Quantitative Methods

1. The sum of the real risk-free interest rate and the inflation premium is the nominal
risk-free rate.

2. The effective annual rate (EAR)

3. Given a €1,000,000 investment for four years with a stated annual rate of 3%
compounded continuously, the difference in its interest earnings compared with the

same investment compounded daily is closest to:

4. Published ratings on stocks ranging from 1 (strong sell) to 5 (strong buy) are
examples of which measurement scale – ordinal
5. Data values that are categorical and not amenable to being organized in a logical order
are most likely to be characterized as: nominal data
6. A two-dimensional rectangular array would be most suitable for organizing a
collection of raw: panel data
7. A bar chart that orders categories by frequency in descending order and includes a
line displaying cumulative relative frequency is referred to as a: Pareto Chart
8. A tree-map is best suited to illustrate value differences of categorical groups
9. A line chart with two variables—for example, revenues and earnings per share—is
best suited for visualizing: underlying trends in the variables over time
10. A heat map is best suited for visualizing the: degree of correlation between different
variables
11. valuation tool is recommended to be used if the goal is to make comparisons of three
or more variables over time? Bubble line chart
12. The harmonic mean is appropriate for determining the average price per unit.

13. mean absolute deviation (MAD)

14. The coefficient of variation (CV) is the ratio of the standard deviation to the mean,
where a higher CV implies greater risk per unit of return.
15. The more disperse a distribution, the greater the difference between the arithmetic
mean and the geometric mean.
16. An analyst calculated the excess kurtosis of a stock’s returns as −0.75. From this
information, we conclude that the distribution of returns is: tin tailed compared to
normal distribution
17. the geometric mean compounds the periodic returns of every period, giving the
investor a more accurate measure of the terminal value of an investment.
18. Both outliers and spurious correlation are potential problems with interpreting
correlation coefficients.
19. The correlation coefficient is positive because the covariance is positive.
20. The coefficient of variation is the ratio of the standard deviation to the arithmetic
average
21. The excess kurtosis is positive, indicating that the distribution is “fat-tailed”;
therefore, there is more probability in the tails of the distribution relative to the
normal distribution.
22. Florence Hixon is screening a set of 100 stocks based on two criteria (Criterion 1 and
Criterion 2). She set the passing level such that 50% of the stocks passed each screen.
For these stocks, the values for Criterion 1 and Criterion 2 are not independent but are
positively related. How many stocks should pass Hixon’s two screens? More than 25
23. Suppose the prospects for recovering principal for a defaulted bond issue depend on
which of two economic scenarios prevails. Scenario 1 has probability 0.75 and will
result in recovery of $0.90 per $1 principal value with probability 0.45, or in recovery
of $0.80 per $1 principal value with probability 0.55. Scenario 2 has probability 0.25
and will result in recovery of $0.50 per $1 principal value with probability 0.85, or in
recovery of $0.40 per $1 principal value with probability 0.15. Compute the
probability of each of the four possible recovery amounts: $0.90, $0.80, $0.50, and
$0.40.
E(recovery) = 0.75($0.845) + 0.25($0.485) = $0.755
Outcomes associated with Scenario 1: With a 0.45 probability of a $0.90 recovery per
$1 principal value, given Scenario 1, and with the probability of Scenario 1 equal to
0.75, the probability of recovering $0.90 is 0.45 (0.75) = 0.3375. By a similar
calculation, the probability of recovering $0.80 is 0.55(0.75) = 0.4125.
E(recovery | Scenario 1) = 0.45($0.90) + 0.55($0.80) = $0.845
Outcomes associated with Scenario 2: With a 0.85 probability of a $0.50 recovery per
$1 principal value, given Scenario 2, and with the probability of Scenario 2 equal to
0.25, the probability of recovering $0.50 is 0.85(0.25) = 0.2125. By a similar
calculation, the probability of recovering $0.40 is 0.15(0.25) = 0.0375.
E(recovery | Scenario 2) = 0.85($0.50) + 0.15($0.40) = $0.485
24. In probability theory, exhaustive events are best described as the set of events that:
include all potential outcomes
25. A subjective probability draws on personal or subjective judgment that may be
without reference to any particular data.
26. A conditional probability is the probability of an event given that another event has
occurred.
27. After estimating the probability that an investment manager will exceed his
benchmark return in each of the next two quarters, an analyst wants to forecast the
probability that the investment manager will exceed his benchmark return over the
two-quarter period in total. Assuming that each quarter’s performance is independent
of the other, which probability rule should the analyst select? Multiplication rule
28. The covariance of returns is positive when the returns on two assets tend to: be on the
same side of their expected value at the same time
29. The correlation of returns
between the hedge fund and the market index is closest to: the standard deviations are
σ(Ri) = 256^ 1/2 = 16 and σ(Rj) = 81 ^1/2 = 9. Thus, ρ(Ri,Rj) = Cov(Ri,Rj)/[σ(Ri)
σ(Rj)] = 110/(16 × 9) = 0.764.
30. All else being equal, as the correlation between two assets approaches +1.0, the
diversification benefits: decrease
31. Given a portfolio of five stocks, how many unique covariance terms, excluding
variances, are required to calculate the portfolio return variance? 10
32. A manager will select 20 bonds out of his universe of 100 bonds to construct a
portfolio. Which formula provides the number of possible portfolios? Combination
formula
33. The null hypothesis is most likely to be rejected when the p-value of the test statistic:
falls below a specified level of significance
34. To test whether a particular portfolio’s volatility has changed following theglobal
financial crisis of 2008, an analyst must compare the portfolio’s meanmonthly returns
and the variances of returns of the pre- and post-crisis [Link] most appropriate
test is the: F Test
35. To project the assets and liabilities of a pension plan using a number of different
assumptions, the most appropriate method to employ is: a monte carlo stimulation
because it can evaluate the effect of changes in the assumption
36. From an approved list of 25 funds, a portfolio manager wants to rank 4 mutual funds
from most recommended to least recommended. Which formula is most appropriate to
calculate the number of possible ways the funds could be ranked? Permutation

37. Compound growth rate can be calculated as

38.
39. The liquidity premium compensates investors for the risk of loss relative to an
investment’s fair value if the investment needs to be converted to cash quickly.
40. The future value (FV) of a given lump sum, calculated using continuous
compounding, is: FV = PVe ^ rn
41. The minimum rate of return an investor must receive in order to accept an investment
is best described as the: required rate of return
42. P(A or B) = P(A) + P(B) − P(AB)
43. Odds are calculated as P(Z)/[1 − P(Z)].
44. If two events, A and B, are independent, and the probability of A does not equal the
probability of B [i.e., P(A) ≠ P(B)], then the probability of event A given that event B
has occurred [i.e., P(A | B)] is best described as: P(A)
45. By definition, the probability of any Event E is a number between: zero and positive
one
46. An empirical probability is a probability estimated from data as a relative frequency
of occurrence.
47. Events are exhaustive when they cover all possible outcomes. Mutually exclusive
means that only one event can occur at a time. Two events are dependent if the
occurrence of one event does affect the probability of occurrence of the other event.
In this situation, Event A and B are both mutually exclusive (because they cannot
occur at the same time) and dependent (because if one event occurs, the probability of
the other becomes zero).

48. Bayes’ formula

49. An economist states that the probability of having the gross domestic product (GDP)
of a country higher than 3% is 0.20. What are the odds against a GDP higher than
3%? 4 to 1
50. The compound rate of return of the portfolio means geometric mean
51. Investors should be most attracted to return distributions that are: positively skewed

52. The portfolio return is the weighted mean return and is calculated as:
53. For a positively skewed unimodal distribution, the mode is less than the median,
which is less than the mean.
54. Equity return distributions are best described as being: leptokurtic
55. Subset of population is best described as sample
56. A graphical depiction of a continuous distribution shows the left tail to be longer than
the right tail. The distribution is best described as having: negative skewness

57. first quintile Linear interpolation is used to find the

approximate value of the first quintile:

58. Common stock prices are approximately lognormally distributed. Therefore, it is most
likely that conventional (discrete) common stock prices are: skewed to right
59. A binomial random variable is defined as the number of successes in n Bernoulli trials
(a trial that produces one of two outcomes). The binomial distribution is used to make
probability statements about a record of successes and failures or about anything with
binary (twofold) outcomes.
60. The value of the cumulative distribution function F(x), where x is a particular
outcome, for a discrete uniform distribution: lies between 0 and 1
61. For a binomial random variable with five trials and a probability of success on each
trial of 0.50, the distribution will be: symmetric
62. State the approximate probability that a normal random variable will fall within the
following intervals:
Mean plus or minus one standard deviation. Approximately 68% of all outcomes
Mean plus or minus two standard deviations. Approximately 95% of all outcomes
Mean plus or minus three standard deviations. Approximately 99% of all outcomes
63. A normal distribution has a kurtosis of 3
64. following assets most likely requires the use of a multivariate distribution for
modeling returns – portfolio of technology stocks
65. The total number of parameters that fully characterizes a multivariate normal
distribution for the returns on two stocks is: 5
66. Strengths: Monte Carlo simulation can be used to price complex securities for which
no analytic expression is available, particularly European-style options.

67. Weaknesses: Monte Carlo simulation provides only statistical estimates, not exact
results. Analytic methods, when available, provide more insight into cause-and-effect
relationships than does Monte Carlo simulation. Its inability to independently specify
cause and effect relationship
68. A Monte Carlo simulation can be used to: test the sensitivity of a model to changes in
assumptions for example on distribution of key variable
69. Skewness para meter equals zero in a normal distribution
70. In contrast to normal distributions, lognormal distributions: have outcomes that
cannot be negative
71. Both chi-square and F-distributions are bounded from below by zero, so the domains
of their pdfs are restricted to positive numbers.
72. Stratified random sampling involves dividing a population into subpopulations based
on one or more classification criteria. Then, simple random samples are drawn from
each subpopulation in sizes proportional to the relative size of each subpopulation.
These samples are then pooled to form a stratified random sample.
73. Julius Spence has tested several predictive models in order to identify undervalued
stocks. Spence used about 30 company-specific variables and 10 market-related
variables to predict returns for about 5,000 North American and European stocks. He
found that a final model using eight variables applied to telecommunications and
computer stocks yields spectacular results. Spence wants you to use the model to
select investments. Should you? What steps would you take to evaluate the model?
Spence may be guilty of data mining. He has used so many possible combinations of
variables on so many stocks, it is not surprising that he found some instances in which
a model worked. In fact, it would have been more surprising if he had not found any.
To decide whether to use his model, you should do two things: First, ask that the
model be tested on out-of-sample data—that is, data that were not used in building the
model. The model may not be successful with out-of-sample data. Second, examine
his model to make sure that the relationships in the model make economic sense, have
a story, and have a future.
74. A population has a non-normal distribution with mean µ and variance σ2. The
sampling distribution of the sample mean computed from samples of large size from
that population will have: its mean approximately equal to the population mean
75. An estimator with an expected value equal to the parameter that it is intended to
estimate is described as: unbaised
76. If an estimator is consistent, an increase in sample size will increase the: accuracy of
estimates
77. For a two-sided confidence interval, an increase in the degree of confidence will result
in: a wider confidence interval
78. The confidence interval is calculated using the following equation:
79. Compared with bootstrap resampling, jackknife resampling: usually requires that the
number of repetitions is equal to the sample size
80. A report on long-term stock returns focused exclusively on all currently publicly
traded firms in an industry is most likely susceptible to: survivorship bias
81. An out-of-sample test is used to investigate the presence of data-mining bias. Such a
test uses a sample that does not overlap the time period of the sample on which a
variable, strategy, or model was developed.
82. The alternative hypothesis exhausts all potential parameter values not accounted for
by the null hypothesis.
83. . In the step “stating a decision rule” in testing a hypothesis, which of the following
elements must be specified? Power of a test
84. Null hypothesis can be stated as “not equal to” provided the alternative hypothesis is
stated as “equal to.”
85. If the population sampled has unknown variance and the sample is large, a z-test may
be used. Hypotheses involving “greater than” or “less than” postulations are one sided
(one tailed).
86. A hypothesis test for a normally distributed population at a 0.05 significance level
implies a: 5% critical value rejection region in a tail of the distribution for one tailed
test
87. Calculated using a sample, a test statistic is a quantity whose value is the basis for
deciding whether to reject the null hypothesis.
88. Type 1 error is rejecting a true null hypothesis
89. Type 2 error is failing to reject false null hypothesis
90. The level of significance of a hypothesis test is best used to: define the test’s rejection
points
91. All else equal, is specifying a smaller significance level in a hypothesis test likely to
increase the probability of a: type 2 error
92. the power of a hypothesis test is: the probability of not making type 2 error
93. When making a decision about investments involving a statistically significant result,
the: economic logic for the future relevance of the result should be further explored
94. An analyst tests the profitability of a trading strategy with the null hypothesis that the
average abnormal return before trading costs equals zero. The calculated t-statistic is
2.802, with critical values of ±2.756 at significance level α = 0.01. After considering
trading costs, the strategy’s return is near zero. The results are most likely:
statistically but not economically significant
95. P-value can be compared directly with the level of significance in reaching test
conclusions. A p-value less than the specified level of significance leads to rejection
of the null hypothesis. The p-value is the smallest level of significance at which H0
can be rejected.
96. The z-test is theoretically the correct test to use in those limited cases when testing the
population mean of a normally distributed population with known variance.
97. A pooled estimator is used when testing a hypothesis concerning the: difference
between the means of two at least approximately normally distributed populations
with unknown but assumed equal variances.
98. When evaluating mean differences between two dependent samples, the most
appropriate test is a: paired comparison test
99. A chi-square test is most appropriate for tests concerning: a single variance
100. difference between the variances of two normally distributed populations – f
test
101. nonparametric test of a hypothesis most likely be used the sample data are
ranked according to magnitude
102. An analyst is examining the monthly returns for two funds over one year. Both
funds’ returns are non-normally distributed. To test whether the mean return of one
fund is greater than the mean return of the other fund, the analyst can use:
nonparametric test only
103. Chi square test of independence has a one sided rejection region
104. Homoskedasticity is best described as the situation in which the variance of
the residuals of a regression is: constant across observation
105. There are two steps in standardizing a random variable X: Subtract the mean
of X from X, and then divide that result by the standard deviation of X. This is
represented by the following formula: Z = (X − μ)/σ.
106. Monte Carlo simulation is best described as: providing a distribution of
possible solutions to complex functions
107. When rolling two six-sided dice and summing their outcomes, which of the
following sums is most likely to occur? Six
108. When flipping three coins simultaneously, the number of outcomes that
contain at least two heads is most likely: four
109. The normal probability distribution: is more suitable as a model for asset
prices than for returns
110. If a stock’s continuously compounded return is normally distributed, then the
distribution of the future stock price is best described as being: lognormal
111. Which statement is most accurate when considering a multivariate normal
distribution for the returns on 10 stocks from different sectors? There are: 45 distinct
correlation not equal to one
112. In generating an estimate of a population parameter, a larger sample size is
most likely to improve the estimator’s: consistency
113. If the distribution of the population from which samples of size n are drawn is
positively skewed and given that the sample size, n, is large, the sampling distribution
of the sample means is most likely to have a: distribution that is approximately normal
114. The central limit theorem is best described as stating that the sampling
distribution of the sample mean will be approximately normal for large-size samples:
for populations described by any probability distribution
115. the confidence interval is most likely to be: narrower as the reliability factor
decreases
116. Survivorship bias is most likely an example of which bias? Sample selection
117. Which sampling-related bias is most likely to result in finding apparent
significance when none exists? Data mining bias
118. The null hypothesis is most likely to be rejected when the p-value of the test
statistic: falls below a specified level of significance
119. The value of a test statistic is best determined as the difference between the
sample statistic and the value of the population parameter under H0 divided by the:
standard error of the sample statistics
120. The Mann–Whitney U-test is most appropriate for tests of differences in
means for nonparametric data such as analysts’ rankings.
121. Wilcoxon signed-rank test is most appropriate for testing the significance of a
single mean or mean differences (paired comparisons test) for nonparametric data.
122. . The power of a test is the probability of correctly rejecting the null—that is,
the probability of rejecting the null when it is false.
123. A z-test regarding a mean is most appropriate when the variance is unknown
and the: central limit theorem is applicable