Securities and Investments

| November 13, 2015

Part A: Essays. Answer only TWO of the three questions in one or two well-composed
paragraphs. If you answer all three, we will grade only the first two. (15 points each)
1. The chief financial officer of a small corporation wants the firm’s investment portfolio to be
diversified and to achieve growth not less than 12 percent per year by investing in stocks.
She doesn’t believe it’s feasible to seek growth exceeding 14 percent per year in stocks. The
investment policy calls for a long-term perspective. The stock market, including all forms of
stocks, is expected to return 10 percent in the long term.
Current allocation
Asset Class
Growth Stocks
Foreign Stocks
Income Stocks
Beta
1.2
1.4
.75
Allocation
40 percent
20 percent
40 percent
What changes should you recommend to the current allocation of stocks? Limit your
answer to the three listed asset classifications, and be sure each class is represented by
at least 10 percent of the recommended portfolio. Make the allocations of growth and foreign
stocks as close to the same as possible, and have all allocations in multiples of 10
percent. Include in your answer the return you expect of your recommended portfolio and
how you arrived at the conclusion.
(Continued on reverse side)
PE1634(0908)
Proctored Final Examination (Alternate)
2. An investment advisor you’ve considered hiring claims his recommendations have beaten
the market in each of the past 12 years. Give three possible explanations for his claim.
3. How should you explain to a prospective investor the benefits, risks, and alternatives
available among government securities?
Part B: Short Answer. Answer each of the following questions in one or two sentences.
(6 points each)
1. What is the relationship between risk and return, and what is the theoretical basis for the
relationship?
2. Suppose you’ve started planning your retirement, and you want to live in retirement only
on your investment earnings. During retirement, you want to earn $40,000 per year before
taxes, and you figure your investments during retirement will earn 6 percent per year.
You can save $20,000 for the next 10 years until you retire. While saving, you expect your
portfolio to earn 8 percent per year, compounded annually. How much money must you
save in order to earn $40,000 during retirement? Explain why you will or won’t be able to
achieve the goal.
3. What is the primary importance of the efficient market hypothesis to the individual
investor?
4. What are the key benefits of international investing?
5. Which of the following bonds trades at a greater discount to its present value? Explain
how you arrived at your answer. Bond Pl.s market value is $1,050, it pays an annual
coupon of $100, and it will mature in three years, paying $1,000. The applicable discount
rate is 7 percent. Bond B’s market value is $1,000, it pays an annual coupon of $70, and it
will mature in two years, paying $1,000. The applicable discount rate is 6 percent.
Part C: Multiple Choice. Circle the letter of the correct answer to each question
or statement. (5 points each)
1. Suppose you’re the chief financial officer for a government agency that intends to sell bonds
to fund a major park development project. This is the biggest single project ever undertaken by
your agency. The present construction project must be timed for completion before the onset of
winter seven months from now, and worst-case scenarios indicate this weather-sensitive operation
can be completed in five months. Your office coordinated planning operations over the
past nine months with other departments and created a budget that has led to approval for the
$200 million project. In your discussions with prospective investment banking firms, the firm
potentially best qualified to underwrite the issue expressed concern over its ability to sell the
entire bond issue. Which of the following tactics should be considered first to achieve the
objective and reduce risk assumed by the parties?
Proctored Final Examination (Alternate)
A. Reevaluate project parameters and seek ways to reduce the project cost, thereby reducing
the size of the bond issue.
B. Time the bond issue when investor demand for bonds is high and the supply of bonds is low.
C. Negotiate with the preferred investment banker for a firm commitment to underwriting.
D. Obtain projections from investment bankers with the assumption that a syndicate is formed.
2. You’re an individual investor on the phone with your broker discussing a potential purchase of 10
round lots of stock (a long position) issued by what you believe is a sound corporation with growth
potential. You express concern that today’s stock price is about $1.50 per share higher than what
you’d like to pay. Which of the following options should the broker suggest to address your concern?
A. Buy the stock on margin because margin provides leverage that offers the potential to gain
more (on a percentage basis) than a cash purchase. The added leverage and potentially
greater gain may compensate for the higher cost.
B. When the stock price begins its decline, place a market order. By timing the purchase in this
manner, the investor can increase the chances of narrowing the premium the market requires
at the current price.
C. Enter a stop order to protect price movement above and away from your target purchase price.
D. Enter a limit order, thereby creating a market order only when the stock price is at or below
the limit price.
3. In recent years, brokerage firm research reporting has been criticized because potential conflicts
of interest may influence buy and sell recommendations. Which of the following steps can an
individual investor take to use published research and limit the impact of misleading research?
A. Treat brokerage firm research as a contra-indicator along with other contra-indicators such
as odd lot volume and the put:call ratio.
B. Balance brokerage firm research with other information sources.
C. Use only the information provided by the more established, visible firms such as MerrillLynch
and Morgan Stanley (to name a few).
D. Include in your own research information on whether the brokerage research operation is
owned by the same firm that provides investment banking services to the clients whose
stock it recommends.
Proctored Final Examination (Alternate)
4. If you were a member of a bank’s funds management committee, one of your tasks might require
selection of bonds for purchase in the bank’s bond portfolio. Suppose the committee has asked
you to select one of two bonds likely to lose less value in the event prevailing interest rates rise.
Both bonds can be purchased at par, they mature on the same date, and third party risk ratings
are identical for both bonds. The bonds are essentially identical in all material respects except for
the coupon payment. Bond A pays a 4.5% semiannual coupon; Bond B pays a 4.0% semiannual
coupon. Why should you select Bond A for the bank’s portfolio?
A. Bond Ns present value is greater because of the higher coupon payment. This greater value
will render a higher yield and, therefore, a superior investment.
B. Bond B’s lower coupon would yield a higher duration, and therefore, greater volatility.
C. Bond Ns present value is less because of the higher coupon payment. This lesser value will
render a lower yield and, therefore, an inferior investment.
D. Bond B’s lower coupon would yield a lower duration and, therefore, less volatility.
5. Which of the following events could offer evidence against the strong form of the efficient
market hypothesis?
A. After comparing 10 years of daily returns on the S&P 500 and a widely held S&P mutual
fund, you discover that S&P 500 consistently outperforms the index mutual fund.
B. XYZ Mutual Fund has outperformed the MSCI EAFEĀ® Index (international, non-U.S.) in all of
the last 15 years in which the Index declined, but it underperformed the Index in all of the
years that the Index rose. The XYZ Mutual Fund strategy is to enter short positions on nonU.S.
stocks.
C. A federal court convicted Bernard Z. to a lengthy jail term for insider trading. Mr. Z had been a
director for six publicly traded corporations, and over the past nine years had traded exclusively
in the stock of the six corporations for which he served on the board. A complete study of his
performance revealed that his average annual yield far surpassed the performance of the S&P
500.
D. A study of money manager performance disclosed that of the 5000 top managers in the
United States, seven outperformed the Dow Jones Industrial Average in at least nine of the
past ten years.
Proctored Final Examination (Alternate)
Part D: Fill-in-the-Blank. Write in the correct answer to each question in the space
provided. (3 points each)
1. An investor seeking to anticipate future economic activity and careful not to incorporate
economic data with historical implications would use ___ economic indicators in her
analysis.
2. The best profitability ratio for assessing a corporation’s management performance is the
___ ratio.
3. A fixed-income investor disinterested in interest income and preferring to buy a bond at a
discount to par should consider purchasing ajan bond.
4. An investor with a long position of 200 shares in ZYX common stock could reduce the risk that
ZYX’s price will drop by purchasing ajan ___ option.
5. Just as a random distribution is best described by both its mean and standard deviation, investment
performance is best described by both return and _

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