Investment Investment/Questions/Test 1 — Questions and Answers
Question 1: What is the primary purpose of an expense ratio in a mutual fund?
- It measures the fund's annual return relative to its benchmark
- It represents the annual fee charged to investors as a percentage of assets (Correct answer)
- It calculates the tax liability on fund distributions
- It tracks the fund manager's performance bonus
Correct answer: It represents the annual fee charged to investors as a percentage of assets
The expense ratio is the annual cost of owning a mutual fund, expressed as a percentage of the fund's average assets. It covers management fees, administrative costs, and other operating expenses, directly reducing investor returns.
Question 2: Which metric measures a stock's price relative to its earnings per share?
- Dividend yield
- Price-to-earnings (P/E) ratio (Correct answer)
- Debt-to-equity ratio
- Book value per share
Correct answer: Price-to-earnings (P/E) ratio
The price-to-earnings (P/E) ratio divides the current stock price by its earnings per share (EPS). It is one of the most widely used valuation metrics, indicating how much investors are willing to pay for each dollar of earnings.
Question 3: An investor purchases a bond with a face value of $1,000, a 5% coupon rate, and a 10-year maturity. How much annual interest will the investor receive?
- $5
- $50 (Correct answer)
- $500
- $1,050
Correct answer: $50
The annual coupon payment equals the face value multiplied by the coupon rate: $1,000 × 5% = $50. This payment is fixed and paid regardless of changes in the bond's market price.
Question 4: What does a beta of 1.5 indicate about a stock compared to the overall market?
- The stock is 50% less volatile than the market
- The stock moves in the opposite direction of the market
- The stock is 50% more volatile than the market (Correct answer)
- The stock has no correlation with the market
Correct answer: The stock is 50% more volatile than the market
Beta measures a security's volatility relative to the market. A beta of 1.5 means the stock is expected to move 1.5 times as much as the market — if the market rises 10%, the stock is expected to rise 15%, and vice versa.
Question 5: Which investment strategy involves regularly investing a fixed dollar amount regardless of asset price?
- Market timing
- Dollar-cost averaging (Correct answer)
- Value investing
- Momentum investing
Correct answer: Dollar-cost averaging
Dollar-cost averaging (DCA) involves investing a consistent fixed amount at regular intervals. This strategy automatically buys more shares when prices are low and fewer when prices are high, reducing the impact of short-term volatility.
Question 6: What is the risk-free rate most commonly used as a benchmark in investment analysis?
- The prime lending rate set by commercial banks
- The dividend yield of the S&P 500 index
- The yield on short-term US Treasury bills (Correct answer)
- The federal funds rate target
Correct answer: The yield on short-term US Treasury bills
Short-term US Treasury bills (T-bills) are considered virtually risk-free because they are backed by the full faith and credit of the US government. Their yield is used as the baseline risk-free rate in models like the Capital Asset Pricing Model (CAPM).
Investment Investment/Questions/Test 1
What is the primary purpose of an expense ratio in a mutual fund?