
b. Futures contract.
c. Put option contract.
d. Call option contract.
e. Warrant contract.
ANS: B PTS: 1

18. Which of the following is not a type of investment company?

a. Money market funds
b. Common stock funds
c. Balanced funds
d. Bond funds
e. None of the above
ANS: E PTS: 1

19. Antiques, art, coins, stamps, jewelry, etc., are not included in the investment portfolios of financial
institutions because
a. Prices vary substantially.
b. Transaction costs are relatively high.
c. They are illiquid.
d. None of the above.
e. All of the above.
ANS: E PTS: 1

20. Rank the following four investments in increasing order of historical risk.
a. Art, T-bills, corporate bonds, and common stock
b. T-bills, common stock, corporate bonds, art
 c. Corporate bonds, T-bills, common stock, art
d. Common stock, corporate bonds, T-bills, art
e. T-bills, corporate bonds, common stock, art
ANS: E PTS: 1

21. An ETF (exchange traded fund):

a. Is priced once a day at the opening of trading.
b. Is priced once a day at the close of trading.
c. Is priced continuously during the trading day.
d. Is priced at the open and close of trading.
e. None of the above.
ANS: C PTS: 1

22. A statistic that measures how two variables tend to move together is the
a. Coefficient of variation
b. Correlation coefficient
c. Standard deviation
d. Mean
e. Variance
ANS: B PTS: 1

23. Which of the following statements concerning historical investment risk and return is false?
a. The geometric mean of the rates of return was always lower than the arithmetic mean of
the rates of return.
b. The rates of return on long-term U.S. government bonds were lower than on stocks.
c. Real estate investments consistently provide higher rates of return than those provided by
common stock.
d. Stocks and bonds experienced results in the middle of the art and antiques series.
e. none of the above (that is, all are true statements)
ANS: C PTS: 1

24. Which of the following are reasons that U.S. investors should consider foreign markets when
constructing global portfolios?
a. Ignoring foreign markets reduced their choices of investment opportunities.
b. Foreign markets have low correlations with U.S. markets.
c. Returns on non-U.S. stocks can substantially exceed returns for U.S securities.
d. All of the above.
e. None of the above.
ANS: D PTS: 1

25. A mutual fund:

a. Is priced once a day at the opening of trading.
b. Is priced once a day at the close of trading.
c. Is priced continuously during the trading day.
d. Is priced at the open and close of trading.
e. None of the above.
ANS: B PTS: 1

26. For a U.S. based investor, a weaker dollar means that overall dollar based returns on overseas security
investment will be higher because
 a. A weaker dollar means that exports will rise.
b. A weaker dollar means that more foreign investors will by U.S. securities.
c. A weaker dollar means that the foreign currency will convert to more dollars.
d. A weaker dollar means that more investors will purchase the foreign security.
e. None of the above.
ANS: C PTS: 1

27. In order to diversify risk an investor must have investments that have correlations with other
investments in the portfolio that are
a. low positive
b. zero
c. negative
d. any of the above
e. none of the above
ANS: D PTS: 1

28. Correlations between bond markets in different countries have been changing over time because
a. Countries are developing closer trade and economic links.
b. Countries are becoming more segmented.
c. There are fewer barriers to travel.
d. U.S. investors are purchasing more foreign securities.
e. Correlations between bond markets of different countries have been rising.
ANS: A PTS: 1

29. Senior secured bonds are

a. The most senior bonds in a firm's capital structure.
b. Bonds with the lowest risk of default.
c. Bonds that are not backed by specific assets.
d. Choices a and b.
e. Choices a and c.
ANS: B PTS: 1

30. Convertible bonds are bonds

a. That are convertible into more bonds.
b. That are convertible from unsecured to secured status.
c. That are convertible into company stock.
d. That are convertible into specific assets.
e. That have an option attached.
ANS: C PTS: 1

31. A Eurobond is an international bond

a. Sold by an issuer within its own country in that country's currency.
b. Denominated in a currency not native to where it is issued.
c. Also known as a Yankee Bond.
d. Is a bond denominated in U.S. dollars but issued by a foreign company.
e. That is sold only to European investors.
ANS: B PTS: 1

32. Foreign equities can be acquired by purchasing all of the following except
a. American Depository Receipts (ADRs)
 b. American shares
c. Foreign shares listed on a U.S. or foreign stock exchange
d. Global Exchange-Traded Funds (GETFs)
e. All of the above are ways to purchase foreign equities.
ANS: E PTS: 1

33. Which of the following is not a characteristic of a warrant?

a. The right to buy common stock in a corporation.
b. Issued by the corporation or an individual.
c. Typically valid for longer time periods than options.
d. Similar to a call option with respect to a striking price.
e. All of the above statements are characteristics of a warrant.
ANS: B PTS: 1

34. Certificates of ownership issued by a U.S. bank that represent indirect ownership of a certain number
of shares of a specific foreign firm on deposit in a bank in the firm's home country are known as:
a. American Depository Receipts (ADRs)
b. Exchange Traded Funds (ETFs)
c. Warrants
d. Options
e. Futures
ANS: A PTS: 1

35. All of the following are ways to invest in real estate except
a. Real Estate Investment Trusts (REITs)
b. Raw Land
c. Land Development
d. Rental Properties
e. All of the above are ways to invest in real estate.
ANS: E PTS: 1

36. Which of the following statements regarding real estate investments is false?
a. The large number of transactions and national data sources provide accurate readily
available estimates of historical returns.
b. Real Estate Investment Trusts (REITs) had higher returns than common stocks from 1972
to 1987.
c. Real Estate Investment Trusts (REITs) had lower volatility than common stocks from 1972
to 1987.
d. All of the above statements are true.
e. All of the above statements are false.
ANS: A PTS: 1

37. A bond provision that specifies payments the issuer must make to redeem a given percentage of the
outstanding issue prior to maturity is known as
a. Call provision
b. Indenture
c. Collateralization
d. Sinking fund
e. Collateral trust bond
ANS: D PTS: 1
 NARRBEGIN: Exhibit 03-01
Exhibit 3-1

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)

Security Annual Percentage Return

U.S. government T-bills 3.04
Long-term government bonds 5.75
Long-term corporate bonds 6.80
Large capitalization common stocks 13.50
Small capitalization common stocks 15.60

The annual rate of inflation is 2%.

NARREND

38. Refer to Exhibit 3-1. What is the real return on long-term corporate bonds?
a. 1.02%
b. 3.68%
c. 4.71%
d. 11.27%
e. 13.33%
ANS: C
Real return on long term corporate bonds = 4.71% = [(1.068)/(1.02)] - 1

PTS: 1 OBJ: Multiple Choice Problems NAR: Exhibit 03-01

39. Refer to Exhibit 3-1. What is the real return on T-bills?

a. 1.02%
b. 3.68%
c. 4.71%
d. 11.27%
e. 13.33%
ANS: A
Real return on T-bills = 1.02% = [(1.034)/(1.02)] - 1

PTS: 1 OBJ: Multiple Choice Problems NAR: Exhibit 03-01

40. Refer to Exhibit 3-1. What is the real return on small capitalization stocks?
a. 1.02%
b. 3.68%
c. 4.71%
d. 11.27%
e. 13.33%
ANS: E
Real return on small cap stocks = 13.33% = [(1.156)/(1.02)] - 1

PTS: 1 OBJ: Multiple Choice Problems NAR: Exhibit 03-01

41. Refer to Exhibit 3-1. What is the real return on large capitalization stocks?
a. 1.02%
 b. 3.68%
c. 4.71%
d. 11.27%
e. 13.33%
ANS: D
Real return on large cap stocks = 11.27% = [(1.135)/(1.02)] - 1

PTS: 1 OBJ: Multiple Choice Problems NAR: Exhibit 03-01

NARRBEGIN: Exhibit 03-02

Exhibit 3-2

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)

Real Returns
INVESTMENT REAL ANNUAL RETURN
Large company stock 6.50%
Small capitalization stock 8.60%
Long-term corporate bonds 3.60%
Long-term government bonds 2.80%
U.S. Treasury bills 1.03%

The annual rate of inflation is 2.5%

NARREND

42. Refer to Exhibit 3-2. What is the large company stock nominal return?
a. 3.56%
b. 5.37%
c. 6.19%
d. 9.16%
e. 11.32%
ANS: D
Nominal return on large cap stocks = 9.16% = [(1.065)(1.025)] - 1

PTS: 1 OBJ: Multiple Choice Problems NAR: Exhibit 03-02

43. Refer to Exhibit 3-2. What is the T-bill nominal return?

a. 3.56%
b. 5.37%
c. 6.19%
d. 9.16%
e. 11.32%
ANS: A
Nominal return on T-bills = 3.56% = [(1.0103)(1.025)] - 1

PTS: 1 OBJ: Multiple Choice Problems NAR: Exhibit 03-02

44. Refer to Exhibit 3-2. What is the long term Treasury bond nominal return?
a. 3.56%
b. 5.37%
c. 6.19%
 d. 9.16%
e. 11.32%
ANS: B
Nominal return on long term government bonds = 5.37% = [(1.028)(1.025)] - 1

PTS: 1 OBJ: Multiple Choice Problems NAR: Exhibit 03-02

45. Refer to Exhibit 3-2. What is the small capitalization stock nominal return?
a. 3.56%
b. 5.37%
c. 6.19%
d. 9.16%
e. 11.32%
ANS: E
Nominal return on small cap stocks = 11.32% = [(1.086)(1.025)] - 1

PTS: 1 OBJ: Multiple Choice Problems NAR: Exhibit 03-02

46. A return series has an arithmetic mean of 12.8% and standard deviation of 7.8%. Assuming the returns
are normally distributed, what is the range of returns that an investor would expect to receive 90% of
the time?
a. 12.8% to 20.6%
b. -10.6% to 36.2%
c. -2.8% to 28.4%
d. -12.8% to 20.6%
e. 10.6% to 36.2%
ANS: C
The range of returns is between 12.8 - 2(7.8) and 12.8 + 2(7.8) = -2.8 and 28.4

PTS: 1 OBJ: Multiple Choice Problems

47. A return series has an arithmetic mean of 12.8% and standard deviation of 7.8%. Assuming the returns
are normally distributed, what is the range of returns that an investor would expect to receive 95% of
the time?
a. 12.8% to 20.6%
b. -10.6% to 36.2%
c. -2.8% to 28.4%
d. -12.8% to 20.6%
e. 10.6% to 36.2%
ANS: B
The range of returns is between 12.8 - 3(7.8) and 12.8 + 3(7.8) = -10.6 and 36.2

PTS: 1 OBJ: Multiple Choice Problems

48. A return series has an arithmetic mean of 10.5% and standard deviation of 13%. Assuming the returns
are normally distributed, what is the range of returns that an investor would expect to receive 95% of
the time?
a. 10.5% to 13%
b. -2.5% to 23.5%
c. -28.5% to 49.5%
 d. -15.5% to 36.5%
e. 0% to 36.5%
ANS: C
The range of returns is between 10.5 - 3(13) and 10.5 + 3(13) = -28.5 and 49.5

PTS: 1 OBJ: Multiple Choice Problems

49. A return series has an arithmetic mean of 10.5% and standard deviation of 13%. Assuming the returns
are normally distributed, what is the range of returns that an investor would expect to receive 90% of
the time?
a. 10.5% to 13%
b. -2.5% to 23.5%
c. -28.5 to 49.5%
d. -15.5% to 36.5%
e. 0% to 10.5%
ANS: D
The range of returns is between 10.5 - 2(13) and 10.5 + 2(13) = -15.5 and 36.5.

PTS: 1 OBJ: Multiple Choice Problems

50. You are trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year
and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors
are the same and you are in the 28% tax bracket, which bond should you choose and why?
a. Corporate bond because the after tax yield is 6.25%.
b. Corporate bond because the after tax yield is 4.5%.
c. Municipal bond because the equivalent taxable yield is 6.3%.
d. Municipal bond because the equivalent taxable yield is 6.6%.
e. You will be indifferent between the two because the after tax yields are the same.
ANS: D
The municipal bond has an equivalent taxable yield of 0.475/(1 - 0.28) = 0.066. This is higher than the
bond yield of .0625.

PTS: 1 OBJ: Multiple Choice Problems

51. What range of returns would an investor expect to achieve 99% of the time on an investment with an
expected return of 11% and a standard deviation of 16%?
a. 5% to 27%
b. -5% to 27%
c. -21% to 43%
d. -37% to 59%
e. 5% to 21%
ANS: D
Assuming the returns are normally distributed, a 99% confidence interval is constructed by 11% plus
or minus three times the standard deviation.

11% - 3(16%) to 11% + 3(16%) = -37% to 59%

PTS: 1 OBJ: Multiple Choice Problems

52. If the nominal return on an investment of common stocks was 11% and inflation was 2.5% annually,
what was the real return on common stock?
a. 8.3%
b. 8.5%
c. 9.7%
d. 11.0%
e. 12.6%
ANS: A
(1.11)/(1.025) - 1 = 0.0829 or 8.3%

PTS: 1 OBJ: Multiple Choice Problems

53. If the real return for corporate bonds was 4% and the inflation rate was 2%, what is the nominal return
for corporate bonds?
a. 1.96%
b. 2.00%
c. 4.00%
d. 6.08%
e. 6.42%
ANS: D
(1.04)(1.02) - 1 = 0.068 or 6.08%

PTS: 1 OBJ: Multiple Choice Problems