Investment Planning practice questions

Answer: B) At a premium or discount to NAV

• AIncorrect. That's open-end funds.
• BCorrect. Based on market supply and demand.
• CIncorrect. They trade on exchanges.
• DIncorrect. They trade on exchanges.

Answer: A) At a discount to par

• ACorrect. Its yield is above its coupon.
• BIncorrect. That's when yield is below the coupon.
• CIncorrect. That's when yield equals the coupon.
• DIncorrect. It still has value.

Answer: B) Total risk

• AIncorrect. That's beta.
• BCorrect. Both systematic and unsystematic.
• CIncorrect. It measures total risk.
• DIncorrect. It measures total risk.

Answer: A) 14%

• ACorrect. ($5 gain + $2 dividend) divided by $50.
• BIncorrect. Include the dividend.
• CIncorrect. Include the price gain.
• DIncorrect. Recheck the calculation.

Answer: D) January effect

• AIncorrect. That isn't the term.
• BIncorrect. That's trend-following.
• CIncorrect. That's about valuation.
• DCorrect. It's a market anomaly.

Answer: B) Upward inflation adjustments to principal are taxable in the year they occur, before they are paid

In a taxable account, the yearly inflation increase in a TIPS bond's principal is taxed as income in the year it occurs, even though the cash isn't received until maturity or sale. That tax on unreceived cash is the 'phantom income.'

• AIncorrect. TIPS pay their semiannual interest in cash. Coupons are not automatically reinvested, and the interest is taxable when it is paid.
• BCorrect. IRS Pub 550 treats increases in the inflation-adjusted principal as income (OID) in the year they occur. The client does not receive that money until maturity or sale, so tax is owed on income not yet received in cash.
• CIncorrect. The fixed coupon rate is applied to the inflation-adjusted principal, and the interest actually paid is what is taxed. The phantom income comes from the principal adjustment, not from a mismatch in how the coupon is calculated.
• DIncorrect. A decrease in inflation-adjusted principal reduces the interest income the holder would otherwise report. It does not add to taxable income.

Answer: A) A decline of about 6%

• ACorrect. Price change ≈ −duration × rate change.
• BIncorrect. Prices fall when rates rise.
• CIncorrect. That ignores duration.
• DIncorrect. That's off by a factor of 10.

Answer: B) Investing fixed amounts at regular intervals

• AIncorrect. That's lump-sum investing.
• BCorrect. Buying more shares when prices are low.
• CIncorrect. It's regular fixed investing.
• DIncorrect. It's regular fixed investing.

Answer: C) 6.0

The Treynor ratio divides excess return (portfolio return minus the risk-free rate) by beta, so it measures return per unit of systematic risk: (12% − 3%) ÷ 1.5 = 6.0. Dividing by standard deviation instead gives the Sharpe ratio.

• AIncorrect. This divides the total return (12%) by beta and forgets to subtract the risk-free rate. The Treynor ratio uses excess return: (12% − 3%) ÷ 1.5 = 6.0.
• BIncorrect. This is the Sharpe ratio: excess return (9%) divided by standard deviation (18%). The Treynor ratio divides by beta (systematic risk), not by total risk.
• CCorrect. Treynor ratio = (portfolio return − risk-free rate) ÷ beta = (12% − 3%) ÷ 1.5 = 6.0, which is the excess return earned per unit of market risk.
• DIncorrect. This multiplies the excess return (9%) by beta instead of dividing by it. The ratio measures excess return per unit of beta, so beta goes in the denominator.

Answer: C) 6.25%

Current yield is the yearly coupon divided by the bond's current price: $50 ÷ $800 = 6.25%. It differs from the coupon rate (based on par) and from yield to maturity (which counts the discount and time to maturity).

• AIncorrect. This is the approximate yield to maturity: ($50 + $200 discount ÷ 10 years) ÷ (($1,000 + $800) ÷ 2) = $70 ÷ $900. Current yield ignores the gain from the discount and the time to maturity.
• BIncorrect. This is the coupon (nominal) rate, $50 ÷ $1,000 par. Current yield uses the bond's market price, not its par value.
• CCorrect. Current yield = annual coupon ÷ current market price = $50 ÷ $800 = 6.25%.
• DIncorrect. This adds the yearly share of the discount to the coupon ($50 + $20 = $70) and divides by par ($1,000). That is a flawed yield-to-maturity estimate, not current yield.