Investment Advisor Financial Investment 2 — Questions and Answers
Question 1: An investor holds a bond with a 5% coupon rate when market interest rates rise to 7%. What happens to the bond's market price?
- It increases above par value
- It falls below par value (Correct answer)
- It remains unchanged at par
- It doubles in value
Correct answer: It falls below par value
Bond prices move inversely to interest rates; when rates rise above the coupon rate, the bond becomes less attractive and trades at a discount.
Question 2: Which metric measures the percentage of a company's earnings paid out as dividends?
- Dividend yield
- Price-to-earnings ratio
- Payout ratio (Correct answer)
- Earnings per share
Correct answer: Payout ratio
The payout ratio is calculated as dividends per share divided by earnings per share, expressed as a percentage.
Question 3: A mutual fund with a 12b-1 fee primarily uses that fee to cover:
- Portfolio management expenses
- Marketing and distribution costs (Correct answer)
- Custodian fees
- Audit and legal expenses
Correct answer: Marketing and distribution costs
12b-1 fees are SEC-authorized charges used to pay for a fund's marketing, advertising, and distribution expenses.
Question 4: What does the Sharpe ratio measure?
- Total return relative to a benchmark index
- Risk-adjusted return per unit of total risk (Correct answer)
- Portfolio beta relative to the market
- Correlation between two asset classes
Correct answer: Risk-adjusted return per unit of total risk
The Sharpe ratio divides a portfolio's excess return over the risk-free rate by its standard deviation to measure return per unit of risk.
Question 5: An investor in the 32% marginal tax bracket compares a municipal bond yielding 3.5% to a taxable bond. What taxable equivalent yield does the muni represent?
- 3.50%
- 4.75%
- 5.15% (Correct answer)
- 6.00%
Correct answer: 5.15%
Taxable equivalent yield = muni yield / (1 - tax rate) = 3.5% / (1 - 0.32) = 5.15%.
Question 6: Which investment strategy involves buying securities in proportion to their market-cap weighting in an index?
- Active management
- Tactical asset allocation
- Passive indexing (Correct answer)
- Factor investing
Correct answer: Passive indexing
Passive indexing replicates an index by holding securities in the same proportions as their market-cap weights, minimizing tracking error and costs.
Question 7: What is the primary purpose of dollar-cost averaging as an investment strategy?
- To time the market and buy at the lowest price
- To reduce the average cost per share by investing fixed amounts regularly (Correct answer)
- To maximize short-term gains through frequent trading
- To eliminate currency risk in international portfolios
Correct answer: To reduce the average cost per share by investing fixed amounts regularly
Dollar-cost averaging invests a fixed dollar amount at regular intervals, automatically buying more shares when prices are low and fewer when prices are high.
Investment Advisor Financial Investment 2
An investor holds a bond with a 5% coupon rate when market interest rates rise to 7%.
What happens to the bond's market price?