NASAA Series 66 — All Questions

In the DuPont breakdown of return on equity, ROE equals net profit margin multiplied by asset turnover multiplied by:

• a.The equity multiplier (total assets divided by shareholders' equity)✓
• b.The current ratio (current assets divided by current liabilities)
• c.The dividend payout ratio (dividends divided by net income)
• d.The interest coverage ratio (EBIT divided by interest expense)

DuPont analysis writes ROE = (net income / sales) x (sales / assets) x (assets / equity). The last term, the equity multiplier, captures financial leverage. The current ratio measures liquidity, the payout ratio measures dividend policy, and interest coverage measures debt-service capacity; none belongs in the identity.

A company has current assets of $600,000, of which $200,000 is inventory, and current liabilities of $400,000. What is its quick (acid-test) ratio?

• a.1.5
• b.2.0
• c.0.5
• d.1.0✓

The quick ratio removes inventory from current assets: ($600,000 - $200,000) / $400,000 = 1.0. Leaving inventory in gives the current ratio of 1.5. Dividing inventory by current liabilities gives 0.5, which is not a liquidity measure. Dividing the inventory-excluded assets by the inventory is another misuse and yields 2.0.

A company has EBIT of $9 million and annual interest expense of $3 million. What is its interest coverage ratio?

• a.0.33 times
• b.3.0 times✓
• c.6.0 times
• d.12.0 times

Interest coverage = EBIT / interest expense = $9M / $3M = 3.0 times, meaning operating profit covers interest three times over. The inverse, 0.33, is the share of EBIT consumed by interest. Subtracting the interest from EBIT gives 6 and adding it gives 12, but neither is a ratio of EBIT to interest.

A company has cost of goods sold of $600 million for the year, and its average inventory was $100 million. What is its inventory turnover?

• a.7.0 times
• b.5.0 times
• c.0.17 times
• d.6.0 times✓

Inventory turnover = cost of goods sold / average inventory = $600M / $100M = 6.0 times. Inverting the fraction gives 0.17, which is not a turnover rate. Subtracting the inventory from the cost base ($500M) or adding it ($700M) before dividing gives 5.0 and 7.0, neither of which is the standard formula.

A company had revenue of $500 million and cost of goods sold of $300 million. What is its gross profit margin?

• a.40%✓
• b.60%
• c.66.7%
• d.200%

Gross margin = (revenue - COGS) / revenue = $200M / $500M = 40%. The 60% figure is the cost ratio, COGS / revenue. Dividing gross profit by COGS gives 66.7%, a markup rather than a margin. A margin on revenue cannot exceed 100%, so 200% could not be right.

Which of the following items appears on a company's income statement rather than on its balance sheet?

• a.Accounts receivable from customers
• b.Depreciation expense for the year✓
• c.Retained earnings at year-end
• d.Accumulated depreciation on equipment

Depreciation expense is a charge against revenue for the period and so belongs on the income statement. Accumulated depreciation is the running total deducted from asset values on the balance sheet. Retained earnings and accounts receivable are balance sheet items measuring cumulative equity and amounts owed by customers at a point in time.

A company reports net income of $10 million, includes $3 million of depreciation expense, and has no changes in working capital. Ignoring other adjustments, its cash flow from operations is approximately:

• a.$3 million, because only the depreciation charge itself is cash generated
• b.$10 million, since depreciation does not affect cash flow in any way
• c.$7 million, because depreciation is a cash cost that must be subtracted
• d.$13 million, because depreciation is a non-cash charge added back✓

Depreciation lowered net income but did not use cash, so it is added back: $10M + $3M = $13M. Subtracting it treats a non-cash charge as a cash outflow. Saying it has no effect ignores the add-back that reconciles net income to cash. The depreciation charge itself is not a source of cash.

A company has an equity market value of $200 million, debt of $100 million, and cash of $50 million. What is its enterprise value?

• a.$150 million
• b.$300 million
• c.$200 million
• d.$250 million✓

Enterprise value = market value of equity + debt - cash = $200M + $100M - $50M = $250M. Using equity alone leaves out the debt claims. Adding debt but ignoring cash gives $300M, which overstates the price a buyer would effectively pay. Subtracting cash from equity without adding the debt gives $150M, which leaves out the debt.

A stock trades at $45 per share. The company's book value per share is $30. What is its price-to-book (P/B) ratio?

• a.75
• b.15
• c.1.5✓
• d.0.67

P/B = market price / book value per share = $45 / $30 = 1.5. Dividing book value by price gives 0.67, the inverse. Subtracting gives $15, a dollar premium rather than a ratio. Adding the two figures gives 75, which has no meaning.

A stock is expected to pay a dividend of $2.00 next year, which is expected to grow 4% per year indefinitely. The required return is 10%. Using the constant-growth dividend discount model, the stock's value is closest to:

• a.$14.29
• b.$20.00
• c.$33.33✓
• d.$50.00

The Gordon growth model gives value = D1 / (r - g) = $2.00 / (0.10 - 0.04) = $33.33. Dividing by the required return alone ($20) ignores growth. Dividing by r + g ($2.00 / 0.14 = $14.29) adds the growth rate when it should be subtracted. Using g alone as the denominator ($50) ignores the required return.

A portfolio's annual returns have a variance of 0.0225. What is the portfolio's standard deviation?

• a.0.05%, found by squaring the variance
• b.15%, found by taking the square root of the variance✓
• c.1.1%, found by dividing the variance by two
• d.2.25%, found by restating the variance as a percentage

Standard deviation is the square root of variance: the square root of 0.0225 is 0.15, or 15%. Restating 0.0225 as 2.25% never takes the root, and dividing by two confuses the root with a half. Squaring the variance moves in the wrong direction and gives a tiny figure.

Weak-form market efficiency holds that current prices already reflect all past price and volume data. Which conclusion follows?

• a.Prices never deviate from intrinsic value, so valuation models are pointless
• b.Corporate insiders cannot earn excess returns from trading on nonpublic information
• c.Fundamental analysis of public financial statements cannot earn any excess returns
• d.Technical analysis of past prices cannot consistently earn excess returns✓

If past prices are fully reflected, chart patterns and trading rules built on historical data have no predictive edge, which defeats technical analysis. Ruling out fundamental analysis requires semi-strong efficiency, and ruling out insider profits requires strong-form efficiency. Efficiency does not claim prices equal intrinsic value in every period, only that deviations are not predictably exploitable.

Semi-strong form market efficiency holds that prices reflect all publicly available information. Which conclusion follows?

• a.Analysis of past price patterns can still consistently produce excess returns over time
• b.Analysis of published financial statements cannot consistently beat the market✓
• c.Insiders trading on material nonpublic information gain no advantage over others
• d.Price changes can be predicted from the previous day's volume and price pattern

If all public information is already in prices, studying financial statements or news cannot reliably beat the market. Semi-strong efficiency includes past prices, so chart analysis also fails to give an edge. Insiders can still profit under semi-strong efficiency, because nonpublic information is not yet reflected; only the strong form rules that out. Volume patterns are historical data and are covered as well.

On a price chart, a head-and-shoulders top is generally interpreted by technical analysts as a signal that:

• a.An uptrend is likely to continue at a faster pace
• b.A downtrend is ending and a rally is likely to begin
• c.An uptrend is likely to reverse into a sustained downtrend✓
• d.Price will remain in a narrow range with no trend

A head-and-shoulders top is a reversal pattern at the end of an advance, with a break below the neckline signaling a decline. A continuation signal would come from patterns such as flags or pennants. A downtrend ending is the job of the inverse head-and-shoulders. A narrow sideways range is a consolidation pattern.

A stock has repeatedly fallen to $40 and then rebounded, and has repeatedly rallied to $55 and then turned back. In technical analysis, $40 and $55 are called, respectively:

• a.Support and resistance✓
• b.Resistance and support
• c.Breakout and breakdown
• d.Floor and ceiling prices

Support is a price level where buying has repeatedly halted declines, and resistance is a level where selling has repeatedly stopped advances. Reversing the terms flips the roles. A breakout or breakdown happens when price moves through one of those levels. Floor and ceiling prices suggest limits imposed from outside, but these levels arise from trading behavior.

A 50-day moving average of a stock's closing prices is used mainly to:

• a.Smooth short-term fluctuations so the underlying trend is easier to see✓
• b.Measure how widely the stock's returns have varied around their mean over time
• c.Calculate the intrinsic value of the company from its projected cash flows
• d.Estimate the company's next quarterly earnings per share from sales trends

A moving average damps daily noise so analysts can judge trend direction. Earnings forecasts come from fundamental analysis of the business. Intrinsic value from cash flows comes from discounting models. The dispersion of returns around their mean is the standard deviation, a different statistic.

A savings account states a 12% annual rate, compounded semiannually. What is its effective annual yield?

• a.6.00%
• b.12.36%✓
• c.12.68%
• d.12.00%

Semiannual compounding at 6% per period gives (1.06)^2 - 1 = 12.36%. The nominal 12% ignores the interest earned on interest in the second period. 12.68% is the result of monthly compounding (1.01^12 - 1), which is not what the account does. 6% is only the rate per period.

A preferred stock pays a fixed dividend of $5 per year indefinitely. If investors require a 5% annual return, the value of one share is:

• a.$25
• b.$100✓
• c.$250
• d.$5

A perpetuity is worth its annual payment divided by the required return: $5 / 0.05 = $100. Multiplying $5 by 5 gives $25, and the payment alone ($5) ignores discounting. Dividing by 0.02 would be needed to reach $250, which does not match the stated 5% return.

Under the net present value (NPV) rule, a company should accept a project when:

• a.Its cash flows, discounted at the required return, exceed its cost✓
• b.The sum of its future cash flows, with no discounting, exceeds its cost
• c.Its payback period is longer than that of the company's other projects
• d.Its accounting profit is positive in the first full year of operation

NPV discounts future cash flows at the required return, and a positive NPV means the project adds value. Undiscounted sums ignore the time value of money. A longer payback is not a criterion for acceptance; shorter payback is preferred. First-year accounting profit does not capture the full timing or size of cash flows.

When the Federal Reserve raises its target for the federal funds rate and market interest rates rise, the prices of existing fixed-rate bonds will most likely:

• a.Rise, because investors prefer bonds when rates are higher
• b.Rise, because higher rates signal a stronger economy ahead
• c.Fall, because new bonds are issued with higher coupons✓
• d.Stay constant, because the coupon payments are fixed in dollars

Bond prices and yields move in opposite directions: existing bonds with lower coupons must trade at a discount to compete with new, higher-yielding bonds. A stronger economy does not lift the price of an existing fixed coupon. The coupon is fixed, but the price is not; it adjusts to the market yield. Investors prefer higher yields, which is exactly why older bonds drop in price.

Quantitative easing by the Federal Reserve refers to:

• a.Cutting the reserve requirement to zero so that banks can lend more freely
• b.Selling longer-term Treasuries from the Fed's portfolio to raise long-term rates
• c.Large Fed purchases of long-term Treasuries and mortgage securities✓
• d.Raising the discount rate sharply to slow bank lending and curb inflation

In quantitative easing the Fed buys large amounts of longer-dated Treasuries and mortgage-backed securities, adding reserves and pushing down long-term yields when the policy rate is already near zero. Selling long-term Treasuries from the portfolio is the reverse, quantitative tightening, and pushes long-term yields up. Cutting the reserve requirement loosens policy through a different channel and involves no asset purchases. Raising the discount rate is a tightening step.

In the expenditure approach to GDP, net exports are:

• a.Exports minus government purchases, which is added to investment
• b.Exports minus imports, which can be a negative amount✓
• c.Imports minus exports, which is added to consumption
• d.Exports plus imports, which is always a positive amount

GDP = C + I + G + (X - M). Net exports are exports less imports and turn negative when a country imports more than it exports. Adding imports and exports overstates the trade component. Reversing the subtraction flips the sign. Government purchases are a separate component, G.

Which of the following is an example of an automatic stabilizer?

• a.A Federal Reserve cut in the federal funds rate after a weak jobs report
• b.Unemployment benefits that increase on their own when layoffs rise✓
• c.A new infrastructure spending program approved by Congress after a recession begins
• d.A one-time tax rebate mailed to households after Congress passes it

Automatic stabilizers, such as unemployment benefits and progressive taxes, adjust without any new decision as the economy changes. A rebate and an infrastructure program require legislation, so they are discretionary fiscal policy. A rate cut is monetary policy made at a committee meeting.

A stock priced at $40 pays annual dividends of $1.20 per share. What is its dividend yield?

• a.33.3%
• b.3.0%✓
• c.4.8%
• d.30.0%

Dividend yield = annual dividend / price = $1.20 / $40 = 3.0%. Dividing the price by the dividend gives 33.3, a multiple of the dividend. Moving the decimal incorrectly gives 30%. A 4.8% result would need a $1.92 dividend.

A portfolio returned 8% with a standard deviation of 12% while the risk-free rate was 2%. What is its Sharpe ratio?

• a.0.67
• b.0.50✓
• c.0.833
• d.0.17

Sharpe ratio = (portfolio return - risk-free rate) / standard deviation = (8% - 2%) / 12% = 0.50. The figure 0.67 divides the raw return by the standard deviation and forgets to subtract the risk-free rate. The figure 0.17 divides the risk-free rate, not the excess return, by the standard deviation. The figure 0.833 adds the risk-free rate to the return instead of subtracting it.

In Modern Portfolio Theory, a correlation coefficient of -0.5 between two assets means that:

• a.the assets move in opposite directions exactly half of the time, so the diversification benefit is negligible
• b.the assets always move in opposite directions by half as much, so the portfolio becomes risk-free
• c.the assets tend to move in opposite directions, though not in lockstep, which lowers portfolio risk✓
• d.the assets move in the same direction, only more weakly than a coefficient of +1.0 would imply

A coefficient of -0.5 is a moderate negative relationship: when one asset rises the other tends to fall, but not by a fixed amount or every time. Correlation measures the strength of a linear relationship, not the share of periods in which prices diverge, so reading it as a 50% frequency is wrong. Only a coefficient of exactly -1.0 would remove all risk, and a negative sign means opposite, not same-direction, movement.

A stock with a beta of 1.0 would be expected to:

• a.move about 1% whenever the overall market moves by 1%✓
• b.stay unchanged whatever the overall market does
• c.fall about 1% when the overall market rises by 1%
• d.move about 2% when the overall market moves by 1%

Beta measures sensitivity to the market, and a beta of 1.0 means the security moves roughly in step with it. A beta of 2.0 would produce the 2% swing. A beta of 0 would leave the price unaffected by market moves. A beta of -1.0 would produce the mirror-image move.

Alpha, in a portfolio context, is best described as:

• a.the expected return of the overall market for the coming year
• b.the return earned above or below what CAPM predicts for the portfolio's beta✓
• c.the volatility of the portfolio's returns relative to its benchmark
• d.the extra return earned over the risk-free rate per unit of total risk

Alpha is the difference between the return actually earned and the return the capital asset pricing model predicts from the portfolio's systematic risk, so a positive alpha means the manager added value. The expected market return is an input to CAPM, not alpha. Volatility relative to a benchmark describes tracking error or beta, not a risk-adjusted excess return. Excess return per unit of total risk is the Sharpe ratio.

A bond pays 3% nominal interest during a year in which inflation is 4%. What is the approximate real return?

• a.+3%, the nominal return alone
• b.+7%, the sum of both rates
• c.+4%, the inflation rate alone
• d.-1%, a loss of purchasing power✓

Real return is approximately the nominal return minus inflation: 3% - 4% = -1%, so purchasing power fell. The answer +3% ignores inflation altogether. The answer +7% adds inflation to the nominal return instead of subtracting it. The answer +4% reports the inflation rate itself rather than the return after inflation.

Present value is inversely related to the discount rate. Which statement follows from this?

• a.The discount rate has no effect on cash flows received far in the future
• b.A higher discount rate lowers the present value of the same future cash flow✓
• c.A higher discount rate raises the present value of the same future cash flow
• d.A higher discount rate raises present value only once the rate passes 5%

Present value divides a future amount by (1 + r) raised to the number of periods, so a larger r produces a smaller present value, and the effect grows with time. The claim that a higher rate raises value reverses the relationship. Distant cash flows are the most sensitive to the discount rate, not immune to it. There is no 5% threshold; the inverse relationship holds at every rate.

Standard deviation, as a measure of investment risk, describes:

• a.how widely an investment's returns have varied around their long-run average✓
• b.the return earned per unit of risk above the risk-free rate
• c.how closely an investment's returns follow the overall market
• d.the probability that an investment will lose money in any given year

Standard deviation measures the dispersion of returns around the mean, so a higher figure means more volatility. Tracking the market is what beta describes. Return per unit of risk is the Sharpe ratio. Standard deviation is not a probability of loss; it measures the spread of outcomes in both directions.

A mutual fund has an R-squared of 95 relative to its benchmark index. This indicates that:

• a.about 95% of the fund's return variation is explained by the benchmark✓
• b.the fund is 95% likely to outperform the benchmark index next year
• c.the fund beat its benchmark by an average of 95 basis points a year
• d.about 95% of the fund's holdings are also held by the benchmark index

R-squared ranges from 0 to 100 and shows how much of a fund's return variation is explained by the benchmark, so a high figure means the fund behaves like the index. It says nothing about the amount of outperformance, which is alpha. It is a statistical fit, not a count of overlapping holdings. It gives no probability of future outperformance.

A client in the 37% federal bracket is considering a municipal bond yielding 3%. What taxable yield is needed to match it after federal tax?

• a.4.76%✓
• b.3.00%
• c.8.11%
• d.1.89%

Taxable-equivalent yield = tax-free yield / (1 - tax rate) = 3% / 0.63 = 4.76%. Multiplying 3% by 0.63 gives 1.89%, which applies the tax in the wrong direction. Dividing by the tax rate itself gives 8.11%, forgetting to subtract it from 1. A taxable bond yielding 3.00% would leave the client with less than the municipal bond after tax.

When the yield curve inverts, so that short-term Treasury rates exceed long-term rates, the usual interpretation is that:

• a.recessions have often followed, as markets price in slower growth and lower future rates✓
• b.inflation expectations have risen sharply across the whole maturity range of Treasuries
• c.short-term borrowing now costs less than long-term borrowing, the usual upward-sloping shape
• d.corporate earnings are expected to accelerate over the next year, as in an expansion

An inverted curve reflects expectations of weaker growth and eventually lower rates, and historically it has often preceded recessions, though it is not a certain predictor. Short-term loans costing less than long-term loans describes a normal, upward-sloping curve. Accelerating earnings would be consistent with expansion, not inversion. Rising inflation expectations would normally push long-term yields up and steepen the curve.

The economy records two consecutive quarters of declining real GDP. Which phase of the business cycle does this describe?

• a.A peak, where output turns downward
• b.A trough, where output turns upward
• c.A contraction, with output falling✓
• d.An expansion, with output still rising

Two or more consecutive quarters of falling real GDP is the common working definition of a contraction. In an expansion output is rising, not falling. A peak is the turning point at the top, after which output starts to decline, so it is not itself a period of declining output. A trough is the turning point at the bottom, after which output starts to rise again.

Which of the following is a leading economic indicator?

• a.Nonfarm payroll employment levels
• b.Industrial production at factories
• c.The average prime rate banks charge
• d.Building permits for new housing✓

Building permits are a leading indicator because construction approvals tend to change before the broader economy turns. Payroll employment and industrial production are coincident indicators that move with the economy. The average prime rate is a lagging indicator that follows turning points.

A coincident economic indicator is one that:

• a.moves with the economy and confirms the current phase of the cycle✓
• b.stays stable throughout the cycle and is used as a baseline
• c.changes after the economy has turned and confirms a trend already under way
• d.changes ahead of the economy and signals a coming turning point

Coincident indicators, such as industrial production and personal income, move at about the same time as the overall economy. Indicators that change ahead of turning points are leading indicators. Indicators that change after the turn, such as the average duration of unemployment, are lagging. An indicator that does not change with the cycle would be of no use for analyzing it.

The Federal Reserve wants to stimulate a weak economy. Which action would most directly support that goal?

• a.Raising the reserve requirement for banks
• b.Purchasing Treasury securities in the open market✓
• c.Selling Treasury securities from its portfolio
• d.Raising the discount rate charged to banks

Open market purchases add reserves to the banking system, push short-term rates down, and encourage lending and spending. Raising the discount rate makes borrowing from the Fed more expensive. Raising reserve requirements leaves banks with less to lend. Selling securities drains reserves and tightens credit, which slows the economy.

Fiscal policy differs from monetary policy in that fiscal policy is set by:

• a.the Federal Reserve through interest rates and the money supply
• b.the SEC through its rules governing the securities markets and exchanges
• c.Congress and the President through taxation and government spending✓
• d.the Treasury Department through the sale of savings bonds only

Fiscal policy is the government's use of taxes and spending, decided by Congress and the President. Control of interest rates and the money supply is monetary policy, carried out by the Federal Reserve. Savings bond sales are a financing tool, not a policy lever, and do not define fiscal policy. The SEC regulates securities markets and does not set economic policy.

How do rising market interest rates typically affect stock valuations?

• a.raise the present value of expected future earnings, because discount rates are higher
• b.affect stock prices only when inflation is above 3% in that same year
• c.have no lasting effect on stock prices, since earnings alone drive valuations
• d.lower the present value of expected earnings and make bonds more competitive✓

Higher rates raise the discount rate applied to future earnings, which lowers their present value, and they make fixed-income yields more attractive relative to stocks. A higher discount rate lowers present value rather than raising it. Rates are one of the main inputs to valuation models, so they matter for stock prices. No inflation threshold is needed for the effect to operate.

A bond with a $1,000 par value is trading at $950. The bond is trading:

• a.at a premium, so its coupon rate is above prevailing market yields
• b.at par, so a buyer faces neither gain nor loss at maturity
• c.at a discount, so its yield to maturity is higher than its coupon rate✓
• d.at a discount, so its current yield is below its coupon rate

A bond priced below par trades at a discount, which happens when its coupon is below what the market now demands, so the yield to maturity exceeds the coupon. A premium price would be above par. Only a price of $1,000 is at par, and a buyer at $950 gains $50 at maturity. For a discounted bond the current yield (coupon divided by price) is higher than the coupon rate, not lower.

Stagflation is best described as an economy with:

• a.rapid growth with falling prices and rising employment
• b.slow or negative growth together with high inflation✓
• c.rapid growth with low unemployment and stable prices
• d.slow growth with falling prices and rising unemployment

Stagflation combines stagnant or shrinking output, usually with high unemployment, and high inflation, which is hard to fight because measures that cure one problem worsen the other. Rapid growth with falling prices and rising employment describes a strong, disinflationary expansion. Slow growth with falling prices and rising unemployment describes a deflationary recession, where inflation is absent. Rapid growth with low unemployment and stable prices describes an ideal expansion with no stagnation.

A U.S. investor's foreign stock fund returned +8% in local-currency terms, and the dollar weakened 3% against that currency. What was the investor's approximate return in dollars?

• a.up about 11%✓
• b.up about 5%
• c.up about 8%
• d.down about 3%

When the dollar weakens, the foreign currency buys more dollars, so the currency move adds to the local return: 8% + 3% = about 11%. The figure +5% treats the weaker dollar as a loss. The figure +8% ignores the currency move entirely. The figure -3% counts only the currency and drops the stock gain.

Currency risk in international investing refers to the possibility that:

• a.exchange-rate movements will reduce the dollar value of foreign returns✓
• b.a foreign government will restrict or seize the assets of foreign investors
• c.foreign companies will report under different accounting standards
• d.foreign securities will be hard to sell quickly without a large price concession

Currency risk is the exchange-rate effect on returns when foreign proceeds are converted back to dollars. Restrictions on or seizure of foreign assets are political risk. Difficulty selling without a price concession is liquidity risk. Differences in accounting standards are a disclosure and comparability issue, not an exchange-rate one.

The semi-strong form of the efficient market hypothesis holds that security prices reflect:

• a.all public and private information, so even insiders cannot earn excess returns
• b.only past prices and trading volume, so technical analysis cannot earn excess returns
• c.only the information published in a company's most recent annual report
• d.all public information, so fundamental analysis cannot earn excess returns✓

The semi-strong form says prices already reflect all public information, which defeats both technical and fundamental analysis, though it leaves room for gains from inside information. Reflecting only past price and volume data describes the weak form. Reflecting all public and private information describes the strong form. Prices reflect all public information, not just one report.

In Modern Portfolio Theory, the efficient frontier is:

• a.the line running from the risk-free rate through the market portfolio
• b.the single portfolio with the lowest possible risk, whatever its expected return
• c.the portfolios giving the highest expected return at each level of risk✓
• d.the set of all portfolios that can be built from the securities available

The efficient frontier connects portfolios that are optimal, meaning no other portfolio gives more return for the same risk. The lowest-risk portfolio is only one point on it, the minimum-variance portfolio. The set of all attainable portfolios includes inefficient ones lying below the frontier. The line from the risk-free rate through the market portfolio is the capital market line.

In behavioral finance, loss aversion is the tendency to:

• a.avoid all investment risk, whatever the client's long-term goals
• b.prefer dividend income to capital appreciation when choosing investments
• c.hold winning positions too long, expecting still more gains
• d.feel the pain of a loss more strongly than the pleasure of an equal gain✓

Loss aversion means losses weigh more heavily than equivalent gains, which can lead investors to avoid selling losers. Holding winners too long is not loss aversion; the disposition effect points the other way. A preference for dividends is an income preference, not a bias about losses. Avoiding all risk would be extreme risk aversion and does not describe the bias.

An investor sells stocks that have gained but holds stocks that have lost, to avoid realizing a loss. This pattern is called:

• a.herding behavior in markets
• b.recency bias in forecasting
• c.the disposition effect bias✓
• d.home bias toward domestic stocks

The disposition effect is the tendency to realize gains quickly while holding on to losers. Herding is following the crowd into popular investments. Recency bias is overweighting the latest performance. Home bias is favoring domestic securities.

A portfolio holds U.S. stocks (beta 1.2), international stocks (beta 0.9) and Treasury bonds (beta 0.0). If the U.S. market rises 10%, which holding would be expected to gain the most?

• a.International stocks, since diversification amplifies gains
• b.All three equally, since each is exposed to the market
• c.Treasury bonds, since they rise when equities rally
• d.U.S. stocks, since their beta of 1.2 is the highest✓

Expected response to the market scales with beta, so a beta of 1.2 implies roughly a 12% gain against about 9% for the international stocks and little or none for Treasuries. Diversification reduces risk but does not amplify gains. A beta of 0.0 means the bonds are not tied to equity moves. Different betas mean the holdings do not move equally.

To keep its special tax status, a REIT must distribute at least what percentage of its taxable income to shareholders?

• a.90%✓
• b.50%
• c.100%
• d.75%

A REIT must distribute at least 90% of its taxable income to qualify for pass-through treatment. The 75% figure is the test for the share of income and assets that must come from real estate sources, not the payout. A 50% payout is below the requirement. A REIT is not required to distribute 100%, though it pays tax on anything it retains.