Chapter 13

Fundamentals of Investing, 12e (Smart/Gitman/Joehnk)
Chapter 13 Managing Your Own Portfolio
13.1 Learning Goal 1
1) Before analyzing needs and objectives, investors should first construct a portfolio.
Answer: FALSE
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: Previous Edition
2) A conservative asset allocation would rely heavily on bonds and short-term securities.
Answer: TRUE
3) Utility stocks are often suitable for low-risk, current-income-oriented portfolios.

Answer: TRUE
4) When developing an asset allocation scheme, it is best to weight each type of asset equally.
Answer: FALSE
Question Status: New Question
5) An investment portfolio should be built around the needs of the individual investor.
Answer: TRUE
6) Asset allocation focuses on selecting specific securities within an asset class.

Answer: FALSE
7) The most important factor in allocation schemes is the investor's age.

Answer: FALSE
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8) An investor's portfolio should only contain securities that are suitable to the investor's goals
and needs.
Answer: TRUE
9) Marti is 31 years old and is saving for retirement. Which one of the following portfolio
allocations might best suit her situation if she is willing to accept a fair amount of risk in
exchange for long-term capital appreciation?
A) 60% bonds, 15% money funds and 25% real estate
B) 5% money funds, 10% bonds and 85% growth stocks
C) 25% bank CDs, 40% corporate bonds, 15% money market, 20% value stocks
D) 50% mortgage bonds, 5% money market, 45% municipal bonds
Answer: B
10) Asset allocation should focus on

A) the investor's financial and family situation.
B) selection of individual securities within an asset class.
C) maximization of current income.
D) maximization of short-term profits.
Answer: A
11) A moderate asset allocation alternative might include

I. bonds.
II. common stocks.
III. foreign securities.
IV. options and commodities futures.
A) I and II only
B) I, III and IV only
C) I, II and III only
D) I, II, III and IV
Answer: C
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12) Which one of the following provides the greatest reduction in total risk?
A) diversification
B) asset allocation
C) security selection
D) beta reduction
Answer: B
13) The fixed-weightings approach to asset allocation

A) is based on an allocation of an equal percentage of the portfolio to each separate asset
category.
B) requires periodic rebalancing of the portfolio to maintain the desired weights.
C) is based on periodic adjustments to category weights in response to market changes.
D) uses stock-index futures and bond futures in a market timing strategy.
Answer: B
14) Tactical asset allocation is most suitable for

A) young, single individuals with good incomes.
B) retirees.
C) large institutional investors.
D) investors who have already accumulated a fair amount of wealth.
Answer: C
15) An asset allocation plan should consider which of the following factors?
I. economic outlook
II. capital preservation
III. changing investment goals
IV. investor risk tolerance
A) II only
B) II, III and IV only
C) I, III and IV only
Answer: D
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16) An asset allocation plan should consider which of the following investor characteristics?
I. income and employment security
II. marital status
III. age and proximity to retirement
IV. social relationships and peer groups
A) II only
B) I, II and III only
C) I, III and IV only
Answer: B
17) Fred and Martha are in their seventies and retired. Which one of the following sets of
portfolio statistics might best suit their situation if their primary investment goal is current
income with limited risk?
A) beta of 0.83 and a dividend yield of 6.3%
B) beta of 0.86, and a dividend yield of 4.6%
C) beta of 1.6 and a dividend yield of 6.4%
D) beta of 1.1 and a dividend yield of 5.4%
Answer: A
18) Fixed weightings, flexible weightings, and tactical asset allocation are three approaches to
asset allocation. Compare and contrast these three different approaches.
Answer: The fixed weightings approach assigns a fixed percentage of the portfolio to each asset
category. This percentage is held constant over time. The flexible weightings approach assigns a
percentage of a portfolio to each asset category but these weightings are changed periodically in
response to changes in the overall market. Tactical asset allocation is a form of market timing
that uses stock-index futures and bond futures to change a portfolio's asset allocation.
1) The Dow Jones Industrial Average (DJIA) includes 500 of the largest companies traded on U.
S. exchanges.
Answer: FALSE
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2) The key areas to monitor when evaluating your portfolio holdings are the overall performance
of both the economy and the financial markets, and the returns on your investments.
Answer: TRUE
3) Once you establish a portfolio designed to achieve your investment goals, you can relax and
forget about your investments until such time as you need the funds.
Answer: FALSE
4) Investors need to monitor economic and market activity to assess the potential impact these
factors can have on their investment portfolios.
Answer: TRUE
5) Several indexes are available to monitor the performance of stocks, but nothing similar is
available for bonds or mutual funds.
Answer: FALSE
6) Most investment professionals consider the Dow Jones Industrial Average (DJIA) to be the
most appropriate comparative gauge for evaluating the investment performance of a broadly
based common stock portfolio.
Answer: FALSE
7) The S&P 500 Stock Composite Index and the NASDAQ Composite Index can be used to
represent the stock market as a whole.
Answer: TRUE
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8) If an investor's portfolio is comprised of a broad range of common stocks, the best measure to
use as a basis of comparison of performance is the
A) Dow Jones Industrial Average (DJIA).
B) S&P 500 index.
C) Dow Jones Corporate Bond Index.
D) American Stock Exchange utilities index.
Answer: B
9) The S & P 500 Index is an appropriate benchmark for

A) diversified portfolios of large company stocks.
B) portfolios diversified among several asset classes such as stocks, bonds, and real estate.
C) diversified portfolios with a mix of large, small, and mid-cap stocks.
D) diversified portfolios of mid-cap and small company stocks.
Answer: A
10) The best index to assess the performance of a portfolio diversified among several asset
classes such as stocks, bonds and real estate is
A) the Lipper Index.
B) the NYSE Composite Index.
C) the Value Line Index.
D) No suitable index exists.
Answer: D
11) Lipper indexes are to assess the performance of

I. equity funds.
II. bond funds.
III. money market funds.
IV. Real Estate Investment Trusts (REITs).
A) I and II only
B) I and III only
Answer: A
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12) The holding period return (HPR) of one's portfolio should be compared to investment goals
I. to assess whether the proper rate of return is being earned for the risk involved.
II. to be sure one's portfolio is outperforming the S&P 500 Index.
III. to isolate any problem investments.
IV. to determine when to change benchmarks from the S&P 500 to the NASDAQ Composite
Index.
A) I and III only
B) II and IV only
D) II, III and IV only
Answer: A
1) The holding period return measures only the capital appreciation of an investment.
Answer: FALSE
2) Returns for periods greater than one year should be measured using the internal rate of return.
Answer: TRUE
3) Holding period return (HPR) captures total return performance by considering current income
and capital gains and is most appropriate for holding periods of one year or less.
Answer: TRUE
4) A rational investor will require the same return from a corporate security as from a
government security.
Answer: FALSE
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5) investors need to consider the effects of taxes and transaction fees when measuring portfolio
returns.
Answer: TRUE
6) If the holding period return (HPR) of an investment is 20 percent before taxes for a nine
month period, an investor in the 30 percent tax bracket would have an after-tax HPR of 14
percent.
Answer: TRUE
7) The calculation of returns on options and futures must consider income as well as capital
gains.
Answer: FALSE
8) Only capital gains that have been realized should be included in the measurement of a
portfolio's return over a given period of time.
Answer: FALSE
9) For a stock investment, the dividend yield is calculated by

A) dividing a stock's annual cash dividend by its price.
B) dividing a stock's price by its annual cash dividend.
C) multiplying a stock's semi-annual dividend by two.
D) dividing the annual change in the stock's price plus its annual dividend amount by the
beginning of the year price.
Answer: A
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10) The holding period return for mutual funds should be based on
A) net asset value exclusively.
B) dividend income exclusively
C) capital gains distributions exclusively
D) capital gains distributions and dividends.
Answer: D
11) The holding period return (HPR)

A) reflects only capital gains and losses for investment periods of one year or less.
B) calculates the annual dividend yield on stocks or current interest yield on bonds.
C) is the most appropriate measure of returns for an investment period exceeding one year.
D) can be used to determine the actual total return on stocks, bonds, and other investments for
periods of one year or less.
Answer: D
12) To compute the holding period return on a bond investment, the investor should divide the
purchase price of the bond into
A) any increase or decrease in the bond's price.
B) the annual coupon payment.
C) the bond's yield to maturity.
D) coupon payments received plus or minus any change in the bond's price.
Answer: D
13) Juan's investment portfolio was valued at $125,640 at the beginning of the year. During the
year, Juan received $603 in interest income and $298 in dividend income. Juan also sold shares
of stock and realized $1,459 in capital gains. Juan's portfolio is valued at $142,608 at the end of
the year. All income and realized gains were reinvested. No funds were contributed or withdrawn
during the year. What is the amount of income Juan must declare this year for income tax
purposes?
A) $0
B) $901
C) $2,360
D) $19,328
Answer: C
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14) On January 1, Stacy's portfolio was valued at $96,534. During the year Stacy received
$3,285 in interest and $4,100 in dividends. She also sold one stock at a gain of $850. The value
of the portfolio on December 31 of the same year was $113,201. At the end of June, Stacy
withdrew $5,000 from the portfolio. What is the holding period return for the year?
A) 25.1%
B) 25.8%
C) 26.5%
D) 27.2%
Answer: C
15) Six months ago, Suzanne purchased a stock for $28 a share. Today she sold the stock at a
price of $32 a share. During the time she owned the stock, she received a total of $1.30 in
dividends per share. What is her holding period return?
A) 16.6%
B) 18.9%
C) 33.2%
D) 37.8%
Answer: B
16) Ten months ago, Junior purchased a stock for $14 a share. The stock pays a quarterly
dividend of $0.50 per share. Today, Junior sold the stock for $15 a share. What is his holding
period return?
A) 10.0%
B) 10.7%
C) 16.7%
D) 17.9%
Answer: D
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17) Ten years ago, Taylor purchased 444.44 shares in a mutual fund for $22.50 per share. He has
never made an additional investment in this fund, but because of reinvested dividends and capital
gains, he now owns 1,200 shares with a net asset value of $25.88 per share. Ignoring taxes, his
compound average annual rate of return (IRR) is
A) 10.0%.
B) 12%.
C) 21%.
D) 31%.
Answer: B
18) Tim purchased a stock ten months ago for $14 a share, received a $1 dividend per share last
month, and sold the stock today for $16 per share. Tim has a marginal tax rate of 30%. Both
capital gains for securities held more than one year and dividend income is taxed at 15%. What is
Tim's after-tax holding period return?
A) 14.1%
B) 15.9%
C) 16.1%
D) 18.2%
Answer: C
19) On February 19, 2004, Angela purchased 100 shares of ABC stock at a total cost of
$1,712.50. She received a total of $125.00 in dividends and sold the stock today, February 22,
2005. Her net proceeds from the sale are $1,892.40. Angela has a combined state and federal
marginal tax rate of 32%. Her combined state and federal tax rate on both her capital gains in
excess of one year and her dividend income is 18%. What is Angela's after-tax holding period
return on her investment in ABC stock?
A) 11.0%
B) 12.1%
C) 13.2%
D) 14.6%
Answer: D
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20) An investor in the 25% marginal tax bracket purchased a bond for $983, received $85 in
interest, and then sold the bond for $955 after holding it for six months. The tax rate for capital
gains with holding periods in excess of one year is 15%. What are the pre-tax and post-tax
holding period returns?
A) 5.8%; 4.3%
B) 6.0%; 4.5%
C) 5.8%; 4.5%
D) 6.0%; 4.3%
Answer: A
21) Investors who wish to minimize the effect of taxes on their investment returns should try to
avoid
A) dividend paying stocks.
B) short-term capital gains.
C) long-term capital gains.
D) municipal bonds.
Answer: B
22) Maria purchased $5,000 of no-load mutual fund shares just over a year ago. She received
$136 in dividend income and $201 in long-term capital gains distributions. Today she sold her
shares for $5,062. Maria is in the 25% marginal tax bracket. Capital gains with holding periods
in excess of one year and dividend income are taxed at 15%. What is Maria's after-tax holding
period return?
A) 6.0%
B) 6.6%
C) 6.8%
D) 8.0%
Answer: C
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23) On January 1, Tim's portfolio was valued at $432,098. During the year Tim received $10,563
in interest and $15,060 in dividends. He also sold stock at a net loss of $12,870 and used the
proceeds to purchase another stock. Tim did not contribute any more funds nor withdraw any
funds during the year. On December 31 of the same year, Tim's portfolio was valued at
$398,189. What is the holding period return for the year?
A) -5.3%
B) -4.9%
C) -2.1%
D) -1.9%
Answer: D
1) Sharpe's measure of portfolio performance adjusts for risk by dividing total portfolio return by
the portfolio beta.
Answer: FALSE
2) Sharpe's measure of portfolio performance compares the risk premium on a portfolio to the
portfolio's standard deviation of return.
Answer: TRUE
3) Sharpe's measure is a measure of the risk premium per unit of total risk.
Answer: TRUE
4) Jensen's measure of portfolio performance compares the risk premium on a portfolio to the
portfolio's beta.
Answer: FALSE
5) Sharpe's measure, Treynor's measure, and Jensen's measure all focus on non-diversifiable risk.
Answer: FALSE
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6) Sharpe measures total risk while Treynor and Jensen measure only systematic risk.
Answer: TRUE
7) A Jensen measure of 2.5% means that a security earned 2.5% more than the overall market.
Answer: FALSE
8) Portfolio revision is the ongoing process of systematically studying the issues in the portfolio
and selling certain issues and purchasing others as the means of maintaining a portfolio that best
meets the investor's objectives.
Answer: TRUE
9) Which of the following are reasons to consider selling an investment that is currently in a
portfolio?
I. The investment has met the original objective.
II. Better investment opportunities currently exist.
III. The outlook for the investment has improved.
IV. The investment has not met expectations and no change is expected.
A) I, II and IV only
B) I, III and IV only
Answer: A
10) A problem investment

A) requires immediate attention.
B) is one you would buy if you did not already own it.
C) is defined as any investment with unrealized losses.
D) should be left alone and given time to correct itself.
Answer: A
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11) Allison's portfolio has an expected return of 14% and a standard deviation of of 20%.
Brianna's portfolio has an expected rate of return of 11% and a standard deviation of 12%. The
risk-free rate is 3%. According to the Sharpe measure,
A) Allison has the better portfolio.
B) Brianna has the better portfolio.
C) The portfolio's are equally desirable.
D) The answer depends on Allison and Brianna's risk tolerance.
Answer: B
12) Ella owns a stock with a beta of 1.34 and a standard deviation of 16.4%. The stock has a total
return of 14.8%. The market risk premium is 8.5%, while the return on the market portfolio was
12.0%. What is the value of Sharpe's measure for Ella's portfolio?
A) 0.21
B) 0.38
C) 0.69
D) 0.90
Answer: C
13) Sharpe's measure of portfolio performance compares the risk premium on a portfolio to
A) a broad-based market index such as the S&P 500 index.
B) the portfolio's standard deviation of return.
C) the portfolio's beta.
D) the prevailing risk-free rate of return.
Answer: B
14) The Sharpe's measure for Jane Smith's investment portfolio is 0.40, while the Sharpe's
measure for the market is 0.30. This information suggests that Smith's portfolio
A) exhibits superior performance because its risk premium per unit of risk is above that of the
market.
B) exhibits poor performance because its risk premium per unit of risk is below that of the
market.
C) is inadequately diversified, and more securities should be added to the portfolio in order to
bring it in line with the market.
D) is overly diversified, and some securities should be sold to bring the portfolio in line with the
market.
Answer: A
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15) Phil has a portfolio with a 13.2% total return. The beta of the portfolio is 1.48 and the
standard deviation is 13%. Currently, the risk-free rate of return is 4% and the overall market has
a total return of 11%. What is the value of Treynor's measure for Phil's portfolio?
A) 2.1%
B) 6.2%
C) 7.1%
D) 8.9%
Answer: B
16) Allison's portfolio has an expected return of 14% and a beta of 1.37. Brianna's portfolio has
an expected rate of return of 11% and a beta of 1. The risk-free rate is 3%. According to the
Treynor measure,
C) The portfolio's are equally desirable.
D) The answer depends on Allison and Brianna's risk tolerance.
Answer: C
17) A portfolio has a total return of 14.5%, a beta of 1.54, and a standard deviation of 17.6%. If
the risk free rate is 4.5% and the market return is 10.2%, then Treynor's measure of this
portfolio's performance is
A) 2.8%.
B) 3.7%.
C) 6.5%.
D) 9.4%.
Answer: C
18) A stock has a total return of 16.4%, a standard deviation of 14.5% and a beta of 1.63. The
market rate of return is 12.4%, while the market's Treynor measure is 6.3. What is the value of
the Treynor measure of this portfolio?
A) 2.5%
B) 6.3%
C) 18.4%
D) 27.6%
Answer: B
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19) Treynor's measure of portfolio performance focuses on
A) nondiversifiable risk.
B) diversifiable risk.
C) total risk.
D) the standard deviation of the portfolio.
Answer: A
20) Which of the following measures is based on the capital asset pricing model?
A) Only Sharpe's measure
B) Only Treynor's measure
C) Only Jensen's measure
D) Both Treynor's and Jensen's measures
Answer: D
Question Status: Revised
21) A portfolio has a total return of 10.5%, a beta of 0.72 and a standard deviation of 6.3%. The
risk free rate is 3.8%, the market return is 12.4%. Jensen's measure of this portfolio's
performance is
A) 0.5%.
B) 4.3%.
C) 7.9%.
D) 9.3%.
Answer: A
22) Which one of the following statements is correct if a portfolio has a Jensen measure of return
of zero?
A) The portfolio has a total return of zero percent.
B) The portfolio earned exactly its expected return on a risk-adjusted basis.
C) The portfolio outperformed the market on a risk-adjusted basis.
D) The market provides a better return on a risk-adjusted basis.
Answer: B
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23) Allison's portfolio has an expected return of 14% and a beta of 1.37. Brianna's portfolio has
an expected rate of return of 11% and a beta of 1. The risk-free rate is 3% and the expected rate
of return on the market is 12%. According to the Jensen's measure,
C) the portfolios are equally desirable.
D) the answer depends on Allison and Brianna's risk tolerance.
Answer: B
24) Which of the following statements about Jensen's measure are correct?
I. Through its use of the capital asset pricing model, Jensen's measure automatically adjusts for
market return.
II. In general, the higher the Jensen's measure, the better a portfolio has performed.
III. Jensen's measure is referred to as alpha.
IV. A positive Jensen's measure indicates an investment has underperformed the market on a
risk-adjusted basis.
A) I and IV only
B) I, II and III only
C) II and III only
D) I, III and IV only
Answer: B
25) The process of selling certain issues in a portfolio and purchasing new ones to replace them
is known as
A) portfolio revision.
B) market timing.
C) red herring baiting.
D) dollar cost averaging.
Answer: A
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26) One year ago, Matt bought 100 shares of ACE Corp. stock for $5,619 including commission.
He is about to sell the ACE stock for $6,528 net of commissions. When he made the purchase the
S&P 500 index was at 907; now it is 1070. The beta of ACE stock is 0.98, and the market's risk-
free rate is 4.0%. No dividends were paid. Based on Jensen's measure, did Matt make a good
purchase?
Answer: HPR (ACE) =($6,528 - $5,619)/$5,619 = 16.18%
HPR (S&P 500) = (1070 - 0907)/907 = 17.97%
Jensen's Measure = (16.18% - 4.0%) - [0.98 (17.97% - 4.0%)]
= 12.18% - 13.69% = -1.51%
Therefore, Matt made a bad investment, since the stock has an excess return of -1.51% which
means the stock earned 1.51% less than it should have on a risk-adjusted basis.
27) The Witney Growth Fund, a no-load mutual fund, had a net asset value per share of $54.28
one year ago. Its current net asset value is $56.93. During the year it paid out dividends and
capital gains of $2.08 per share. It has a beta value of 1.75. Over the same period the market
return was 6.4% and the risk-free rate of return was 3.5%.
(a) Calculate Treynor's measure for the Witney Growth Fund. (Show all work.)
(b) Based on Treynor's measure, how did the fund perform in relation to the overall market?
Answer:
(a) HPR (fund) =[$2.08 + ($56.93 - $54.28)]/$54.28 = 8.71%
Treynor's (fund) = (8.71% - 3.5%)/1.75 = 2.98%
(b) Treynor (market) = (6.4% - 3.5%)/1.00 = 2.90%
The fact that Treynor's measure of 2.98% for the Witney Growth Fund is greater than the 2.90%
measure for the market indicates that the fund's performance is superior to the market. That is,
the fund's risk premium per unit of nondiversifiable risk is greater than that of the market.
28) Explain the type of risk measured by each of the following measures. Also identify the factor
in each formula that determines the type of risk that is being measured.
(a) Jensen's measure
(b) Sharpe's measure
(c) Treynor's measure
Answer:
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1) Formula plans are high-risk investment strategies that attempt to benefit from cyclical price
movements.
Answer: FALSE
2) Dollar cost averaging is a formula plan to purchase the same number of shares of stock at
regular intervals of time.
Answer: FALSE
3) Dollar cost averaging is a formula plan which automatically causes investors to purchase more
shares when the price is low and purchase fewer shares when the price is high.
Answer: TRUE
4) Successful dollar cost averaging depends on the investor's skill in timing the market.
Answer: FALSE
5) Investors who use formula plans believe that they have above average ability to time the
market and pick successful investments.
Answer: FALSE
6) A constant-ratio plan requires an investor to periodically rebalance the portfolio.

Answer: TRUE
Question Status: Revised
7) A constant ratio plan allows for speculative gains while limiting potential losses.
Answer: TRUE
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8) Which one of the following statements concerning formula plans is correct?
A) The use of subjective judgment is important to the routine administration of most formula
plans.
B) Formula plans are based on the adherence to a mechanical set of rules with regard to when to
buy and/or sell.
C) The objective of most formula plans is to maximize profits.
D) Securities with very stable prices are best suited to nearly all formula plans.
Answer: B
9) Dollar cost averaging is a procedure by which an investor

A) buys more stock as its price increases.
B) times investments in order to buy low and sell high.
C) invests a fixed dollar amount in a security at fixed intervals.
D) maintains a constant ratio of conservative and aggressive investments.
Answer: C
10) Which one of the following statements is correct concerning dollar cost averaging plans?
A) Dollar cost averaging is an active trading strategy.
B) Dollar cost averaging is a short-term trading strategy.
C) The goal of dollar cost averaging is current dividend income.
D) The goal of dollar cost averaging is long-term capital appreciation.
Answer: D
11) The general theory of dollar cost averaging is

A) to time the market to take advantage of low stock prices.
B) to buy more stock when prices are low and less when prices are high.
C) to equal the performance of market averages at the lowest dollar cost.
D) to sell as markets decline and buy as they begin to rise.
Answer: B
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12) When using a constant dollar plan,
A) gains from the speculative portion of the portfolio are transferred to the safe portion of the
portfolio.
B) the amount of money in the speculative portion of the portfolio should decline over time.
C) the percentage of funds in the speculative portion of the portfolio should increase over time.
D) the ratio of safe funds to speculative funds remains constant over time.
Answer: A
13) The formula plan that requires maintaining a target dollar investment in the speculative
portion of an investor's portfolio is the
A) most passive of all the formula plans.
B) target return plan.
C) constant ratio plan.
D) constant dollar plan.
Answer: D
14) If a constant-dollar plan portfolio is profitable over the long run, the ________ in value over
time.
A) conservative portion will increase
B) conservative portion will remain constant
C) aggressive portion will decrease
D) entire portfolio will remain constant
Answer: A
15) The constant-ratio plan

A) requires the establishment of trigger points for portfolio rebalancing.
B) utilizes a predetermined ratio between desired current yield and expected capital gains.
C) strictly adheres to a buy-and-hold strategy.
D) is an attempt to time the cyclical movements of the market.
Answer: A
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16) The formula plan which requires the greatest management attention and is also the most
aggressive is called the ________ plan.
A) dollar cost averaging
B) constant dollar
C) constant ratio
D) variable ratio
Answer: D
17) The theory behind the variable ratio plan is to

A) passively buy and hold a wide variety of securities.
B) time the cyclical movements of the stock market and thereby "buy low and sell high."
C) avoid selling any security for a capital gain, and thus indefinitely avoiding the capital gains
tax.
D) keep the unit cost of the portfolio at a constant level.
Answer: B
18) Investors who who accept the random walk theory should use
A) a dollar cost averaging plan.
B) a constant dollar plan.
C) a constant ratio plan.
D) a variable ratio plan.
Answer: A
19) Which of the following is ideally suited to automatic investing through a payroll deduction
plan?
A) a dollar cost averaging plan
B) a constant dollar plan
C) a constant ratio plan
D) a variable ratio plan
Answer: A
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20) Under the variable-ratio plan, additional speculative investments are made when the ratio
A) of conservative investments to speculative investments increases by 10%.
B) of the rate of return on the speculative investments exceeds the overall market return by 1%
or more.
C) of the realized rate of return falls below the desired rate of return by 1% or more.
D) of the value of the speculative investments to the total portfolio value drops below a
predetermined level.
Answer: D
21) An investor adopts a policy of investing in both an aggressive mutual fund and a short-term
bond fund. When the value of the aggressive fund exceeds 65% of the portfolio value, shares of
that fund are sold such that the aggressive fund represents only 45% of the portfolio. This is an
example of a ________ plan.
A) constant-dollar
B) dollar-cost averaging
C) constant-ratio
D) variable-ratio
Answer: D
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22) Net asset values at the end of each month for the no-load Currier & Ives fund are shown
below. Holly Tannenbaum invests $500 in the fund each month through an automatic
investment plan. Compute:
a. the number of shares purchased each month
b. the number of shares she owns at the end of December
c. the average price of the shares over the period
d. the average price per share paid by Holly
NAV end of Shares

Month month purchased
July 12.85
August 11.08
September 9.99
October 9.85
November 13.55
December 12.21
Answer:
NAV end of Shares
Month month purchased
July 12.85 38.91
August 11.08 45.13
September 9.99 50.05
October 9.85 50.76
November 13.55 36.90
December 12.21 40.95
Total shares 262.70
Average price
over the
period 11.59
Average price
paid by Holly 11.42
25
23) Dollar-cost averaging plans and constant-dollar plans are both formula approaches to
portfolio management. Briefly explain the two plans.
Answer: Dollar-cost averaging involves investing a fixed dollar amount in a security at fixed
intervals. It's a passive buy-and-hold strategy. If the price of the security declines, more shares
are bought; if the price rises, fewer shares are bought. A constant dollar plan divides a portfolio
into a speculative and a conservative part. The target dollar amount for the speculative portion is
constant, and the investor establishes trigger points at which funds are added to or removed from
that portion. For example, if the speculative part goes up, funds are skimmed off and put into the
conservative part.
1) A stop-loss order guarantees that an investor's unrealized profit will be protected.

Answer: FALSE
2) If an investor has a loss position in an investment and wants to sell it, the best time to sell for
tax purposes is when a capital gain is available against which the loss can be applied.
Answer: TRUE
3) The maximum capital loss that can be applied to ordinary income for income tax purposes in
any one year is $3000.
Answer: TRUE
4) An investor who wants to take advantage of a temporary decline in the price of a stock should
use a limit order.
Answer: TRUE
5) Over a period of time if an investment has not met its return objective, it should be sold.
Answer: TRUE
26
6) For tax purposes, it is advisable to sell stocks that have lost value and keep stocks that have
increased in value.
Answer: TRUE
7) The primary risk in using a GTC limit sell order rather than a market order is that
A) the market price may exceed the limit price when the order is placed.
B) the limit order may not be executed.
C) the limit order may be executed at a price above the market price.
D) the limit order expires at the end of the day and may not be executed.
Answer: B
8) A stop loss order may not protect an investor's profits if

A) the price drops even slightly below the stop price before the order can be executed.
B) the price enters a prolonged period of gradual decline.
C) an unexpected event cause the price to drop steeply when the markets are closed.
D) the stop loss price is never reached.
Answer: C
9) A stop loss order may not be advisable

A) when an investor wants to protect a gain.
B) an investor wants is expecting an earnings announcement that may either exceed or fall short
of expectations.
C) a stock exhibits wide and rapid price fluctuations.
D) when an investor wants to sell in the near future but still profit from any short-term price
increases.
Answer: C
27
10) Which of the following are characteristics of stop-loss orders?
I. the risk of whipsawing
II. the ability to limit downside losses
III. the guaranteed execution within the order period
IV. the conversion to a market order
A) I and II only
B) III and IV only
C) I, II and IV only
D) II, III and IV only
Answer: C
11) Suppose the shares of the Chickadee Corporation traded seven times in the following
sequence one day last week: 46, 45.88, 45.75, 45.50, 45.63, 46, 46.13. In this case, a limit order
to sell at 46 would have been executed
A) between 46 and 46.13, whereas a market order to sell could have been executed anywhere
between 45.50 and 46.13.
B) anywhere between 45.50 and 46.13, whereas a market order to sell would have been executed
only at 46.
C) only at 46, whereas a market order to sell would have been executed at 46.13.
D) only at 46.13, and a market order to sell would have been executed between 46 and 46.13.
Answer: A
12) The two primary media for warehousing liquidity are

A) money market mutual funds and money market deposit accounts.
B) certificates of deposit and short-term bond funds.
C) certificates of deposit and long-term bond funds.
D) short-term bond funds and asset allocation funds.
Answer: A
28
13) Which of the following are reasons why a person may want to warehouse liquidity?
I. protect against total loss
II. ability to exploit future opportunities
III. capitalize on the high rates of return available on cash
IV. protect against the need to disturb the existing portfolio
A) I and II only
B) I, II and IV only
C) II, III and IV only
Answer: B
14) One important tax rule concerning capital losses is that

A) capital losses are always fully deductible.
B) a maximum of $3,000 of losses in excess of capital gains can be written off against ordinary
income in any one year.
C) a maximum of $10,000 of losses in excess of capital gains can be written off against other
income in any one year.
D) capital losses are never deductible.
Answer: B
15) Which of the following are generally considered to be good investment guidelines?
I. Sell any security that has become riskier than anticipated.
II. Hold all securities until they produce the highest profit attainable.
III. Sell securities only if the profit can be offset with a tax loss.
IV. Sell any security that no longer meets the needs of the investor.
A) I and IV only
B) I and III only
C) I, II and IV only
Answer: A
29
16) Late in the calendar year, Jessica must choose between selling stock that was purchased 2
years ago for $10,000 and has fallen to $7,000 or a different stock that was purchased 1 year ago
for $5,000 and has risen to $7,000. If the investor has no other capital gains, which stock should
she sell?
Answer: The tax laws allow investors to deduct up to $3,000 of long-term capital losses from
ordinary income. If Jessica is in the 25% marginal tax bracket, selling the losing stock will save
her $3,000 × .25 or $750 in taxes. If she sells the winning stock, she will pay a capital gains tax
of 15% ($2,000 × .15 = $300), so she will be better off by $1.050 if she sells the losing stock and
keeps the winner.
17) Explain the use of limit orders and stop-loss orders in rebalancing an investor's stock
portfolio. What are the principal risks in using these orders?
Answer: Limit orders can be used to buy or sell securities. They can ensure that an investor buys
only at or below his or her desired purchase price or sells only at or above the desired price. The
risk is the order might not be executed. The stop-loss order can be used to limit the downside
loss exposure of an investment, or to protect a profit. The principal risk is whipsawing—where a
stock temporarily drops then bounces back up after an investor has sold it at the low price.
30

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Fundamentals of Investing, 12e (Smart/Gitman/Joehnk)

Chapter 13 Managing Your Own Portfolio

13.1 Learning Goal 1

3) Utility stocks are often suitable for low-risk, current-income-oriented portfolios.

6) Asset allocation focuses on selecting specific securities within an asset class.

7) The most important factor in allocation schemes is the investor's age.

10) Asset allocation should focus on

11) A moderate asset allocation alternative might include

13) The fixed-weightings approach to asset allocation

14) Tactical asset allocation is most suitable for

13.2 Learning Goal 2

9) The S & P 500 Index is an appropriate benchmark for

11) Lipper indexes are to assess the performance of

13.3 Learning Goal 3

9) For a stock investment, the dividend yield is calculated by

11) The holding period return (HPR)

13.4 Learning Goal 4

10) A problem investment

6) A constant-ratio plan requires an investor to periodically rebalance the portfolio.

9) Dollar cost averaging is a procedure by which an investor

11) The general theory of dollar cost averaging is

15) The constant-ratio plan

17) The theory behind the variable ratio plan is to

NAV end of Shares

13.6 Learning Goal 6

1) A stop-loss order guarantees that an investor's unrealized profit will be protected.

8) A stop loss order may not protect an investor's profits if

9) A stop loss order may not be advisable

12) The two primary media for warehousing liquidity are

14) One important tax rule concerning capital losses is that

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