Investment Advisor Financial Investment 3 — Questions and Answers
Question 1: A portfolio has a beta of 1.4. If the market rises 10%, how much would this portfolio be expected to gain, assuming no alpha?
- 10%
- 12%
- 14% (Correct answer)
- 18%
Correct answer: 14%
Expected portfolio return = beta × market return = 1.4 × 10% = 14%; beta measures sensitivity to market movements.
Question 2: Which type of risk CANNOT be eliminated through diversification?
- Business risk
- Liquidity risk
- Systematic risk (Correct answer)
- Credit risk
Correct answer: Systematic risk
Systematic (market) risk affects all securities and cannot be diversified away, unlike unsystematic risks tied to individual companies or sectors.
Question 3: An ETF trades at a price above its net asset value (NAV). This condition is called:
- A discount
- A premium (Correct answer)
- Arbitrage convergence
- Price dislocation
Correct answer: A premium
When an ETF's market price exceeds its NAV, it is trading at a premium; authorized participants can create new shares to arbitrage this difference.
Question 4: Which of the following best describes a 'laddered' bond portfolio strategy?
- Concentrating all bonds in a single maturity date
- Purchasing bonds that mature at staggered intervals over time (Correct answer)
- Buying only zero-coupon bonds
- Allocating bonds equally between government and corporate issuers
Correct answer: Purchasing bonds that mature at staggered intervals over time
A bond ladder spreads maturities over multiple time periods, reducing reinvestment risk and providing regular liquidity as each rung matures.
Question 5: Under the Efficient Market Hypothesis (EMH) in its strong form, which type of analysis would be unable to consistently produce excess returns?
- Technical analysis only
- Fundamental analysis only
- Both technical and fundamental analysis (Correct answer)
- Neither; strong form EMH still allows alpha from insider knowledge
Correct answer: Both technical and fundamental analysis
Strong-form EMH states that all public and private information is already reflected in prices, making both technical and fundamental analysis unable to generate consistent excess returns.
Question 6: A real estate investment trust (REIT) is required to distribute what minimum percentage of its taxable income to shareholders to maintain REIT status?
- 50%
- 75%
- 90% (Correct answer)
- 100%
Correct answer: 90%
IRS rules require REITs to distribute at least 90% of their taxable income as dividends to shareholders each year.
Question 7: What does a negative convexity in a mortgage-backed security (MBS) typically indicate?
- The MBS will outperform Treasuries in all interest rate environments
- Price appreciation is limited when rates fall due to prepayment risk (Correct answer)
- The security has no call features or prepayment options
- Duration increases as interest rates rise
Correct answer: Price appreciation is limited when rates fall due to prepayment risk
Negative convexity means that when rates fall, homeowners prepay mortgages early, causing the MBS to be 'called away' and limiting price appreciation.
Investment Advisor Financial Investment 3
A portfolio has a beta of 1.4.
If the market rises 10%, how much would this portfolio be expected to gain, assuming no alpha?