Question 1

Which of the following most closely defines the term risk in finance?

Accepted Answer

A) Knowing that you will lose money on an investment 
B) A decision in which the potential outcomes are known with certainty 
C) A measure of the variability of cash flows 
D) A situation in which the required return on an asset equals its expected return 
E) A measure of the magnitude of cash flows 
A) Knowing that you will lose money on an investment 
B) A decision in which the potential outcomes are known with certainty 
C) A measure of the variability of cash flows 
D) A situation in which the required return on an asset equals its expected return 
E) A measure of the magnitude of cash flows C

Question 2

The Table below presents returns across three states of nature for two assets: Risky and Safe. The expected return on Safe is 8.4%. Which asset has a higher expected return? $$\begin{array} { | c | c | c | c | } 
\hline \text { State of Nature } & \text { Probability } & \begin{array} { c } 
\text { Return to Risky } \
\text { Investment }
\end{array} & \begin{array} { c } 
\text { Return to Safe } \
\text { Investment }
\end{array} \
\hline \text { Recession } & 0.2 & - 5 \% & 14 \% \
\hline \text { Normal } & 0.6 & 15 \% & 8 \% \
\hline \text { Boom } & 0.2 & 25 \% & 4 \% \
\hline
\end{array}$$

Accepted Answer

A) Risky 
B) Safe 
C) Both have the same expected return 
A) Risky 
B) Safe 
C) Both have the same expected return A

Question 3

XYZ Corp expects to have $350,000 in sales in a poor economy, $500,000 in a moderate economy, and $900,000 in a booming economy. If the chances of a booming economy and poor economy are 10% each, what is the expected return?

Accepted Answer

A) 525,000 
B) 512,500 
C) 500,000 
D) 805,000 
E) 621,000 
A) 525,000 
B) 512,500 
C) 500,000 
D) 805,000 
E) 621,000 A

Question 4

Which of the following statements is true?

Accepted Answer

A) Calculus of variations (CV)adjusts standard deviations to compare the risk of securities with different expected returns. 
B) Risk-averse investors prefer securities with high standard deviations. 
C) An increase in risk will result in an increase in the standard deviation. 
D) Standard deviations can be computed for stock returns, but not for bond yields. 
E) If the returns from a security are normally distributed, 86% of the observations fall within one standard deviation of the expected value. 
A) Calculus of variations (CV)adjusts standard deviations to compare the risk of securities with different expected returns. 
B) Risk-averse investors prefer securities with high standard deviations. 
C) An increase in risk will result in an increase in the standard deviation. 
D) Standard deviations can be computed for stock returns, but not for bond yields. 
E) If the returns from a security are normally distributed, 86% of the observations fall within one standard deviation of the expected value.

Question 5

Suppose that you hold a two-asset portfolio consisting of 100 shares of Clooney Brothers at $33 per share and 100 shares of Marx Brothers at $42 per share. Assume that you have computed the expected return on Clooney Brothers and Marx Brothers to be 20% and 12%, respectively. What is the expected return from the portfolio?

Accepted Answer

A) 20.0% 
B) 16.0% 
C) 15.5% 
D) 12.0% 
E) 13.5% 
A) 20.0% 
B) 16.0% 
C) 15.5% 
D) 12.0% 
E) 13.5%

Question 6

The stock for L-Corp expects a 12% return in a down economy, 15% in a normal economy, and 20% in a booming economy. What is the expected return if there is a 20% chance for a down economy and a 65% chance for a normal economy?

Accepted Answer

A) 13.05% 
B) 15.00% 
C) 15.15% 
D) 15.55% 
E) 14.25% 
A) 13.05% 
B) 15.00% 
C) 15.15% 
D) 15.55% 
E) 14.25%

Question 7

A company has a 40% probability of earning 20%, a 40% probability of earning 10%, and a 20% probability of earning 5%. The standard deviation is:

Accepted Answer

A) 13.0% 
B) 36.0% 
C) 37.0% 
D) 6.0% 
E) 15.0% 
A) 13.0% 
B) 36.0% 
C) 37.0% 
D) 6.0% 
E) 15.0%

Question 8

By incrementally adding securities to a portfolio

Accepted Answer

A) you can reduce portfolio risk only if the new security is uncorrelated with the others in the portfolio. 
B) you raise portfolio risk since having more securities in a portfolio increases the likelihood that one of them will become worthless. 
C) you may reduce portfolio risk, even if new securities are not negatively correlated with others in the portfolio. 
D) you may eliminate all risk with about 15 different stocks in a portfolio. 
E) you reduce risk at an increasing rate. 
A) you can reduce portfolio risk only if the new security is uncorrelated with the others in the portfolio. 
B) you raise portfolio risk since having more securities in a portfolio increases the likelihood that one of them will become worthless. 
C) you may reduce portfolio risk, even if new securities are not negatively correlated with others in the portfolio. 
D) you may eliminate all risk with about 15 different stocks in a portfolio. 
E) you reduce risk at an increasing rate.

Question 9

XYZ Corp has a 30% chance to earn 12% returns, a 40% chance for 18% returns, and a 30% chance to earn 15% returns. What is the standard deviation?

Accepted Answer

A) 2.49% 
B) 15.3% 
C) 4.24% 
D) 15% 
E) 5.62% 
A) 2.49% 
B) 15.3% 
C) 4.24% 
D) 15% 
E) 5.62%

Question 10

A home insurance company anticipates the following pattern of claims, based on historical data. What is the standard deviation of claims? $\begin{array}{c}
\begin{array}{|c|}
\hline\
\
\
\text { Type of Claim }\
\hline1 \
\hline 2 \
\hline 3 \
\hline 4\
\hline
\end{array}
\begin{array}{c}
\hline\
\
\
\text { Size of Claim }\
\hline \$ 200,000 \
\hline \$ 50,000 \
\hline \$ 2,000 \
\hline \$ 0\
\hline
\end{array}
\begin{array}{|c|}
 \hline \text {Number of}\
\text { Claims out of}\
\text {10,000 Policy }\
\text {Holders}\
\hline 1 \
\hline 10 \
\hline 200 \
\hline 9,789\
\hline 
\end{array}
\begin{array}{c|}
\hline\
\
\
\text { Probability } \
\hline 0.0001 \
\hline 0.001 \
\hline 0.02 \
\hline 0.9789\
\hline
\end{array}
\end{array}$

Accepted Answer

A) $2,562.79 
B) $6,567,900 
C) $2,000 
D) $110 
E) $3,753.52 
A) $2,562.79 
B) $6,567,900 
C) $2,000 
D) $110 
E) $3,753.52

Question 11

The Table below presents returns across three states of nature for two assets: Risky and Safe. The standard deviation of Safe is 3.2%. What is the difference between the standard deviation of Risky and Safe? (Risky - Safe) $$\begin{array} { | c | c | c | c | } 
\hline \text { State of Nature } & \text { Probability } & \begin{array} { c } 
\text { Return to Risky } \
\text { Investment }
\end{array} & \begin{array} { c } 
\text { Return to Safe } \
\text { Investment }
\end{array} \
\hline \text { Recession } & 0.2 & - 5 \% & 14 \% \
\hline \text { Normal } & 0.6 & 15 \% & 8 \% \
\hline \text { Boom } & 0.2 & 25 \% & 4 \% \
\hline
\end{array}$$

Accepted Answer

A) 3.6% 
B) 4.6% 
C) 5.6% 
D) 6.6% 
E) 7.6% 
A) 3.6% 
B) 4.6% 
C) 5.6% 
D) 6.6% 
E) 7.6%

Question 12

It costs $1,000 to enter the following game of chance, which is based on the outcome of a coin toss (fair coin). If the coin comes up 'heads' then you win and walk away with $1,100, which is a 10% rate of return. If the coin comes up 'tails', then you lose and walk away with $900, which is a -10% rate of return. What is the standard deviation of the returns?

Accepted Answer

A) 9% 
B) 15% 
C) 30% 
D) 10% 
E) 5% 
A) 9% 
B) 15% 
C) 30% 
D) 10% 
E) 5%

Question 13

Bond prices rise when interest rates fall. These two variables (bond prices and interest rates)are:

Accepted Answer

A) Not correlated 
B) Positively correlated 
C) Negatively correlated 
D) Positively skewed 
A) Not correlated 
B) Positively correlated 
C) Negatively correlated 
D) Positively skewed

Question 14

Which of the following is a false statement?

Accepted Answer

A) Expected returns are not always predicted accurately. 
B) Expected returns may differ from actual returns because of an unforeseen recession. 
C) Historical returns can be calculated with more confidence than expected returns. 
D) Accurate predictions of expected returns depend on the analyst's ability to estimate probabilities. 
E) Although expected returns may differ from actual returns, they seldom do. 
A) Expected returns are not always predicted accurately. 
B) Expected returns may differ from actual returns because of an unforeseen recession. 
C) Historical returns can be calculated with more confidence than expected returns. 
D) Accurate predictions of expected returns depend on the analyst's ability to estimate probabilities. 
E) Although expected returns may differ from actual returns, they seldom do.

Question 15

Which of the following is a true statement?

Accepted Answer

A) It is easy to predict the probability and length of a foreign country's recession. 
B) Although economists understand the relationship between risk and return, they have been unable to develop a way to quantify it. 
C) There is a direct relationship between risk and expected return. 
D) Risk and the likelihood of realizing future cash flows from an investment are unrelated. 
E) Riskless investments do not usually earn a positive return. 
A) It is easy to predict the probability and length of a foreign country's recession. 
B) Although economists understand the relationship between risk and return, they have been unable to develop a way to quantify it. 
C) There is a direct relationship between risk and expected return. 
D) Risk and the likelihood of realizing future cash flows from an investment are unrelated. 
E) Riskless investments do not usually earn a positive return.

Question 16

The expected return on an asset is 13% and the required return is 12%. You should probably

Accepted Answer

A) wait and see what happens to actual returns before making a decision. 
B) buy the asset now. 
C) sell the asset now. 
D) hold the asset. 
E) None of the above. 
A) wait and see what happens to actual returns before making a decision. 
B) buy the asset now. 
C) sell the asset now. 
D) hold the asset. 
E) None of the above.

Question 17

Given the following probability distributions, what are the expected returns for the Market and for Security J? State 1 P1 = 0.2 Km = -10% Kj = 40% : State 2 P1 = 0.5 Km = 10% Kj = -20% : State 3 P1 = 0.3 Km = 30% Kj = 30%

Accepted Answer

A) 10.0%; 13.0% 
B) 9.5%; 13.0% 
C) 10.0%; 11.3% 
D) 12.0%; 7.0% 
E) 10.0%; 9.5% 
A) 10.0%; 13.0% 
B) 9.5%; 13.0% 
C) 10.0%; 11.3% 
D) 12.0%; 7.0% 
E) 10.0%; 9.5%

Question 18

You have a portfolio of two stocks: you invested $12,000 in a small biotech company and $6,000 in a fiber optic cable manufacturer. What is the portfolio weight on the biotech stock?

Accepted Answer

A) 0.25 
B) 0.33 
C) 0.50 
D) 0.67 
E) 0.75 
A) 0.25 
B) 0.33 
C) 0.50 
D) 0.67 
E) 0.75

Question 19

If the required return from an asset is 10%, and the asset has a 60% probability of yielding a 20% return and a 40% probability of earning a 5% return, you should:

Accepted Answer

A) Not acquire the asset since the expected return of 32% exceeds the required return. 
B) Purchase the asset since the expected return of 14% exceeds the required return. 
C) Buy the asset because the expected return of 32% exceeds the required return. 
D) Forgo the investment opportunity since the expected return of 14% is too low. 
E) Buy the asset because the expected return of 12.5% exceeds the required return. 
A) Not acquire the asset since the expected return of 32% exceeds the required return. 
B) Purchase the asset since the expected return of 14% exceeds the required return. 
C) Buy the asset because the expected return of 32% exceeds the required return. 
D) Forgo the investment opportunity since the expected return of 14% is too low. 
E) Buy the asset because the expected return of 12.5% exceeds the required return.

Question 20

Correlation

Accepted Answer

A) is a measure similar to the standard deviation, but more precise. 
B) may only be positive. 
C) is usually negative for a portfolio with two securities. 
D) measures the degree to which a change in the riskiness of one security causes the risk of another to change. 
E) ranges between −1 and +1. 
A) is a measure similar to the standard deviation, but more precise. 
B) may only be positive. 
C) is usually negative for a portfolio with two securities. 
D) measures the degree to which a change in the riskiness of one security causes the risk of another to change. 
E) ranges between −1 and +1.

Which of the following most closely defines the term risk in finance?

XYZ Corp expects to have $350,000 in sales in a poor economy, $500,000 in a moderate economy, and $900,000 in a booming economy. If the chances of a booming economy and poor economy are 10% each, what is the expected return?

Which of the following statements is true?

The stock for L-Corp expects a 12% return in a down economy, 15% in a normal economy, and 20% in a booming economy. What is the expected return if there is a 20% chance for a down economy and a 65% chance for a normal economy?

A company has a 40% probability of earning 20%, a 40% probability of earning 10%, and a 20% probability of earning 5%. The standard deviation is:

By incrementally adding securities to a portfolio

XYZ Corp has a 30% chance to earn 12% returns, a 40% chance for 18% returns, and a 30% chance to earn 15% returns. What is the standard deviation?

Bond prices rise when interest rates fall. These two variables (bond prices and interest rates)are:

Which of the following is a false statement?

Which of the following is a true statement?

The expected return on an asset is 13% and the required return is 12%. You should probably

Given the following probability distributions, what are the expected returns for the Market and for Security J? State 1 P1 = 0.2 Km = -10% Kj = 40% : State 2 P1 = 0.5 Km = 10% Kj = -20% : State 3 P1 = 0.3 Km = 30% Kj = 30%

You have a portfolio of two stocks: you invested $12,000 in a small biotech company and $6,000 in a fiber optic cable manufacturer. What is the portfolio weight on the biotech stock?

If the required return from an asset is 10%, and the asset has a 60% probability of yielding a 20% return and a 40% probability of earning a 5% return, you should:

Correlation

Overview of Finance

Financial Statements and Ratio Analysis

Time Value of Money - Introduction

Time Value of Money - Streams and Valuations

Portfolio Theory

Interest Rates and Bond Valuation

Stock Valuation and Market Efficiency

Capital Budgeting Techniques

Capital Budgeting - Cash Flows

Cost of Capital

Capital Structure

Dividends, Repurchases, and Splits

Financial Planning

The Management of Working Capital

International Finance

Filters

Exam 5: Risk and Return - Introduction

Which of the following most closely defines the term risk in finance?

XYZ Corp expects to have $350,000 in sales in a poor economy, $500,000 in a moderate economy, and $900,000 in a booming economy. If the chances of a booming economy and poor economy are 10% each, what is the expected return?

Which of the following statements is true?

The stock for L-Corp expects a 12% return in a down economy, 15% in a normal economy, and 20% in a booming economy. What is the expected return if there is a 20% chance for a down economy and a 65% chance for a normal economy?

A company has a 40% probability of earning 20%, a 40% probability of earning 10%, and a 20% probability of earning 5%. The standard deviation is:

By incrementally adding securities to a portfolio

XYZ Corp has a 30% chance to earn 12% returns, a 40% chance for 18% returns, and a 30% chance to earn 15% returns. What is the standard deviation?

Bond prices rise when interest rates fall. These two variables (bond prices and interest rates)are:

Which of the following is a false statement?

Which of the following is a true statement?

The expected return on an asset is 13% and the required return is 12%. You should probably

Given the following probability distributions, what are the expected returns for the Market and for Security J? State 1 P1 = 0.2 Km = -10% Kj = 40% : State 2 P1 = 0.5 Km = 10% Kj = -20% : State 3 P1 = 0.3 Km = 30% Kj = 30%

You have a portfolio of two stocks: you invested $12,000 in a small biotech company and $6,000 in a fiber optic cable manufacturer. What is the portfolio weight on the biotech stock?

If the required return from an asset is 10%, and the asset has a 60% probability of yielding a 20% return and a 40% probability of earning a 5% return, you should:

Correlation

Overview of Finance

Financial Statements and Ratio Analysis

Time Value of Money - Introduction

Time Value of Money - Streams and Valuations

Portfolio Theory

Interest Rates and Bond Valuation

Stock Valuation and Market Efficiency

Capital Budgeting Techniques

Capital Budgeting - Cash Flows

Cost of Capital

Capital Structure

Dividends, Repurchases, and Splits

Financial Planning

The Management of Working Capital

International Finance

Filters