Question 1
Investment Policy Statement (IPS). Several of the components of the IPS include the statement
of investment goals, objectives, and constraints; performance measures and benchmarks;
considerations in developing strategic asset allocation; and investment strategies and investment
styles.
True
False
Question 2
Basis Risk and Convergence: While the futures price and the spot price must converge at
maturity, the basis defines the difference between the futures price and the spot price. Basis risk
is assumed over the life of the contract, except at maturity where convergence occurs.
True
False
Question 3
Operating & Financial Leverage: Operating leverage and financial leverage increase sensitivity
to the business cycle. By definition, operating leverage links to fixed costs as a percentage of
total costs while financial leverage links to the percentage of debt to total capital.
True
False
Question 4
Tracking Error (TE). TE is estimated from the time series of differences between the returns of
the risky portfolio and the risk free returns. Over the past 30+ years, TEs have tended to
decline, suggesting that risky portfolios have become more index-like.
True
False
Question 5
Internal Rate of Return: Dollar weighted rates of return is another term for Internal Rate of
Return (IRR). Because of the nuances of the (oftentimes) highly irregular cash flows both into
and out of the limited liability partnership (LLP), IRR is used in the performance measurement of
alternative assets.
True
False
Question 6
Equity Style Analysis: Equity style analysis was introduced by William Sharpe and finds its
visualization in the Morningstar Boxes. Regressing fund returns on style benchmarks would
enable the analyst to measure the fund’s implicit allocation to that style.
True
False
Question 7
Binomial and Black Scholes Option Pricing Model: The multi period approach to option pricing
is labeled the binomial model and with the use of continuously compounded mathematics, the
Black Scholes pricing formula can be derived. The Black Scholes model assumes a constant
volatility over the life of the option.
True
False
Question 8
Venture Capital Business Model: The successful venture capital portfolio model hinges on the
ability to find a “home run,” thereby generating a return that offsets the losses and the breakeven
positions. Roughly half of the portfolio positions are assumed to eventually fail.
True
False
Question 9
Long or Short Futures: The trader taking the long position commits to buying the commodity on
the delivery date while the trader taking the short position commits to selling.
True
False
Question 10
Futures Hedge Ratio: In general, the hedge ratio is the number of futures contracts one would
need to offset the risk of a particular unprotected position. Futures contracts could be used to
hedge interest rates, stock market indices, currency or commodity risk.
True
False
Question 11
Earning Quality (EQ): One of the best indicators of EQ is a high percentage of the earnings,
accrual accounting defined, covered (or reflected) by working capital.
True
False
Question 12
Option Basics: A put option is the right to sell an asset at an agreed upon exercise price. A call
option is the right to buy an asset at a given strike price. The difference between the asset price
and the exercise price is used to determine whether the option is in the money, at the money, or
out of the money.
True
False
Question 13
Protective Put and Covered Call: A protective put is a form of insurance whereby a stock is
overlaid with a put option that is purchased. A covered call is the purchase of a share of stock
with a simultaneous sale of a call option on that stock. A protective put is an
example of the use of options in risk management.
True
False
Question 14
Price Metrics: The P/E ratio is a useful measure of the market’s assessment of the firm’s growth
opportunities. Many analysts form their estimates of a stock’s value by multiplying their forecast
of next year’s earnings per share by a predicted P/E multiple. The P/B ratio is a useful measure
of the market’s assessment of the firm’s return on equity (ROE) opportunities. The P/S ratio is a
useful measure of the market’s assessment of the firm’s net margins and the expectations thereof.
True
False
Question 15
FCFF: The Free Cash Flow to the Firm (FCFF) is oftentimes employed by private equity firms to
measure available pretax cash flows from operations minus necessary working capital and
essential capital spending needs. It is discounted via WACC. For equity valuation, the FCFF is
discounted by the WACC to arrive at a present value (PV), from which debt is subtracted to
arrive at an equity value.
True
False
Question 16
Swaps: Swaps in essence, call for the exchange of a series of cash flows. For example, an interest
rate swap may call for the exchange of a series of fixed cash flows for a series of floating rate
cash flows.
True
False
Question 17
Implied Volatility: The implied volatility of an option is the standard deviation of stock returns
consistent with an option’s market price or stated differently, the volatility level for the stock that
is embedded in its price. The measure of volatility of the S&P500 is known commonly as the
open interest. High levels of open interest correspond to perceived risky markets while low levels of open interest
correspond to less risk markets.
True
False
Question 18
Real Assets: Real assets (as an alternative asset class) include timberland, farmland, REITs, direct
real estate investment, and infrastructure. Its particularly important characteristic is its inflation
sensitivity or more specifically, its ability to act as an inflation hedge.
True
False
Question 19
Home Country Bias (HCB). HCB refers to the common tendency for investors to overweight
foreign equities in their portfolio of risky assets.
True
False
Question 20
Attribution: Common attribution procedures partition performance improvements to asset
allocation, sector selection, and security selection. Performance is assessed by calculating
departure of portfolio composition from a benchmark portfolio.
True
False
Question 21
Futures Markets: “Backwardation” futures markets are those in which spot prices are higher than
futures prices while “Contango” futures markets are those in which spot prices are lower than
futures prices
True
False
Question 22
Life Cycle Approach to Investing (LCAI). The LCAI views the individual as passing through a
series of stages, becoming more risk seeking in later years, the rationale being that one ages, an
individual uses up his/her human capital and have less time remaining to recoup possible
portfolio losses through increased labor supply.
True
False
Question 23
Strategic Asset Allocation (SAA) and Tactical Asset Allocation (TAA). TAA represents a
dynamic investment strategy that actively adjusts the portfolio’s asset allocation, shifting it
towards undervalued assets and away from overvalued assets for time periods generally spanning
one to several years. Conversely, SAA is long term.
True
False
Question 24
Futures Profitability and Zero Sum Game: The profit to a long futures contract is the spot price at
maturity minus the original futures price. The profit to a short futures contract is the original
futures price minus the spot price at maturity. When summed, the profits to the long and the short
suggest that futures contracts are a zero-sum arrangement.
True
False
Question 25
Valuation Model Consistency: Valuation model consistency refers to the proper linking of the
numerator and denominator’s components. For example, the discounting factors for FCFE and
FCFF are the CAPM required return and the WACC, respectively.
True
False
Question 26
FCFE. The Free Cash Flow to Equity equals FCFF minus after tax interest expenditures plus
increase in net debt. FCFE is discounted by the CAPM.
True
False
Question 27
Alternative Asset Attributes: Diversification, illiquidity, and inefficiency define a number of the
distinguishing characteristics of the alternative assets space. Alternative assets are termed alpha
investments (representing manager skill to generate a positive risk adjusted return).
True
False
Question 28
Forwards & Futures: A futures contract is similar to a forward contract, differing more
importantly in the aspects of standardization and daily marking to market, which is the process by
which gains and losses on futures contract positions are settled daily. Futures contracts can be
used for hedging or speculating.
True
False
Question 29
Two Classes of LLP Partners. The two classes of LLP partners are Equity Partners and Debt
Partners. Debt partners, while limited in their authority, are nonetheless responsible for
providing the majority of the capital investment.
True
False
Question 30
M^2 Measure of Performance. To compute the M^2 measure-of-performance, a managed
portfolio is adjusted such that the adjusted portfolio matches the volatility of the benchmark
portfolio. Because the adjusted portfolio and the benchmark have the same standard deviation, an
analyst can compare their performance simply by comparing returns.
True
False
Question 31
Option Hedge Ratio: Hedge ratios (or deltas) are one for deep out-of-the-money call options and
zero for deep in-the-money calls.
True
False
Question 33
Portfolio Constraints (PC) in Investment Policy Statements. PC can include liquidity, investment
horizon, regulations, tax considerations, and unique needs.
True
False
Question 34
Option Valuation: Option values may be viewed as the sum of intrinsic value plus time value.
The value of a call option increases if the stock price increases, the exercise price (or strike price)
decreases, the volatility increases, the time to expiration increases, the risk free interest rate
increases, and the dividend payment decreases.
True
False
Question 35
Sector Rotation (SR): One means analysts think about the relationship between industry analysis
and the business cycle is the notion of SR. The idea is to shift the portfolio more heavily into
industry or sector groups that are expected to outperform based on one’s assessment of the state
of the business cycle. For instance, if one were anticipating an economic expansion, one would
focus attention on the consumer discretionary, materials, industrials, and energy sectors.
True
False
Question 36
Defined Contribution (DC) vs. Defined Benefit (DB). The two types of pension plans are DC and
DB, the later where the contributions made on behalf of the employees by the firm specifies the
retirement benefits to which the employee is entitled. The benefit formula typically takes into
account years of service for the employer and level of wages. In DC plans, the investment risk is
transferred to the employee.
True
False
Question 37
J Curves. J curves are generally associated with venture capital investments and indicate the
anticipated negative return (or cash flows) early on in its life cycle.
True
False
Question 38
Value Proposition: The consulting model value proposition suggests that a stock price will be
higher the larger the expected dividend per share (or free cash flow), the higher the market
capitalization rate (or risk), and the higher the expected growth rate of dividends (or free cash
flow).
True
False
Question 39
Credit Default Swaps (CDS). CDS are in effect, an insurance product that pays off in the event of
a trigger event (some sort of technical or real default). The protection seller receives a premium
from the protection buyer.
True
False
Question 40
European Australasia, Far East (EAFE) Index. EAFE is one of the most used indexes of non-US
stocks.
True
False
Question 41
Tobin’s Q. Tobin’s Q is the ratio of market price to book value.
True
False
Question 42
Industry Life Cycle: When conducting an analysis, the company’s positioning on the industry life
cycle may oftentimes yield important valuation information. For example, as one travels from
start-up to consolidation to maturity to relative decline, one
will usually witness an increase in the price / earnings ratio.
True
False
Question 43
Constant Growth DDM (CG): The CG is best suited for firms that are expected to exhibit stable
growth rates over the foreseeable future. It is oftentimes used as a normalized measure of
terminal value in intrinsic value calculations after shorter horizon DCFs (i.e., 3-5 years, for
example) are modeled.
True
False
Question 44
Risk Adjusted Performance: Because portfolio or position risk must be considered in assessing
performance, risk adjusted performance measures have been developed. Sharpe’s Ratio,
Treynor’s Measure, Jensen’s Alpha, and the Information Ratio each measure risk adjusted
performance that can be compared to a peer universe or benchmark.
True
False
Question 45
Straddle. A long straddle is established by buying both a call and a put on the stock, each with the same exercise price and the same expiration date. A straddle is an example of how options can be combined to capture an anticipated outcome.
True
False
Question 46
Dollar vs. Time Weighted Returns: Time weighted rates of return are fundamentally the internal
rate of return (IRR) while the dollar weighted returns are the geometric average rate of return.
True
False
Question 47
Commodity Cost of Carry: The commodity cost of carry is similar to the financial cost of carry
except that storage costs are added in the place of dividends: F = S (1 + RF + C)^T, where the
latter term in parenthesis is the cost of carry.
True
False
Question 48
Economic Value Added: EVA is the spread between ROC and the COC and measures the return
in excess of the opportunity cost. Stern Stewart, the human resources consulting firm, uses the
term residual income to describe EVA and in the HR function, it can be used as a hurdle rate for
bonuses.
True
False
Question 49
International Risk: Exchange rate risk imparts an extra source of uncertainty to investments
dominated in foreign currencies. To this end, political risk in international markets is generally a
risk factor as well. International equities are generally subdivided into developed and emerging
markets
True
False
Question 49
International Risk: Exchange rate risk imparts an extra source of uncertainty to investments
dominated in foreign currencies. To this end, political risk in international markets is generally a
risk factor as well. International equities are generally subdivided into developed and emerging
markets
True
False
Question 50
DCF: Discounted cash flow models give estimates of the intrinsic value (V) of a stock that in
turn, can be compared to market prices (P) for purchase (buy when V > P) or sale (sell when V <
P) decision making. The discounted cash flows, in general, are the free cash flows that can be
returned to the capital providers
True
False
Question 51
Good Companies as Good Investments. Good companies are not necessarily good investments.
Stock market prices of successful firms may be bid up to levels that reflect that success, or
perhaps more. These firms are often labeled glamour firms and have high, embedded growth and
/ or profitability expectations.
True
False
Question 52
Out of the Money Call Option. An out-of-the-money call option would be where the stock price
is greater than the exercise price.
True
False
Question 53
Cyclical vs. Defensive Industries. Cyclical industries have an above average sensitivity to the
business cycle while defensive industries have below average sensitivity.
True
False
Question 54
European vs. American style options. European style options can be exercised early (i.e., at any
time over the life of the contract) while American style can be exercised on at the maturity date of
the contract.
True
False
Question 55
Financial Cost of Carry: The financial cost of carry is determined by the relative costs of buying a
stock with deferred delivery in the futures market versus buying it in the spot market with
immediate delivery and carrying it in inventory. The financial cost of carry is depicted as F = S
(1 + RF – D)^T where the latter term in parenthesis is the cost of carry.
True
False
Question 56
Market Value Added: MVA and EVA are usually inversely related. In general, when EVA rises,
MVA falls. Conceptually, a positive MVA is a byproduct of a high – or positive – EVA (or
series of EVAs).
True
False
Question 57
Hedge Fund Philosophies: Hedge fund philosophies can oftentimes be characterized as macro &
managed futures, relative value, equity biased, and event driven. Hedge funds have a long / short construction.
True
False
Question 58
Capitalized Earnings Valuation: For firms with no growth opportunities (i.e., no PVGO), the P/E
ratio is simply the reciprocal of the capitalization rate (i.e. the required rate of return).
True
False
Question 59
Structured Assets. Structuring is the process of reengineering cash flows from existing asset
exposures (i.e. portfolios of mortgages, credit card debt, etc.). Financial structuring (or
engineering) enables different investors to hold claims with different risk exposures (labeled as
tranches) from the same underlying assets.
True
False
Question 60
ROE Determinants: A firm’s current ROE is a key determinant of the (potential) growth rate of
its earnings.
True
False
Question 61
Emerging Markets Risk: Emerging markets average returns are riskier (and generally higher)
than developed market returns.
True
False
Question 62
International Benefits: The benefits (employing the Markowitz efficient frontier) from
international diversification are oftentimes enhanced in bear markets because correlations
tend to ratchet downward (towards zero).
True
False
Question 64
In the Money Put Option. An in-the-money put option would be where the exercise price is
greater than the stock price.
True
False
Question 65
Implied Volatility: If the anticipated volatility forecast by the analyst is greater than the implied
volatility (the standard deviation of stock returns consistent with the options price), the call option
is considered a buy. If the anticipated volatility is less, the analyst should consider selling or
writing the call option.
True
False
Question 66
DuPont Analysis: It is often useful to decompose a firm’s ROE or ROA or ROIC into the
product of several accounting ratios and to analyze their separate behaviors over time (i.e., trends)
and across companies (i.e., cross sectional) within an industry.
True
False
Question 67
Growth Theory: The expected growth rate of earnings is related both to the firm’s expected
profitability (ROE) and to its dividend policy, more specifically the retention rate.
True
False
Question 69
Fiscal & Monetary Policy: The traditional tools of macro-policy are government spending and
tax collection, which constitute fiscal policy, and manipulation of the money supply, which
constitute monetary policy, primarily through the use of the fed funds rate, discount rate, open
market operations, and quantitative easing.
True
False
Question 70
Private Equity Business Model: The four-step process of a private equities manager is to
recapitalize the acquired public company, cut costs, maximize free cash flows, and finally, return
the company to the public market, usually via an IPO or sale to a strategic buyer.
True
False
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