CIMA Applied Finance & Economics 2 — Questions and Answers
Question 1: A portfolio manager observes that a stock's beta is 1.4 and the market risk premium is 6%. If the risk-free rate is 3%, what is the expected return per the CAPM?
- 8.4%
- 11.4% (Correct answer)
- 9.0%
- 12.6%
Correct answer: 11.4%
CAPM: E(r) = 3% + 1.4 × 6% = 3% + 8.4% = 11.4%.
Question 2: Which yield curve shape historically has the strongest predictive power for an impending economic recession in the US?
- Steep upward-sloping curve
- Flat yield curve
- Inverted yield curve (Correct answer)
- Humped yield curve
Correct answer: Inverted yield curve
An inverted yield curve, where short-term yields exceed long-term yields, has historically preceded US recessions.
Question 3: The Treynor ratio differs from the Sharpe ratio primarily because it uses which denominator?
- Total standard deviation
- Tracking error
- Portfolio beta (Correct answer)
- Semi-deviation
Correct answer: Portfolio beta
The Treynor ratio uses portfolio beta (systematic risk) as the denominator, while Sharpe uses total standard deviation.
Question 4: A bond with a duration of 7 years is expected to decrease in price by approximately how much if interest rates rise by 50 basis points?
- 7.0%
- 3.5% (Correct answer)
- 0.5%
- 14.0%
Correct answer: 3.5%
Approximate price change = –Duration × Δy = –7 × 0.005 = –3.5%.
Question 5: In a perfectly competitive market, a firm's long-run equilibrium price equals:
- Marginal revenue only
- Average variable cost
- Minimum average total cost (Correct answer)
- Marginal cost only
Correct answer: Minimum average total cost
In long-run perfectly competitive equilibrium, P = MC = minimum ATC, eliminating economic profit.
Question 6: Which of the following best describes the J-curve effect following a currency depreciation?
- The trade balance immediately improves, then worsens over time
- The trade balance initially worsens before improving as trade volumes adjust (Correct answer)
- Interest rates rise sharply before stabilizing
- Inflation falls before rising due to cheaper imports
Correct answer: The trade balance initially worsens before improving as trade volumes adjust
The J-curve describes how the trade deficit worsens short-term after depreciation (due to price effects) before improving as export/import volumes adjust.
Question 7: A callable bond compared to an otherwise identical non-callable bond will typically have:
- Higher price and lower yield
- Lower price and higher yield (Correct answer)
- Same price but lower convexity
- Higher price and negative convexity
Correct answer: Lower price and higher yield
Callable bonds carry call risk, so investors demand a higher yield (and thus lower price) as compensation.
CIMA Applied Finance & Economics 2
A portfolio manager observes that a stock's beta is 1.4 and the market risk premium is 6%.
If the risk-free rate is 3%, what is the expected return per the CAPM?