Investment Advisor Financial Investment 4 — Questions and Answers
Question 1: Which of the following describes the concept of 'duration' in fixed income investing?
- The number of years until a bond matures
- A measure of a bond's price sensitivity to interest rate changes (Correct answer)
- The time between coupon payments
- The period during which a bond is callable
Correct answer: A measure of a bond's price sensitivity to interest rate changes
Duration measures how much a bond's price will change for a 1% change in interest rates; it is expressed in years but represents price sensitivity.
Question 2: An investor buys a stock at $50, receives a $2 dividend, and sells at $55. What is the total return?
- 10%
- 12%
- 14% (Correct answer)
- 4%
Correct answer: 14%
Total return = (price gain + dividend) / purchase price = ($5 + $2) / $50 = 14%.
Question 3: Which asset class has historically provided the best long-term hedge against unexpected inflation?
- Long-term government bonds
- Cash equivalents
- Common equities and real assets (Correct answer)
- Fixed annuities
Correct answer: Common equities and real assets
Common stocks and real assets (real estate, commodities) tend to appreciate with inflation over the long run, unlike fixed-income instruments whose real value erodes.
Question 4: What is the key difference between a closed-end fund and an open-end mutual fund?
- Closed-end funds are not registered with the SEC
- Closed-end funds issue a fixed number of shares that trade on an exchange (Correct answer)
- Open-end funds hold only stocks while closed-end funds hold bonds
- Closed-end funds never pay dividends
Correct answer: Closed-end funds issue a fixed number of shares that trade on an exchange
Closed-end funds have a fixed share count and trade on exchanges at market-determined prices, which may differ from NAV, unlike open-end funds that issue/redeem at NAV.
Question 5: A portfolio manager who selects securities based on predicted macroeconomic trends (GDP growth, inflation, interest rates) is using which approach?
- Bottom-up investing
- Top-down investing (Correct answer)
- Quantitative screening
- Momentum investing
Correct answer: Top-down investing
Top-down investing starts with macroeconomic analysis to select favorable sectors and countries before choosing individual securities within those areas.
Question 6: What is the primary risk associated with callable bonds for investors?
- Default risk increases when the bond is called
- Reinvestment risk, because bonds are typically called when rates fall (Correct answer)
- Liquidity risk, because called bonds cannot be resold
- Currency risk when the issuer is foreign
Correct answer: Reinvestment risk, because bonds are typically called when rates fall
Issuers call bonds when interest rates decline so they can refinance at lower rates, forcing investors to reinvest their principal at the now-lower prevailing rates.
Question 7: Modern Portfolio Theory (MPT) suggests that an investor should choose a portfolio on the efficient frontier based primarily on their:
- Investment time horizon only
- Risk tolerance and desired return trade-off (Correct answer)
- Tax bracket
- Age and employment status
Correct answer: Risk tolerance and desired return trade-off
MPT's efficient frontier shows the best possible return for each level of risk; the investor's position on it is determined by their individual risk-return preference.
Investment Advisor Financial Investment 4
Which of the following describes the concept of 'duration' in fixed income investing?