CFP Investment Planning Measures of
Investment Returns questions with
answers.
Robin purchased a 20-year bond with a duration of 11 years for $1,323.18. Which of the following
statements is CORRECT?
A)
The yield to maturity (YTM) is less than both the current yield and the coupon rate.
B)
The coupon rate is lower than the YTM, and the current yield should be higher than the coupon rate.
C)
The current yield is higher than both the coupon rate and the yield to maturity.
D)
The coupon rate is higher than the yield to maturity, and the YTM is higher than the current yield. ANS -
a
CR = coupon rate
CY = current yield
YTM = yield to maturity
Premium bonds: CR > CY > YTM
Par bonds: CR = CY = YTM
Discount bonds: CR < CY < YTM
Because the bond was purchased at a premium, the yield to maturity is less than both the current yield
and the coupon rate.
LO 7.4.1
Cindy has been an active investor for many years. She currently has a money market mutual fund and
several equity mutual funds. She wants to maximize her return on an intermediate-term bond and plans
to hold the bond to maturity.
,Which of the following two bonds would be more appropriate for Cindy, and why?
Bond 1: callable at par value; BBB rated; coupon = 6%; matures in six years; selling for $863; duration =
5.16
Bond 2: callable at par value; A rated; coupon = 10%; matures in four years; selling for $1,103; duration =
3.5
Bond 1, because it is selling for a discount and is less likely to be called.
Bond 1, because it has a higher yield to maturity than Bond 2.
Bond 2, because its higher coupon gives it a better total return.
Bond 2, because it has a higher yield to maturity than Bond 1. ANS -The answer is I and II.
YTM for Bond 1:
END Mode, 2 P/YR
-863 = PV
1000 = FV
30 = PMT
6, DOWNSHIFT, N = 12
Solve for I/YR = 9%
And for Bond 2:
PV = -1103
FV = 1000
PMT = 50
4, DOWNSHIFT, N = 8
Solve for I/YR =7%
In addition, Bond 1 is selling at a discount—unlike Bond 2 selling at a premium—so it is not likely to be
called.
LO 7.4.1
Which of the following statements regarding the various performance measures are CORRECT?
,A positive alpha indicates that the manager consistently underperformed the market on a risk-adjusted
basis.
Jensen's alpha indicates how much the realized return differs from the expected return, as per the
capital asset pricing model (CAPM).
The Sharpe ratio is not useful for evaluating the performance of nondiversified portfolios.
The Treynor ratio does not indicate whether a portfolio manager outperformed or underperformed the
market portfolio.
A)
II, III, and IV
B)
II and IV
C)
I and II
D)
I and III ANS -b
The answer is II and IV. Statements I and III are incorrect. A positive alpha indicates that the manager
outperformed the market on a risk-adjusted basis. The Sharpe ratio uses total risk, as measured by
standard deviation, and is useful for evaluating the performance of both nondiversified and well-
diversified portfolios.
LO 7.2.1
Quincy has narrowed his choice down to the following four mid-cap funds, which is a category he wants
to add to his portfolio. Which fund should Quincy choose?
A Fund J Fund Q Fund Z Fund
Return 12% 9% 13% 11%
Alpha 0.52 -1.04 0.66 1.10
Treynor 0.68 0.21 0.58 0.62
Sharpe 0.44 0.32 0.21 0.37
R-squared 0.88 0.78 0.82 0.84
, A)
J Fund
B)
Z Fund
C)
A Fund
D)
Q Fund ANS -b
The R-squared for all four funds is greater than 0.70, meaning beta is reliable. Alpha uses beta, and is a
measure of absolute return, and the best measure to use if beta is reliable. The fund with the highest
alpha is the Z fund.
LO 7.2.1
A mutual fund with an investment objective of growth and income has an alpha of +4, a beta of 1.5, and
a Sharpe ratio of 1.15. The fund
A)
should not be purchased even though the rate of return compensates for the level of risk.
B)
should be purchased, because the rate of return is high in relation to risk.
C)
should not be purchased, because it has a low level of return in relation to risk.
D)
should be purchased, because it has a relatively low level of risk in relation to return. ANS -b
The answer is should be purchased, because the rate of return is high in relation to risk. A positive alpha
indicates the fund performed better than it should have on a risk-adjusted basis. Also, an alpha of +4,
which is very high, means it performed 4% better than expected.
LO 7.2.1
Andy purchased a four-year bond with a coupon rate of 7.5% paid semiannually. The bond is trading for
$1,025 in the secondary market. Calculate the bond's yield to maturity (YTM).
A)
Investment Returns questions with
answers.
Robin purchased a 20-year bond with a duration of 11 years for $1,323.18. Which of the following
statements is CORRECT?
A)
The yield to maturity (YTM) is less than both the current yield and the coupon rate.
B)
The coupon rate is lower than the YTM, and the current yield should be higher than the coupon rate.
C)
The current yield is higher than both the coupon rate and the yield to maturity.
D)
The coupon rate is higher than the yield to maturity, and the YTM is higher than the current yield. ANS -
a
CR = coupon rate
CY = current yield
YTM = yield to maturity
Premium bonds: CR > CY > YTM
Par bonds: CR = CY = YTM
Discount bonds: CR < CY < YTM
Because the bond was purchased at a premium, the yield to maturity is less than both the current yield
and the coupon rate.
LO 7.4.1
Cindy has been an active investor for many years. She currently has a money market mutual fund and
several equity mutual funds. She wants to maximize her return on an intermediate-term bond and plans
to hold the bond to maturity.
,Which of the following two bonds would be more appropriate for Cindy, and why?
Bond 1: callable at par value; BBB rated; coupon = 6%; matures in six years; selling for $863; duration =
5.16
Bond 2: callable at par value; A rated; coupon = 10%; matures in four years; selling for $1,103; duration =
3.5
Bond 1, because it is selling for a discount and is less likely to be called.
Bond 1, because it has a higher yield to maturity than Bond 2.
Bond 2, because its higher coupon gives it a better total return.
Bond 2, because it has a higher yield to maturity than Bond 1. ANS -The answer is I and II.
YTM for Bond 1:
END Mode, 2 P/YR
-863 = PV
1000 = FV
30 = PMT
6, DOWNSHIFT, N = 12
Solve for I/YR = 9%
And for Bond 2:
PV = -1103
FV = 1000
PMT = 50
4, DOWNSHIFT, N = 8
Solve for I/YR =7%
In addition, Bond 1 is selling at a discount—unlike Bond 2 selling at a premium—so it is not likely to be
called.
LO 7.4.1
Which of the following statements regarding the various performance measures are CORRECT?
,A positive alpha indicates that the manager consistently underperformed the market on a risk-adjusted
basis.
Jensen's alpha indicates how much the realized return differs from the expected return, as per the
capital asset pricing model (CAPM).
The Sharpe ratio is not useful for evaluating the performance of nondiversified portfolios.
The Treynor ratio does not indicate whether a portfolio manager outperformed or underperformed the
market portfolio.
A)
II, III, and IV
B)
II and IV
C)
I and II
D)
I and III ANS -b
The answer is II and IV. Statements I and III are incorrect. A positive alpha indicates that the manager
outperformed the market on a risk-adjusted basis. The Sharpe ratio uses total risk, as measured by
standard deviation, and is useful for evaluating the performance of both nondiversified and well-
diversified portfolios.
LO 7.2.1
Quincy has narrowed his choice down to the following four mid-cap funds, which is a category he wants
to add to his portfolio. Which fund should Quincy choose?
A Fund J Fund Q Fund Z Fund
Return 12% 9% 13% 11%
Alpha 0.52 -1.04 0.66 1.10
Treynor 0.68 0.21 0.58 0.62
Sharpe 0.44 0.32 0.21 0.37
R-squared 0.88 0.78 0.82 0.84
, A)
J Fund
B)
Z Fund
C)
A Fund
D)
Q Fund ANS -b
The R-squared for all four funds is greater than 0.70, meaning beta is reliable. Alpha uses beta, and is a
measure of absolute return, and the best measure to use if beta is reliable. The fund with the highest
alpha is the Z fund.
LO 7.2.1
A mutual fund with an investment objective of growth and income has an alpha of +4, a beta of 1.5, and
a Sharpe ratio of 1.15. The fund
A)
should not be purchased even though the rate of return compensates for the level of risk.
B)
should be purchased, because the rate of return is high in relation to risk.
C)
should not be purchased, because it has a low level of return in relation to risk.
D)
should be purchased, because it has a relatively low level of risk in relation to return. ANS -b
The answer is should be purchased, because the rate of return is high in relation to risk. A positive alpha
indicates the fund performed better than it should have on a risk-adjusted basis. Also, an alpha of +4,
which is very high, means it performed 4% better than expected.
LO 7.2.1
Andy purchased a four-year bond with a coupon rate of 7.5% paid semiannually. The bond is trading for
$1,025 in the secondary market. Calculate the bond's yield to maturity (YTM).
A)
