Finance Exam - Learn IT All

The beta of an asset measures its sensitivity to market movements. A beta of 0 indicates that the asset's returns are not correlated with the market, meaning it is unaffected by market fluctuations. In other words, the risk-free asset has no exposure to systematic risk and its returns are solely determined by the risk-free rate of return.

The line passing through the risk-free rate and the market portfolio is called the market line. This line represents the relationship between expected return and systematic risk for all assets in the market. It shows the expected return an investor should receive for taking on additional risk beyond the risk-free rate. The market line is used in the capital asset pricing model (CAPM) to determine the expected return of an asset based on its beta, which measures its systematic risk.

The changing relationships among currencies of interest to you constitute foreign exchange risk. This refers to the potential losses or gains that can occur due to fluctuations in exchange rates between different currencies. This risk arises when conducting international transactions or investments and can impact the value of assets or the profitability of businesses operating in multiple currencies. It is important to manage and mitigate foreign exchange risk through various strategies such as hedging or diversification.

Inflation in the home country causes the value of the home currency to depreciate in the global market. This is because when there is inflation, the purchasing power of the currency decreases. As a result, the currency becomes less valuable compared to other currencies in the global market. This depreciation makes imports more expensive and exports more competitive, as foreign buyers can get more of the home currency for their money.

Risk averse people only take risks when they believe they will be rewarded for doing so because they are cautious and prefer to avoid potential losses. They are more likely to engage in risky behavior if they perceive a higher probability of gaining a reward that outweighs the potential risks. This mindset allows them to carefully assess the potential benefits and drawbacks before making a decision, ensuring that the potential rewards justify the risks involved.

The Security Market Line (SML) relates expected return to beta. Beta is a measure of a stock's volatility in relation to the overall market. It indicates how much a stock's price is expected to move in response to changes in the market. The SML graphically represents the relationship between expected return and beta, showing the expected return for a given level of risk (beta). In other words, the SML helps investors assess whether a stock's expected return is sufficient given its level of risk. Therefore, the correct answer is beta.

The Security Market Line is a straight line that passes through the risk-free rate and the Market portfolio. This line represents the relationship between the expected return and the beta of an asset. The risk-free rate represents the return on an investment with zero risk, while the Market portfolio represents a well-diversified portfolio that includes all risky assets in the market. The straight line indicates that the expected return of an asset is directly proportional to its beta, with assets above the line being undervalued and assets below the line being overvalued.

A portfolio manager is most concerned with economic exposure when it comes to foreign exchange risk. Economic exposure refers to the impact of exchange rate fluctuations on a company's future cash flows and overall value. It considers the long-term effects of currency movements on a company's competitiveness, market share, and profitability. This type of exposure is important for a portfolio manager as it helps them assess the potential risks and opportunities associated with investing in different currencies and countries. By understanding economic exposure, a portfolio manager can make informed decisions to mitigate risks and maximize returns.

The correct answer is both a and b. This means that a security dominates another if it offers the same expected return with less risk, as well as if it offers a higher expected return for the same level of risk. In other words, a security is considered to be better if it provides either a higher return with the same risk or the same return with lower risk compared to another security.

The correct answer is increasing. This means that the correlation among securities on European exchanges is generally getting stronger. As the correlation increases, it suggests that the prices of these securities are moving in a more similar direction. This could be due to various factors such as economic trends, market influences, or investor behavior. Overall, this indicates a higher level of interconnectedness and similarity in the performance of securities on European exchanges.

The contractual rate between a bank and a client for the future delivery of foreign exchange is referred to as the "forward" rate. This rate allows the bank and the client to agree upon a specific exchange rate for a future date, providing both parties with certainty and protection against potential fluctuations in the currency market. The forward rate is commonly used in international trade and investment to manage currency risk and ensure smooth transactions.

The current price of a foreign currency is known as the spot rate. This refers to the exchange rate at which a currency can be bought or sold for immediate delivery. The spot rate is used for immediate transactions and reflects the current market conditions. It is different from forward and futures rates, which involve buying or selling currencies at a predetermined price for future delivery. Delivery, on the other hand, refers to the physical transfer of the currency, which is not directly related to its price.

Portfolios above the efficient frontier do not exist because the efficient frontier represents the set of portfolios that provide the highest possible expected return for a given level of risk. Portfolios above the efficient frontier would have a higher expected return than any portfolio on the efficient frontier, which is not possible according to the principles of efficient portfolio theory. Therefore, portfolios above the efficient frontier are not feasible or attainable.

The cost in U.S. dollars can be calculated by multiplying the cost in New Zealand dollars by the exchange rate. In this case, the cost in U.S. dollars would be NZ$110 multiplied by $0.5855/NZ$, which equals $64.41.

The correct answer is entering into a forward contract to buy Swiss francs. By entering into a forward contract, the storekeeper can lock in the exchange rate at which they will buy Swiss francs in the future. This allows them to hedge against any potential fluctuations in the exchange rate, ensuring that they can pay for the goods at a predetermined rate.

A negative beta asset has the risk reducing properties when added to a portfolio. This means that when the asset is added to a portfolio, it tends to move in the opposite direction of the overall market. This can help to offset the risk of other assets in the portfolio, as the negative beta asset's performance is not correlated with the market. Therefore, including a negative beta asset can potentially reduce the overall risk of the portfolio.

Portfolios that lie on the efficient frontier are considered to be optimal portfolios because they offer the highest expected return for a given level of risk. The efficient frontier represents a set of portfolios that offer the best risk-return tradeoff. Portfolios that are not dominated, meaning they are not outperformed by any other portfolio, are likely to lie on the efficient frontier. Therefore, the given answer suggests that portfolios that are not dominated are optimal portfolios that offer the best risk-return tradeoff.

A typical allocation to international stocks in the U.S. is usually around 10-20%. This range allows investors to diversify their portfolios and potentially benefit from the growth of international markets. It strikes a balance between the potential for higher returns and the risks associated with investing in foreign markets. Allocating too little to international stocks may limit the diversification benefits, while allocating too much may expose investors to excessive risk. Therefore, 10-20% is considered a reasonable allocation for most investors.

The correct answer is 11.7%. According to a study by Solnik, including both U.S. and international stocks in a portfolio can reduce systematic risk to about 11.7%. This suggests that diversifying the portfolio across different markets can help lower the overall risk exposure.

The correct answer is 1 million. This is because globally, there are approximately 1 million equity securities available. Equity securities represent ownership in a company and are traded on stock exchanges. The number of equity securities can vary over time as new companies are listed or existing companies delist. However, as of now, the estimated number is around 1 million.

When a risk-free rate is available, the efficient frontier becomes linear. This is because investors can now borrow and lend at the risk-free rate, allowing them to combine the risk-free asset with risky assets to create a portfolio with any desired level of risk. By adding the risk-free asset to their portfolio, investors can achieve higher returns without taking on additional risk. As a result, the efficient frontier becomes a straight line connecting the risk-free rate to the optimal risky portfolio. This linear relationship allows investors to easily determine the optimal portfolio based on their risk preferences and return expectations.

The correct answer is "security universe". The term "security universe" refers to the collection or group of eligible investments that an investor can choose from. It represents all the available securities or financial instruments that meet certain criteria or requirements for investment. This term is commonly used in finance and investment management to describe the range of options available to investors when constructing their portfolios.

The statement "In the absence of a risk-free rate, the minimum variance portfolio is always efficient" means that when there is no risk-free rate available, the minimum variance portfolio is always considered efficient. This implies that the portfolio achieves the highest possible return for a given level of risk, making it an optimal choice for investors. The absence of a risk-free rate means that there is no alternative investment option with zero risk, so the minimum variance portfolio becomes the most efficient option.

When the Evans and Archer study is repeated with a security universe that includes international securities, the level of systematic risk decreases. This can be attributed to the fact that including international securities in the security universe diversifies the portfolio and reduces the overall risk. By including securities from different countries, the study is able to capture a broader range of market movements and reduce the reliance on any single market. As a result, the systematic risk, which is the risk associated with the overall market, decreases.

According to the separation theorem, investors should only hold the risk-free rate and the market portfolio. This is because the risk-free rate represents a guaranteed return, while the market portfolio represents a diversified portfolio that includes all risky assets in the market. By holding these two portfolios, investors can achieve the best risk-return tradeoff and maximize their wealth. Holding any additional securities or portfolios would not provide any additional benefits in terms of risk reduction or return enhancement.

If the Australian value of the security does not change but the U.S. dollar depreciates relative to the Australian dollar, the security holder will experience a paper gain. This is because even though the value of the security in Australian dollars remains the same, when converted back to U.S. dollars, the value will increase due to the depreciation of the U.S. dollar. However, this gain is only on paper and not realized until the security is sold.

U.S. equities represent about 51% of the world's equity capitalization. This means that more than half of the total value of global equity markets is attributed to U.S. companies. This indicates the significant influence and dominance of the U.S. stock market in the global economy.

Market risk refers to the risk that an investment will decrease in value due to factors such as economic conditions, market volatility, or changes in interest rates. In a portfolio with only U.S. securities, market risk accounts for about 27% of a security's total risk. This means that approximately 27% of the risk associated with holding a U.S. security is due to market factors, while the remaining percentage is attributed to other factors such as company-specific risk or industry risk.

Most computer output of efficient portfolios lists only the corner portfolios. Corner portfolios are the extreme portfolios in the efficient frontier that represent the optimal combination of assets. These portfolios are used as reference points for constructing efficient portfolios within the risk-return spectrum. By listing only the corner portfolios, the computer output provides a concise representation of the most important portfolios for investors to consider.

Beta is usually calculated using the market model. The market model is a statistical tool used to analyze the relationship between the returns of a specific security and the returns of the overall market. Beta measures the sensitivity of a security's returns to changes in the market returns. By using the market model, analysts can estimate the beta coefficient for a security, which helps investors assess the risk and potential return of the investment. Therefore, the market model is the appropriate method for calculating beta.

The Markowitz algorithm is an application of quadratic programming. This algorithm is used in portfolio optimization to determine the optimal allocation of assets in a portfolio. It aims to minimize the portfolio risk while maximizing the expected return. Quadratic programming is used because the objective function and constraints in portfolio optimization involve quadratic terms, such as variance and covariance. By solving the quadratic programming problem, the Markowitz algorithm helps investors find the most efficient portfolio allocation that balances risk and return.

Forward rates reflect differences in national interest rates. This is because forward rates are the exchange rates at which two parties agree to exchange currencies in the future. These rates are influenced by the interest rates set by central banks in different countries. Higher interest rates in a country tend to attract foreign investors, increasing the demand for its currency and thus strengthening its value. Therefore, the difference in national interest rates affects the forward rates as it reflects the expected future exchange rate between two currencies.

The text described an example of purchasing power parity using Big Mac hamburgers. This refers to the concept of comparing the prices of a Big Mac hamburger in different countries to determine the relative value of currencies. By comparing the prices, it can be determined if a currency is overvalued or undervalued.

Efficient portfolios to the left of the market portfolio are called lending portfolios. This is because these portfolios have a lower expected return and lower risk compared to the market portfolio. Investors who hold these portfolios are essentially lending their funds to other investors or entities, expecting to receive a lower return in exchange for the reduced risk. These portfolios are considered efficient because they offer the best risk-return tradeoff given the investor's risk preferences.

An investor's exchange rate "frame of reference" refers to the currency in which they keep their financial accounts. This is known as the currency of account. It is the currency that the investor uses to measure their gains or losses in their investments and to make decisions based on these measurements.

When the investor purchased the security, the exchange rate was ¥750/$. This means that the investor initially paid $13.33 (¥10,000/¥750) for the security.
When the investor sold the security, the exchange rate had changed to ¥850/$. This means that the investor received $14.12 (¥12,000/¥850) from the sale.
The holding period return can be calculated as the percentage change in value, which is (($14.12 - $13.33) / $13.33) * 100 = 5.9%.
Therefore, the holding period return from a US investor's perspective is 5.9%.

According to Bruno Solnik's study, holding international securities can diversify away seven eighths or 87.5% of the total risk. This implies that by investing in international securities, a significant portion of the risk associated with the investment can be reduced or eliminated.

The prime rate is one of the factors that determine the nominal rate of interest. The nominal rate of interest is the sum of the real rate, inflation rate, and the risk premium. The prime rate is the interest rate that commercial banks charge their most creditworthy customers. It serves as a benchmark for other interest rates, and changes in the prime rate can have a significant impact on borrowing costs for individuals and businesses. Therefore, the prime rate is an important component in determining the overall nominal rate of interest.