CHAPTER 3—SELECTING INVESTMENTS IN A GLOBAL MARKET
TRUE/FALSE
1. The U.S. equity and bond markets have grown in terms of their relative size of the world equity and
bond market.
2. Diversification with foreign securities can help reduce portfolio risk.
3. The total domestic return on German bonds is the return that would be experienced by a Canadian
investor who owned German bonds.
4. The performance of the Canadian bond market ranked higher than the U.S. bond market.
5. A Canadian investor who ignores foreign markets reduces overall number of investment choices.
6. Treasury bills are long-term investments that make regular interest and principal payments.
7. A debenture is an option issued by a corporation that gives the holder the right to acquire common
stock from the issuing firm at a specified price within a designated period of time.
8. Income bonds are considered as safe as debentures because they pay higher rates of interest.
9. A Eurobond is an international bond denominated in a currency other than that of Canada.
10. Warrants are options often issued in connection with the sale of fixed income securities.
11. A call option is usually issued in conjunction with convertible bonds.
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12. Yields on money market funds are often lower than yields available to individuals investing in
guaranteed investment securities because of the fees involved.
13. Municipal bond nominal yields are generally below comparable taxable bond yields.
14. REITS are investment companies that invest in high-quality money market instruments such as
Treasury bills, high-grade commercial paper, and guaranteed investment securities.
15. It is very important when diversifying that the correlation between rates of return for various countries
be high and very stable over time.
16. The decrease in the standard deviation of returns after adding 30 to 40 securities within a country is
known as domestic diversification.
17. Agency securities that are issued by Crown corporations and various agencies, are direct obligation of
the government.
18. Subordinated bondholders have claim to the assets of the firm only after the firm has satisfied the
claims of all senior secured and debenture bondholders.
MULTIPLE CHOICE
1. An investor who purchases a put option:
a.
Has the right to buy a given stock at a specified price during a designated time period.
b.
Has the right to sell a given stock at a specified price during a designated time period.
c.
Has the obligation to buy a given stock at a specified price during a designated time
period.
d.
Has the obligation to sell a given stock at a specified price during a designated time
period.
e.
None of the above.
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2. If you are considering investing in German stocks as a means to reduce the risk of your portfolio, the
initial factor that you should examine is:
a.
The average rate of return of the portfolio when you combine Canadian and German
stocks.
b.
The standard deviation of the German stocks.
c.
The standard deviation of the German stocks compared to the standard deviation of
Canadian stocks.
d.
The correlation between the rates of return for German stocks and Canadian stocks.
e.
The coefficient of variation (CV) of rates of return for German stocks versus the CV of
rates of return for Canadian stocks.
3. Which of the following is not considered a fixed income investment?
a.
Corporate bonds.
b.
Preferred stock.
c.
Treasury bills, notes, and bonds.
d.
Money market mutual funds.
e.
Guaranteed investment securities.
4. Which of the following is not considered a capital market instrument?
a.
Canadian Treasury notes and bonds.
b.
Canadian Treasury bills.
c.
Canadian government agency securities.
d.
Municipal bonds.
e.
Corporate bonds.
5. What is the original maturity of a Canadian Treasury note?
a.
Zero years to five years.
b.
Six months to ten years.
c.
One year or less.
d.
Over one year to ten years.
e.
Over ten years.
6. What is the original maturity of a Canadian Treasury bill?
a.
Zero years to five years.
b.
Six months to ten years.
c.
One year or less.
d.
One year to ten years.
e.
Over ten years.
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7. What is the original maturity of a Canadian Treasury bond?
a.
Zero years to five years.
b.
Six months to ten years.
c.
One year or less.
d.
One year to ten years.
e.
Over ten years.
8. Which of the following is not an international bond?
a.
Eurobond
b.
Maple bond
c.
International domestic bond
d.
Guaranteed investment security
e.
Yankee bond
9. What is the name of the legal document setting forth the obligations of a bond’s issuer?
a.
A debenture.
b.
A warrant.
c.
An indenture.
d.
The preemptive right.
e.
A trustee deed.
10. Which of the following is not a considered fixed income security?
a.
Debentures
b.
Eurobonds
c.
Preferred stock
d.
Mutual funds
e.
Guaranteed investment certificates
11. The purchase and sale of commodities for current delivery and consumption is known as dealing in the
_________________ market.
a.
Futures
b.
Spot
c.
Money
d.
Capital
e.
Options
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12. An investor who purchases a call option:
a.
Has the right to buy a given stock at a specified price during a designated time period.
b.
Has the right to sell a given stock at a specified price during a designated time period.
c.
Has the obligation to buy a given stock at a specified price during a designated time
period.
d.
Has the obligation to sell a given stock at a specified price during a designated time
period.
e.
None of the above.
13. If this year is consistent with historical trends you would expect the return for small capitalization
stocks to be
a.
Below common stocks and above long-term government bonds.
b.
Below common stocks and below long-term government bonds.
c.
Above last year’s return on the same stocks.
d.
Above common stock, long-term government, and corporate bonds.
e.
The least variable among long-term bonds and common stocks.
14. The correlation between Canadian government bonds and U.K. government bonds is
a.
Strongly positive.
b.
Weakly positive.
c.
Strongly negative.
d.
Weakly negative.
e.
Indeterminate.
15. The best way to directly acquire the shares of a foreign company is through
a.
International mutual funds.
b.
Global mutual funds.
c.
American Depository Receipts (ADRs)
d.
Investment in Canadian companies operating internationally.
e.
Eurobonds.
16. Which of the following would be considered a low liquidity investment?
a.
Warrants
b.
Call options
c.
Zero coupon bonds
d.
Balanced mutual funds
e.
Diamonds
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17. An agreement that provides for the future delivery or receipt of an asset at a specified date for a
specified price is a
a.
Eurobonds contract.
b.
Futures contract.
c.
Put option contract.
d.
Call option contract.
e.
Warrant contract.
18. Which of the following is a type of investment company?
a.
Money market funds
b.
Common stock funds
c.
Balanced funds
d.
Bond funds
e.
All of the above.
19. Antiques, art, coins, stamps, jewellery, etc., are not included in the investment portfolios of financial
institutions because
a.
Prices vary substantially.
b.
Transaction costs are relatively high.
c.
They are illiquid.
d.
None of the above.
e.
All of the above.
20. Rank the following four investments in increasing order of historical risk.
a.
Art, T-bills, corporate bonds, and common stock
b.
T-bills, common stock, corporate bonds, art
c.
Corporate bonds, T-bills, common stock, art
d.
Common stock, corporate bonds, T-bills, art
e.
T-bills, corporate bonds, common stock, art
21. An ETF (exchange traded fund) is:
a.
priced once a day at the opening of trading.
b.
priced once a day at the close of trading.
c.
priced continuously during the trading day.
d.
priced at the open and close of trading.
e.
None of the above.
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22. A statistic that measures how two variables tend to move together is the
a.
Coefficient of variation
b.
Correlation coefficient
c.
Standard deviation
d.
Mean
e.
Variance
23. Which of the following statements concerning historical investment risk and return is false?
a.
The geometric mean of the rates of return was always lower than the arithmetic mean of
the rates of return.
b.
The rates of return on long-term Canadian government bonds were lower than on stocks.
c.
Real estate investments consistently provide higher rates of return than those provided by
common stock.
d.
Stocks and bonds experienced results in the middle of the art and antiques series.
e.
None of the above statements are false.
24. Which of the following are reasons that Canadian investors should consider foreign markets when
constructing global portfolios?
a.
Ignoring foreign markets reduced their choices of investment opportunities.
b.
Foreign markets have low correlations with Canadian markets.
c.
Returns on non-Canadian stocks can substantially exceed returns for Canadian securities.
d.
All of the above.
e.
None of the above.
25. How often is a mutual fund priced?
a.
Once a day at the opening of trading.
b.
Once a day at the close of trading.
c.
Continuously during the trading day.
d.
At the open and close of trading.
e.
None of the above.
26. For a Canadian-based investor, a weaker dollar means that overall dollar based returns on overseas
security investment will be higher because
a.
A weaker dollar means that exports will rise.
b.
A weaker dollar means that more foreign investors will by U.S. securities.
c.
A weaker dollar means that the foreign currency will convert to more dollars.
d.
A weaker dollar means that more investors will purchase the foreign security.
e.
None of the above.
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27. In order to diversify risk an investor must have investments that have correlations with other
investments in the portfolio that are
a.
low positive
b.
zero
c.
negative
d.
any of the above
e.
none of the above
28. Correlations between bond markets in different countries have been changing over time because
a.
Countries are developing closer trade and economic links.
b.
Countries are becoming more segmented.
c.
There are fewer barriers to travel.
d.
Canadian investors are purchasing more foreign securities.
e.
Correlations between bond markets of different countries have been rising.
29. Senior secured bonds are
a.
The most senior bonds in a firm’s capital structure.
b.
Bonds with the lowest risk of default.
c.
Bonds that are not backed by specific assets.
d.
A and B
e.
A and C
30. Convertible bonds are bonds
a.
That are convertible into more bonds.
b.
That are convertible from unsecured to secured status.
c.
That are convertible into company stock.
d.
That are convertible into specific assets.
e.
That have an option attached.
31. A Eurobond is an international bond
a.
Sold by an issuer within its own country in that country’s currency.
b.
Denominated in a currency not native to where it is issued.
c.
Also known as a Maple bond.
d.
Is a bond denominated in Canadian dollars but issued by a foreign company.
e.
That is sold only to European investors.
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32. Foreign equities can be acquired by purchasing all of the following
a.
American Depository Receipts (ADRs)
b.
American shares
c.
Foreign shares listed on foreign stock exchange
d.
Global Exchange-Traded Funds (GETFs)
e.
All of the above.
33. Which of the following is not a characteristic of a warrant?
a.
The right to buy common stock in a corporation.
b.
Issued by the corporation or an individual.
c.
Typically valid for longer time periods than options.
d.
Similar to a call option with respect to a striking price.
e.
All of the above are characteristics of a warrant.
34. Certificates of ownership issued by a U.S. bank that represent indirect ownership of a certain number
of shares of a specific foreign firm on deposit in a bank in the firm’s home country are known as:
a.
American Depository Receipts (ADRs)
b.
Exchange Traded Funds (ETFs)
c.
Warrants
d.
Options
e.
Futures
35. Which of the following are ways to invest in real estate?
a.
Real Estate Investment Trusts (REITs)
b.
Raw Land purchase
c.
Land Development
d.
Rental Properties
e.
All of the above.
36. Which of the following statements regarding real estate investments is false?
a.
The large number of transactions and national data sources provide accurate readily
available estimates of historical returns.
b.
S&P/TSX had higher returns than 90-day Treasury-bill from 1993 to 2009.
c.
S&P/TSX had lower returns than 90-day Treasury-bill from 1993 to 2009.
d.
S&P/TSX had higher volatility than 90-day Treasury-bill from 1993 to 2009.
e.
All of the above are false.
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37. What is a bond provision that specifies payments the issuer must make to redeem a given percentage
of the outstanding issue prior to maturity known as?
a.
Call provision
b.
Indenture
c.
Collateralization
d.
Sinking fund
e.
Collateral trust bond
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Security
Annual Percentage Return
Canadian government T-bills
3.04
Long-term government bonds
5.75
Long-term corporate bonds
6.80
Large capitalization common stocks
13.50
Small capitalization common stocks
15.60
The annual rate of inflation is 2%.
38. Refer to Exhibit 3-1. What is the real return on long-term corporate bonds?
a.
1.02%
b.
3.68%
c.
4.71%
d.
11.27%
e.
13.33%
39. Refer to Exhibit 3-1. What is the real return on T-bills?
a.
1.02%
b.
3.68%
c.
4.71%
d.
11.27%
e.
13.33%
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40. Refer to Exhibit 3-1. What is the real return on small capitalization stocks?
a.
1.02%
b.
3.68%
c.
4.71%
d.
11.27%
e.
13.33%
41. Refer to Exhibit 3-1. What is the real return on large capitalization stocks?
a.
1.02%
b.
3.68%
c.
4.71%
d.
11.27%
e.
13.33%
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Real Returns
INVESTMENT
REAL ANNUAL RETURN
Large company stock
6.50%
Small capitalization stock
8.60%
Long-term corporate bonds
3.60%
Long-term government bonds
2.80%
Canadian Treasury bills
1.03%
The annual rate of inflation is 2.5%
42. Refer to Exhibit 3-2. What is the large company stock nominal return?
a.
3.56%
b.
5.37%
c.
6.19%
d.
9.16%
e.
11.32%
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43. Refer to Exhibit 3-2. What is the T-bill nominal return?
a.
3.56%
b.
5.37%
c.
6.19%
d.
9.16%
e.
11.32%
44. Refer to Exhibit 3-2. What is the long term Treasury bond nominal return?
a.
3.56%
b.
5.37%
c.
6.19%
d.
9.16%
e.
11.32%
45. Refer to Exhibit 3-2. What is the small capitalization stock nominal return?
a.
3.56%
b.
5.37%
c.
6.19%
d.
9.16%
e.
11.32%
46. A return series has an arithmetic mean of 12.8% and standard deviation of 7.8%. Assuming the returns
are normally distributed, what is the range of returns that an investor would expect to receive 90% of
the time?
a.
12.8% to 20.6%
b.
−10.6% to 36.2%
c.
−2.8% to 28.4%
d.
−12.8% to 20.6%
e.
10.6% to 36.2%
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47. A return series has an arithmetic mean of 12.8% and standard deviation of 7.8%. Assuming the returns
are normally distributed, what is the range of returns that an investor would expect to receive 95% of
the time?
a.
12.8% to 20.6%
b.
−10.6% to 36.2%
c.
−2.8% to 28.4%
d.
−12.8% to 20.6%
e.
10.6% to 36.2%
48. A return series has an arithmetic mean of 10.5% and standard deviation of 13%. Assuming the returns
are normally distributed, what is the range of returns that an investor would expect to receive 95% of
the time?
a.
10.5% to 13%
b.
−2.5% to 23.5%
c.
−28.5% to 49.5%
d.
−15.5% to 36.5%
e.
0% to 36.5%
49. A return series has an arithmetic mean of 10.5% and standard deviation of 13%. Assuming the returns
are normally distributed, what is the range of returns that an investor would expect to receive 90% of
the time?
a.
10.5% to 13%
b.
−2.5% to 23.5%
c.
−28.5 to 49.5%
d.
−15.5% to 36.5%
e.
0% to 10.5%
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50. You are trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year
and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors
are the same and you are in the 28% tax bracket, which bond should you choose and why?
a.
Corporate bond because the after tax yield is 6.25%.
b.
Corporate bond because the after tax yield is 4.5%.
c.
Municipal bond because the equivalent taxable yield is 6.3%.
d.
Municipal bond because the equivalent taxable yield is 6.6%.
e.
You will be indifferent between the two because the after tax yields are the same.
51. What range of returns would an investor expect to achieve 99% of the time on an investment with an
expected return of 11% and a standard deviation of 16%?
a.
5% to 27%
b.
−5% to 27%
c.
−21% to 43%
d.
−37% to 59%
e.
5% to 21%
52. If the nominal return on an investment of common stocks was 11% and inflation was 2.5% annually,
what was the real return on common stock?
a.
8.3%
b.
8.5%
c.
9.7%
d.
11.0%
e.
12.6%
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53. If the real return for corporate bonds was 4% and the inflation rate was 2%, what is the nominal return
for corporate bonds?
a.
1.96%
b.
2.00%
c.
4.00%
d.
6.08%
e.
6.42%