1

Chapter One: The Investment Setting

1. Which of the following best describes the essence of an investment?

A. Using funds for immediate consumption
B. Postponing current consumption for potential future benefits
C. Spending all current income to avoid future uncertainty
D. Accumulating debt for immediate needs
Answer: B
2. The Holding Period Yield (HPY) is calculated by:
A. Subtracting 1 from the Holding Period Return (HPR)
B. Dividing the ending investment value by the beginning value
C. Multiplying the rate of return by the number of years
D. Adding dividends received to the HPR
Answer: A
3. In a portfolio, the mean historical rate of return is calculated as:
A. The sum of all returns divided by the number of investments
B. The weighted average of individual investment returns based on their market
values
C. The overall percentage change in the portfolio’s total value only
D. The return of the largest investment in the portfolio
Answer: B
4. Which of the following measures is used to quantify the uncertainty (risk)
associated with an investment’s expected return?
A. Nominal interest rate
B. Standard deviation
C. Capital gains tax rate
D. Dividend yield
Answer: B
5. What component reflects the compensation for postponing consumption in an
investment’s required rate of return?
A. Real risk-free rate (RRFR)
B. Risk premium
C. Expected inflation rate
D. Dividend yield
Answer: A
6. Which of the following is considered an unsystematic risk?
A. Market risk
B. Inflation risk
C. Business risk
D. Interest rate risk
Answer: C
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7. Systematic risk affects:

A. Individual companies only
B. The entire market or a large segment of it
C. Only high-risk investments
D. Fixed-income securities exclusively
Answer: B
8. A key measure of systematic risk that assesses a security’s risk relative to the
overall market is:
A. Alpha
B. Beta
C. Standard deviation
D. Sharpe ratio
Answer: B
9. According to the Capital Market Theory, the optimal portfolio is one that:
A. Minimizes risk regardless of return
B. Maximizes expected return for a given level of risk
C. Avoids investments in emerging markets
D. Consists only of risk-free securities
Answer: B
10. Which theory explains the relationship between the expected return of an
asset and its systematic risk?
A. Arbitrage Pricing Theory
B. Modern Portfolio Theory
C. Capital Asset Pricing Model (CAPM)
D. Dividend Discount Model
Answer: C
11. In the Security Market Line (SML), an upward shift indicates:
A. An increase in the risk-free rate
B. A decrease in the market risk premium
C. A decrease in overall risk levels
D. A decrease in investor risk aversion
Answer: A
12. The risk premium component of the required rate of return compensates
investors for:
A. Delaying consumption
B. Uncertainty about inflation rates
C. The possibility of default or other risks
D. Administrative costs associated with investments
Answer: C
 3

13. The Real Rate of Return (RRFR) reflects:

A. A return adjusted for inflation and risk factors
B. The risk-free return in an economy without inflation
C. The return after taxes are deducted
D. The nominal interest rate minus the risk premium
Answer: B
14. Which of the following describes the function of diversification in portfolio
management?
A. Increasing the expected return while maintaining a high level of risk
B. Eliminating all risks associated with investments
C. Reducing unsystematic risk by spreading investments across different assets
D. Ensuring only systematic risks affect the portfolio
Answer: C
15. The main difference between arithmetic and geometric mean returns is that:
A. The arithmetic mean accounts for compounding effects
B. The geometric mean considers the effect of volatility over time
C. The geometric mean is always higher than the arithmetic mean
D. Both measures yield the same results when used over short periods
Answer: B
16. If the nominal risk-free rate increases due to higher inflation expectations,
what impact does it have on the required rate of return?
A. It increases
B. It decreases
C. It remains the same
D. It becomes negative
Answer: A
17. What is the primary purpose of calculating a portfolio's beta?
A. To determine its overall return potential
B. To assess the portfolio’s volatility relative to the market
C. To calculate the total risk of each individual asset
D. To measure the unsystematic risk present in the portfolio
Answer: B
18. Which of the following is a limitation of the CAPM model?
A. It assumes risk-free investments do not exist
B. It is unable to explain the expected return for diversified portfolios
C. It relies on historical data, which may not predict future returns
D. It doesn’t account for systematic risks
Answer: C
 4

19. A portfolio consisting only of the market portfolio and a risk-free asset will lie
on which line?
A. The Capital Market Line (CML)
B. The Security Market Line (SML)
C. The Efficient Frontier
D. The Yield Curve
Answer: A
20. A high standard deviation in a portfolio typically indicates:
A. Lower overall risk
B. Greater predictability of returns
C. Higher volatility and risk
D. Consistency in performance
Answer: C
21. When a security lies above the SML, it is considered:
A. Overpriced
B. Underpriced
C. At equilibrium
D. Fairly valued
Answer: B
22. In a well-diversified portfolio, which type of risk remains?
A. Unsystematic risk
B. Diversifiable risk
C. Systematic risk
D. Company-specific risk
Answer: C
23. Markowitz’s Modern Portfolio Theory primarily focuses on:
A. Single asset analysis
B. Diversification to minimize risk
C. Timing the market accurately
D. Choosing high-risk investments for maximum return
Answer: B
24. What is the purpose of the efficient frontier in portfolio management?
A. To display the highest level of risk for each return
B. To identify the optimal portfolio mix that offers the highest return for a given risk
C. To indicate the minimum possible return of a portfolio
D. To show only the returns of individual assets
Answer: B
25. The Treynor Ratio measures:
A. Return relative to standard deviation
B. Return relative to risk-free investments
C. Return relative to systematic risk
D. Absolute return on investment
Answer: C
 5

26. If a portfolio’s Sharpe Ratio is lower than the market's, this implies:
A. The portfolio is underperforming relative to its risk
B. The portfolio has a lower beta than the market
C. The portfolio is outperforming relative to its risk
D. The portfolio has minimal unsystematic risk
Answer: A
27. Which of the following statements is true regarding risk aversion?
A. Risk-averse investors prefer high-risk, high-return investments
B. Risk-averse investors seek to minimize risk and prefer safer investments
C. Risk-averse investors are indifferent to risk levels
D. Risk-averse investors focus only on systematic risk
Answer: B
28. The nominal risk-free rate (NRFR) includes:
A. The real risk-free rate and the inflation premium
B. The risk premium only
C. The expected return of the market
D. The rate of return on corporate bonds
Answer: A
29. Which of the following assets is most likely to have a beta of zero?
A. A tech company stock
B. A government bond
C. A small-cap growth stock
D. A high-yield bond fund
Answer: B
30. The Jensen’s Alpha measures:
A. The deviation of a portfolio's return from its benchmark
B. The volatility of an asset compared to the market
C. The relationship between risk and return
D. The return of the risk-free asset
Answer: A
31. The Efficient Market Hypothesis (EMH) suggests that:
A. Stock prices fully reflect all available information
B. Investors can consistently outperform the market by analyzing past price patterns
C. The market can be easily predicted using technical analysis
D. Prices only reflect public, not private, information
Answer: A
32. Which form of market efficiency states that stock prices reflect all publicly
available information, including past prices?
A. Weak form efficiency
B. Semi-strong form efficiency
C. Strong form efficiency
D. Perfect market efficiency
Answer: B
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33. Under the weak form of market efficiency:

A. Investors can predict future prices based on past price patterns
B. Prices reflect all public and private information
C. Historical price data is of no use in predicting future price movements
D. Only inside information is not reflected in stock prices
Answer: C
34. Which of the following is a limitation of technical analysis?
A. It relies heavily on fundamental data and financial ratios
B. It assumes that all past market information is irrelevant
C. It may not work in an efficient market where prices fully reflect all information
D. It only applies to long-term investment strategies
Answer: C
35. According to the CAPM, the market portfolio should contain:
A. Only high-risk assets
B. All available risky assets in the market
C. Government bonds exclusively
D. A mix of high-risk and risk-free assets
Answer: B
36. What does the alpha of a portfolio indicate?
A. Its risk level compared to the market
B. Its outperformance or underperformance compared to a benchmark
C. The average return of the market portfolio
D. The volatility of the portfolio's returns
Answer: B
37. A zero-coupon bond differs from other bonds in that:
A. It pays regular interest payments throughout its life
B. It has no maturity date
C. It is issued at a discount and pays no periodic interest
D. It always has a shorter maturity period
Answer: C
38. The duration of a bond is a measure of:
A. The time it takes for the bond to reach maturity
B. The bond’s sensitivity to interest rate changes
C. The frequency of coupon payments
D. The creditworthiness of the issuer
Answer: B
39. In portfolio management, diversification reduces:
A. Systematic risk
B. Market risk
C. Unsystematic risk
D. Beta
Answer: C
 7

40. Which investment strategy focuses on the long-term ownership of assets to

capitalize on potential appreciation over time?
A. Market timing
B. Day trading
C. Buy-and-hold strategy
D. Swing trading
Answer: C
41. The primary goal of a hedge fund is to:
A. Offer maximum liquidity and transparency
B. Invest solely in government bonds
C. Achieve high returns through speculative investments
D. Minimize risk regardless of market conditions
Answer: C
42. The primary distinction between a growth stock and a value stock is:
A. Growth stocks offer high dividends, while value stocks do not
B. Growth stocks are expected to grow rapidly, while value stocks are perceived as
undervalued
C. Growth stocks are always risk-free investments
D. Value stocks belong only to large-cap companies
Answer: B
43. An investor who uses the fundamental analysis approach primarily focuses
on:
A. Historical price patterns and charts
B. The company’s financial statements and economic factors
C. Behavioral patterns and market psychology
D. Technical indicators and trading volume
Answer: B
44. The price-to-earnings (P/E) ratio is a key indicator used to:
A. Measure a stock’s dividend yield
B. Evaluate a stock’s price relative to its earnings
C. Assess the risk level of a bond
D. Predict future market performance
Answer: B
45. When calculating the Net Present Value (NPV) of an investment, which of the
following is typically subtracted from the present value of future cash flows?
A. Future revenues
B. Initial investment cost
C. Interest earned over time
D. Total market value of the asset
Answer: B
 8

46. An advantage of the Internal Rate of Return (IRR) method is:

A. It does not consider the time value of money
B. It provides a percentage rate of return, making it easy to compare different
investments
C. It guarantees accurate predictions of future cash flows
D. It is only applicable to short-term investments
Answer: B
47. A company’s capital structure refers to:
A. The mix of debt and equity used to finance its operations
B. The company’s dividend policy
C. Its cash flow management strategy
D. The proportion of fixed to variable costs
Answer: A
48. Which of the following is an example of a defensive stock?
A. A technology company stock
B. A utility company stock
C. A startup company stock
D. A luxury car manufacturer’s stock
Answer: B
49. A stock’s dividend yield is calculated as:
A. The annual dividend per share divided by the stock’s current price
B. The total dividends paid divided by the company’s total assets
C. The stock’s price-to-earnings ratio divided by earnings per share
D. The stock’s market cap divided by its book value
Answer: A
50. A company is considered highly leveraged if:
A. It has a large amount of cash reserves
B. It relies heavily on debt to finance its operations
C. It issues a large number of shares annually
D. It focuses on reinvesting profits rather than paying dividends
Answer: B
51. The concept of "beta" in investing measures:
A. The overall return of the market
B. The risk-free rate of an asset
C. An asset's volatility relative to the market
D. The number of shares available for trade
Answer: C
52. Which of the following is considered a "growth" investment strategy?
A. Focusing on high-dividend-yield stocks
B. Targeting companies with above-average earnings growth potential
C. Investing in mature companies with stable revenues
D. Prioritizing investments in government bonds
Answer: B
 9

53. A bond's coupon rate is defined as:

A. The interest rate paid relative to the bond's face value
B. The market price of the bond
C. The percentage increase in bond value over time
D. The frequency of interest payments made to bondholders
Answer: A
54. Convertible bonds allow the bondholder to:
A. Convert the bond into a fixed-interest loan
B. Exchange the bond for shares of the issuing company
C. Extend the maturity period of the bond
D. Exchange the bond for another company’s bond
Answer: B
55. Which of the following is a characteristic of an exchange-traded fund (ETF)?
A. They are only available to institutional investors
B. They can be traded on stock exchanges like individual stocks
C. They are always actively managed
D. They require a minimum investment of $100,000
Answer: B
56. The "yield curve" shows the relationship between:
A. Interest rates and bond maturities
B. Stock prices and market volumes
C. Dividend yields and stock prices
D. The inflation rate and GDP growth
Answer: A
57. What is the primary objective of value investing?
A. Finding stocks with high growth potential
B. Identifying undervalued stocks that are expected to appreciate
C. Investing exclusively in high-risk startups
D. Maximizing dividend income regardless of stock price
Answer: B
58. A callable bond allows the issuer to:
A. Convert the bond to equity
B. Repay the bond before its maturity date
C. Extend the maturity date
D. Transfer the bond to another entity
Answer: B
59. When a stock splits, its primary effect is to:
A. Increase the company’s market value
B. Reduce the stock’s price and increase the number of shares
C. Convert the stock into bonds
D. Pay a dividend to shareholders
Answer: B
 10

60. The Price-to-Book (P/B) ratio measures:

A. A stock’s price relative to its earnings
B. A company’s market value compared to its book value
C. The annual dividend yield of a stock
D. The average trading volume of the stock
Answer: B
 11

Chapter Two: Portfolio Theory

1. What is the primary objective of portfolio theory?

A. To maximize returns regardless of risk
B. To minimize risk while maximizing returns
C. To invest in the highest-yielding assets
D. To achieve zero risk in investments
Answer: B
2. According to Markowitz's Portfolio Theory, risk is reduced through:
A. Investing in only one type of asset
B. Holding a diversified portfolio of assets
C. Focusing solely on government bonds
D. Investing only in stocks
Answer: B
3. The measure used to assess risk in Portfolio Theory is typically:
A. Beta
B. Alpha
C. Standard deviation
D. Dividend yield
Answer: C
4. A portfolio is considered efficient if:
A. It offers the highest return regardless of risk
B. It maximizes return for a given level of risk
C. It has the lowest possible return
D. It minimizes return and risk
Answer: B
5. An investor’s risk preference plays a role in:
A. Determining which assets to include in the risk-free portfolio
B. Choosing between portfolios on the efficient frontier
C. Deciding the interest rate for bonds
D. The beta coefficient calculation
Answer: B
6. The efficient frontier is defined as:
A. The set of portfolios that provide the highest return for a given level of risk
B. The set of portfolios that minimizes risk for a given level of return
C. A straight line representing risk-free assets
D. The risk associated with individual stocks
Answer: A
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7. What does the Capital Asset Pricing Model (CAPM) help investors determine?
A. The expected return on an asset based on its risk
B. The best time to sell a security
C. The amount to invest in a single asset
D. The minimum return required for all investments
Answer: A
8. The concept of diversification in portfolio theory refers to:
A. Investing all funds into a single asset
B. Spreading investments across different asset classes to reduce risk
C. Concentrating investments in high-risk securities
D. Eliminating all forms of risk from a portfolio
Answer: B
9. Which of the following represents systematic risk?
A. Risks associated with individual companies
B. Risks that can be eliminated through diversification
C. Market-wide risks affecting all securities
D. Risks that arise from company-specific events
Answer: C
10. In portfolio management, the term "correlation" refers to:
A. The degree to which two assets move in relation to one another
B. The total risk of a portfolio
C. The expected return of a portfolio
D. The diversification benefits of a portfolio
Answer: A
11. A risk-averse investor is likely to:
A. Invest only in stocks
B. Seek higher returns with higher risks
C. Choose a portfolio that minimizes risk, even if it means lower returns
D. Avoid any form of investment
Answer: C
12. Which of the following factors is least likely to affect portfolio
diversification?
A. The number of assets in the portfolio
B. The correlation between asset returns
C. The expected returns of individual assets
D. The risk-free rate of return
Answer: D
13. The term "alpha" in portfolio management refers to:
A. The total return of a portfolio
B. The excess return of an investment relative to the return predicted by CAPM
C. The systematic risk of a portfolio
D. The diversification ratio of a portfolio
Answer: B
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14. A portfolio composed solely of U.S. government bonds is considered:

A. High risk
B. Low risk
C. A market portfolio
D. An efficient frontier portfolio
Answer: B
15. The security market line (SML) represents:
A. The risk-return trade-off for all assets
B. The relationship between systematic risk and expected return
C. The maximum return achievable at zero risk
D. The minimum risk for a given return
Answer: B
16. The concept of “risk premium” is defined as:
A. The return on risk-free investments
B. The additional return expected from a risky asset compared to a risk-free asset
C. The average return of all assets
D. The minimum return acceptable for any investment
Answer: B
17. Which type of risk can be minimized through diversification?
A. Systematic risk
B. Unsystematic risk
C. Market risk
D. Interest rate risk
Answer: B
18. In which scenario would you expect a higher required return?
A. A low-risk bond
B. A high-risk stock
C. A diversified portfolio
D. A government treasury bill
Answer: B
19. Which of the following is a key assumption of Modern Portfolio Theory?
A. All investors have the same risk tolerance
B. All investors have access to the same information
C. Markets are inefficient
D. Investors make decisions based solely on expected returns
Answer: B
20. A market portfolio is defined as:
A. A collection of all available assets in the market
B. A diversified portfolio of only stocks
C. A portfolio containing only bonds
D. A single asset that carries no risk
Answer: A
 14

21. When considering the trade-off between risk and return, an investor should:
A. Only focus on high returns
B. Consider personal risk tolerance
C. Invest only in government securities
D. Avoid all forms of risk
Answer: B
22. The risk-return relationship in portfolio theory suggests that:
A. Higher risk does not guarantee higher returns
B. There is no relationship between risk and return
C. Lower risk always results in higher returns
D. Higher risk typically correlates with higher expected returns
Answer: D
23. Which portfolio construction method focuses on optimizing expected returns
for a given risk level?
A. Bottom-up approach
B. Top-down approach
C. Mean-variance optimization
D. Single-index model
Answer: C
24. Which of the following is NOT a characteristic of an efficient portfolio?
A. It has the maximum return for a given level of risk
B. It is fully diversified
C. It is comprised solely of low-risk assets
D. It has the lowest risk for a given level of return
Answer: C
25. In the context of portfolio management, the term "beta" is used to measure:
A. The systematic risk of an asset relative to the market
B. The total return of a portfolio
C. The correlation between two assets
D. The average return of all assets
Answer: A
26. The principle of “rebalancing” in portfolio management refers to:
A. Adjusting the portfolio's risk level by changing asset allocation
B. Selling all assets and starting over
C. Holding assets indefinitely without change
D. Doubling the investment in underperforming assets
Answer: A
27. An investor seeking to reduce portfolio risk would likely:
A. Concentrate investments in one asset class
B. Diversify investments across multiple asset classes
C. Invest only in high-risk assets
D. Invest in foreign stocks only
Answer: B
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28. What does the term "drawdown" refer to in portfolio management?

A. The total gain of a portfolio
B. The peak value of a portfolio
C. The decline from a portfolio's peak value to its lowest point
D. The total investment made into a portfolio
Answer: C
29. Which of the following strategies is most aligned with Modern Portfolio
Theory?
A. Investing only in real estate
B. Concentrating investments in high-yield bonds
C. Diversifying investments across asset classes to optimize risk
D. Following trends in the stock market without a plan
Answer: C
30. In portfolio optimization, the term "efficient set" refers to:
A. The set of portfolios that offers the highest returns for every level of risk
B. The set of all possible portfolios
C. The set of portfolios with the lowest risk
D. The set of portfolios that yields the minimum return
Answer: A
31. The concept of "utility" in portfolio theory is used to:
A. Measure total market returns
B. Assess investor satisfaction based on risk and return
C. Calculate dividends from stocks
D. Evaluate the liquidity of assets
Answer: B
32. The minimum variance portfolio is defined as:
A. The portfolio with the highest return
B. The portfolio that minimizes risk for a given return
C. The most diversified portfolio available
D. The portfolio with zero risk
Answer: B
33. What is a common measure used to evaluate the performance of a portfolio
relative to its risk?
A. Sharpe Ratio
B. Price to Earnings Ratio
C. Yield to Maturity
D. Current Ratio
Answer: A
 16

34. Which investment strategy focuses on a long-term investment horizon with a

focus on growth?
A. Day trading
B. Buy and hold
C. Value investing
D. Market timing
Answer: B
35. What is the primary risk associated with investing in equities?
A. Inflation risk
B. Market risk
C. Credit risk
D. Currency risk
Answer: B
36. Which of the following best describes a “value stock”?
A. A stock that is expected to grow faster than the market
B. A stock that is undervalued relative to its fundamentals
C. A stock that consistently pays high dividends
D. A stock that has a high beta
Answer: B
37. A portfolio manager’s main goal is to:
A. Minimize returns while maximizing risk
B. Achieve the highest returns with the lowest risk
C. Avoid all forms of investment risk
D. Invest exclusively in government securities
Answer: B
38. The "risk-return trade-off" concept suggests that:
A. Investors can achieve high returns without assuming risk
B. Higher potential returns are associated with higher risk
C. Low-risk investments always yield low returns
D. Risk and return are unrelated
Answer: B
39. Which financial instrument is typically considered the safest investment?
A. Corporate bonds
B. Municipal bonds
C. Treasury bills
D. High-yield stocks
Answer: C
 17

40. Which investment strategy involves selecting stocks based on their potential
for rapid price appreciation?
A. Value investing
B. Growth investing
C. Income investing
D. Defensive investing
Answer: B
41. What does it mean for a portfolio to be “overweighted” in a specific asset
class?
A. It has too little investment in that class
B. It has a higher proportion of investments in that class compared to the benchmark
C. It is diversified across all asset classes
D. It has no exposure to that class
Answer: B
42. The term "liquidity" in investment refers to:
A. The amount of return generated by an investment
B. The ease with which an investment can be converted to cash
C. The risk associated with a specific investment
D. The market demand for a particular stock
Answer: B
43. Which of the following best defines “systematic risk”?
A. Risk that can be eliminated through diversification
B. Risk associated with the overall market movements
C. Risk specific to a company or industry
D. Risk that is unrelated to economic factors
Answer: B
44. What is the role of an investment analyst?
A. To sell investment products
B. To advise clients on real estate purchases
C. To evaluate securities and market trends for investment decisions
D. To determine the interest rates for loans
Answer: C
45. Which investment vehicle is often associated with a high degree of risk?
A. Savings accounts
B. Government bonds
C. High-yield corporate bonds
D. Money market funds
Answer: C
 18

46. What is the primary purpose of a hedge fund?

A. To invest only in government securities
B. To achieve absolute returns regardless of market conditions
C. To provide guaranteed returns to investors
D. To focus solely on low-risk investments
Answer: B
47. Which investment strategy involves purchasing stocks with strong
fundamentals at a low price?
A. Momentum investing
B. Value investing
C. Growth investing
D. Index investing
Answer: B
48. What does the term "market capitalization" refer to?
A. The total debt of a company
B. The market value of a company’s outstanding shares
C. The total assets of a company
D. The number of shares a company has issued
Answer: B
49. Which ratio is commonly used to assess a company's profitability?
A. Price to Earnings (P/E) ratio
B. Current ratio
C. Debt to Equity ratio
D. Quick ratio
Answer: A
50. Which type of risk is associated with individual investment decisions?
A. Systematic risk
B. Unsystematic risk
C. Market risk
D. Liquidity risk
Answer: B
51. Which financial instrument typically offers the highest potential return?
A. Treasury bills
B. High-yield stocks
C. Corporate bonds
D. Municipal bonds
Answer: B
52. What is the primary focus of behavioral finance?
A. The analysis of stock prices
B. The psychology behind investor behavior and market movements
C. The technical analysis of financial markets
D. The legal regulations governing financial transactions
Answer: B
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53. In portfolio management, diversification helps to:

A. Increase the total risk of the portfolio
B. Achieve guaranteed returns
C. Reduce the impact of individual asset performance on the overall portfolio
D. Focus investments in a single asset class
Answer: C
54. The term "emerging markets" refers to:
A. Economically developed countries
B. Economies that are growing rapidly and becoming more integrated into the global
market
C. Markets that are declining in value
D. Markets with stable economic conditions
Answer: B
55. Which of the following is a characteristic of a bear market?
A. Prices are rising
B. Investors are optimistic
C. Prices are falling
D. Economic growth is robust
Answer: C
56. The financial metric used to compare the relative value of a company's shares
is known as:
A. Dividend yield
B. Price to Earnings (P/E) ratio
C. Return on Equity (ROE)
D. Market capitalization
Answer: B
57. Which of the following is an example of a fixed-income investment?
A. Stocks
B. Real estate
C. Bonds
D. Commodities
Answer: C
58. The primary purpose of financial markets is to:
A. Facilitate the buying and selling of consumer goods
B. Provide a platform for companies to issue stocks and bonds
C. Regulate interest rates
D. Set economic policy
Answer: B
59. Which investment approach focuses on using historical price data to predict
future price movements?
A. Fundamental analysis
B. Technical analysis
C. Behavioral analysis
 20

D. Market analysis
Answer: B
60. A financial planner typically focuses on:
A. Short-term trading strategies
B. Long-term financial goals and investment planning
C. Real estate purchases only
D. Corporate finance issues
Answer: B
 21

Chapter Three: The Capital Market Line and the Efficient Frontier

1. The Capital Market Line (CML) represents:

A. The risk-free rate of return
B. The set of efficient portfolios combined with the risk-free asset
C. The total risk of a single asset
D. The average returns of individual stocks
Answer: B
2. In the context of the CML, the risk of a portfolio is measured by:
A. Systematic risk
B. Unsystematic risk
C. Standard deviation
D. Covariance
Answer: C
3. Which of the following lies on the Capital Market Line?
A. Individual risky assets
B. Market portfolio and risk-free asset combinations
C. Non-diversified portfolios
D. Only the risk-free asset
Answer: B
4. What happens to the CML when the risk-free rate increases?
A. It shifts downward
B. It becomes steeper
C. It shifts horizontally
D. It remains unchanged
Answer: B
5. The point where the CML touches the efficient frontier is called:
A. The risk-free point
B. The market portfolio
C. The arbitrage point
D. The zero-beta portfolio
Answer: B
6. The expected return of a portfolio can be calculated using which formula?
A. Weighted average of the returns of individual assets
B. Risk-free rate plus the market return
C. The sum of all asset prices
D. Standard deviation divided by beta
Answer: A
 22

7. The slope of the Capital Market Line represents:

A. The market risk premium
B. The total return of a portfolio
C. The risk-free rate
D. The beta of the market portfolio
Answer: A
8. A portfolio that is on the CML is considered to be:
A. Inefficient
B. Efficient
C. Risk-free
D. Over-leveraged
Answer: B
9. The risk-return trade-off implies that:
A. Higher returns are not associated with higher risk
B. Higher risk is associated with the potential for higher returns
C. There is no correlation between risk and return
D. Low-risk investments yield the highest returns
Answer: B
10. Which of the following portfolios is considered the market portfolio?
A. A portfolio that contains all risky assets in the market
B. A portfolio that invests solely in government bonds
C. A portfolio that is diversified across only one asset class
D. A portfolio with no risk
Answer: A
11. The Capital Market Line assumes that investors are:
A. Only concerned with maximizing return
B. Risk-averse and rational
C. Always able to borrow and lend at the risk-free rate
D. All of the above
Answer: D
12. The concept of efficient frontier is associated with which of the following?
A. The maximum return for any level of risk
B. The minimum risk for any level of return
C. Both A and B
D. Neither A nor B
Answer: C
13. A portfolio that lies below the CML is considered:
A. Efficient
B. Inefficient
C. Risk-free
D. Overvalued
Answer: B
 23

14. An investor can achieve a higher return by:

A. Reducing the number of assets in their portfolio
B. Increasing their exposure to riskier assets
C. Investing only in government securities
D. Avoiding all forms of equity
Answer: B
15. The market portfolio contains:
A. All available risky assets in the market
B. Only stocks with high returns
C. Bonds and cash equivalents
D. Only assets with low volatility
Answer: A
16. A portfolio with a high beta indicates:
A. Higher systematic risk compared to the market
B. Lower risk than the market
C. No correlation with the market
D. High unsystematic risk
Answer: A
17. Which of the following statements is TRUE regarding the Capital Market
Line?
A. It represents the relationship between risk and return for inefficient portfolios.
B. It is derived from the risk-return characteristics of the risk-free asset only.
C. It provides a benchmark for evaluating portfolio performance.
D. It only includes high-risk investments.
Answer: C
18. The risk-free rate is typically associated with:
A. Stock investments
B. Treasury bonds
C. High-yield bonds
D. Real estate
Answer: B
19. Which of the following is NOT a characteristic of the market portfolio?
A. It contains all risky assets.
B. It has the highest Sharpe ratio among all portfolios.
C. It is the only portfolio that offers the highest possible return.
D. It is the tangency point of the CML.
Answer: C
20. What does a higher Sharpe ratio indicate?
A. Lower return per unit of risk
B. Higher return per unit of risk
C. Inefficient portfolio
D. No risk associated with the portfolio
Answer: B
 24

21. Which of the following is a limitation of the Capital Market Line?

A. It assumes that all investors have the same risk tolerance.
B. It does not account for taxes.
C. It assumes that returns are normally distributed.
D. All of the above.
Answer: D
22. If an investor has a portfolio with a beta of 1.5, this indicates that:
A. The portfolio is less volatile than the market.
B. The portfolio is more volatile than the market.
C. The portfolio is not influenced by market movements.
D. The portfolio will always generate higher returns than the market.
Answer: B
23. Which investment strategy is least likely to generate alpha?
A. Market timing
B. Passive investing
C. Value investing
D. Growth investing
Answer: B
24. If the CML is steeper, it indicates:
A. A higher risk-free rate
B. A lower risk-free rate
C. A lower market risk premium
D. A higher market risk premium
Answer: D
25. The main reason for a portfolio to lie below the CML is:
A. The portfolio is composed of only risk-free assets.
B. The portfolio is poorly diversified.
C. The portfolio has no risk.
D. The portfolio is composed of all high-risk assets.
Answer: B
26. Which of the following is the primary goal of the Capital Asset Pricing Model
(CAPM)?
A. To determine the expected return of an investment based on its risk
B. To calculate the total risk of a portfolio
C. To evaluate individual stock performance
D. To predict market movements
Answer: A
27. An efficient portfolio on the frontier can be expected to:
A. Have the lowest risk among all portfolios
B. Maximize return for a given level of risk
C. Yield no returns
D. Include only low-risk assets
Answer: B