Investment Tools and Concepts Flashcards

Which statistical measure describes the degree to which two variables move together, standardized to range between -1 and +1?

Answer: Correlation coefficient

The correlation coefficient standardizes covariance by dividing by the product of the two variables' standard deviations.

Under the Gordon Growth Model, if a stock's required return equals its dividend growth rate, the model implies the stock price is:

Answer: Undefined (infinite)

When required return equals growth rate, the denominator (r - g) equals zero, making the price undefined/infinite.

A bond's yield to maturity (YTM) assumes that all coupon payments are:

Answer: Reinvested at the YTM rate

YTM implicitly assumes all intermediate coupon payments are reinvested at a rate equal to the YTM itself.

Which of the following best describes a 'call option'?

Answer: Right to buy an asset at a specified price

A call option gives the buyer the right, but not the obligation, to purchase the underlying asset at the strike price.

In portfolio construction, the minimum-variance frontier represents portfolios that:

Answer: Minimize variance for any given level of expected return

The minimum-variance frontier plots the lowest possible variance achievable for each target return level.

Negative convexity in a mortgage-backed security (MBS) primarily occurs due to:

Answer: Prepayment risk when interest rates fall

MBS exhibit negative convexity because homeowners prepay mortgages when rates fall, limiting price appreciation.

The time value of a European call option approaches zero as:

Answer: Time to expiration decreases toward zero

Time value decays (theta decay) and reaches zero at expiration, leaving only intrinsic value.