Deck 1: The Investment Setting

Question 1

In the phrase "nominal risk free rate," nominal means

A) Computed.
B) Historical.
C) Market.
D) Average.
E) Risk adverse.

Answer 1

C

Question 2

An individual who selects the investment that offers greater certainty when everything else is the same is known as a risk averse investor.

Answer 2

True

Question 3

An investment is the current commitment of dollars over time to derive future payments to compensate the investor for the time funds are committed, the expected rate of inflation and the uncertainty of future payments.

Answer 3

True

Question 4

The nominal risk free rate of interest is a function of

A) The real risk free rate and the investment's variance.
B) The prime rate and the rate of inflation.
C) The T-bill rate plus the inflation rate.
D) The tax free rate plus the rate of inflation.
E) The real risk free rate and the rate of inflation.

Question 5

The geometric mean of a series of returns is always larger than the arithmetic mean and the difference increases with the volatility of the series.

Question 6

The variance of expected returns is equal to the square root of the expected returns.

Question 7

The rate of exchange between future consumption and current consumption is

A) The nominal risk-free rate.
B) The coefficient of investment exchange.
C) The pure rate of interest.
D) The consumption/investment paradigm.
E) The expected rate of return.

Question 8

The real risk-free rate is affected by two factors:

A) The relative ease or tightness in capital markets and the expected rate of inflation.
B) The expected rate of inflation and the set of investment opportunities available in the economy.
C) The relative ease or tightness in capital markets and the set of investment opportunities available in the economy.
D) Time preference for income consumption and the relative ease or tightness in capital markets.
E) Time preference for income consumption and the set of investment opportunities available in the economy.

Question 9

If a significant change is noted in the yield of a T-bill, the change is most likely attributable to

A) A downturn in the economy.
B) A static economy.
C) A change in the expected rate of inflation.
D) A change in the real rate of interest.
E) A change in risk aversion.

Question 10

The rate of exchange between certain future dollars and certain current dollars is known as the pure rate of interest.

Question 11

The coefficient of variation is the expected return divided by the standard deviation of the expected return.

Question 12

The expected return is the average of all possible returns.

Question 13

The _____________ the variance of returns, everything else remaining constant, the ______ the dispersion of expectations and the ________________ the risk.

A) Larger, greater, lower
B) Larger, smaller, higher
C) Larger, greater, higher
D) Smaller, greater, lower
E) Smaller, greater, greater

Question 14

The risk premium is a function of the volatility of operating earnings, sales volatility and inflation.

Question 15

The coefficient of variation is a measure of

A) Central tendency.
B) Absolute variability.
C) Absolute dispersion.
D) Relative variability.
E) Relative return.

Question 16

Nominal rates are averages of all possible real rates.

Question 17

Investors are willing to forgo current consumption in order to increase future consumption for a nominal rate of interest.

Question 18

Two measures of the risk premium are the standard deviation and the variance.

Question 19

The basic trade-off in the investment process is

A) between the anticipated rate of return for a given investment instrument and its degree of risk.
B) between understanding the nature of a particular investment and having the opportunity to purchase it.
C) between high returns available on single instruments and the diversification of instruments into a portfolio.
D) between the desired level of investment and possessing the resources necessary to carry it out.

Question 20

The holding period return (HPR) is equal to the holding period yield (HPY) stated as a percentage.

Question 21

A decrease in the market risk premium, all other things constant, will cause the security market line to

A) Shift up
B) Shift down
C) Have a steeper slope
D) Have a flatter slope
E) Remain unchanged

Question 22

Measures of risk for an investment include

A) Variance of returns and business risk
B) Coefficient of variation of returns and financial risk
C) Business risk and financial risk
D) Variance of returns and coefficient of variation of returns
E) All of the above

Question 23

Exhibit 1-2
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Suppose you bought a GM corporate bond on January 25, 2009 for $750, on January 25, 2010 sold it for $650.00.
Refer to Exhibit 1-2. What was your annual holding period yield?

A) -0.0466
B) -0.1333
C) 0.0333
D) 0.3534
E) 0.8667

Question 24

The ability to sell an asset quickly at a fair price is associated with

A) Business risk.
B) Liquidity risk.
C) Exchange rate risk.
D) Financial risk.
E) Market risk.

Question 25

Exhibit 1-2
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Suppose you bought a GM corporate bond on January 25, 2009 for $750, on January 25, 2010 sold it for $650.00.
Refer to Exhibit 1-2. What was your annual holding period return?

A) 0.8667
B) -0.1333
C) 0.0333
D) 0.9534
E) -0.0466

Question 26

Which of the following is not a component of the risk premium?

A) Business risk
B) Financial risk
C) Liquidity risk
D) Exchange rate risk
E) Unsystematic market risk

Question 27

Sources of risk for an investment include

A) Variance of returns and business risk
B) Coefficient of variation of returns and financial risk
C) Business risk and financial risk
D) Variance of returns and coefficient of variation of returns
E) All of the above

Question 28

The total risk for a security can be measured by its

A) Beta with the market portfolio
B) Systematic risk
C) Standard deviation of returns
D) Unsystematic risk
E) Alpha with the market portfolio

Question 29

A decrease in the expected real growth in the economy, all other things constant, will cause the security market line to

A) Shift up
B) Shift down
C) Have a steeper slope
D) Have a flatter slope
E) Remain unchanged

Question 30

All of the following are major sources of uncertainty EXCEPT:

A) Business risk
B) Financial risk
C) Default risk
D) Country risk
E) Liquidity risk

Question 31

The uncertainty of investment returns associated with how a firm finances its investments is known as

A) Business risk.
B) Liquidity risk.
C) Exchange rate risk.
D) Financial risk.
E) Market risk.

Question 32

Two factors that influence the nominal risk-free rate are:

A) The relative ease or tightness in capital markets and the expected rate of inflation.
B) The expected rate of inflation and the set of investment opportunities available in the economy.
C) The relative ease or tightness in capital markets and the set of investment opportunities available in the economy.
D) Time preference for income consumption and the relative ease or tightness in capital markets.
E) Time preference for income consumption and the set of investment opportunities available in the economy.

Question 33

Exhibit 1-1
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume you bought 100 shares of NewTech common stock on January 15, 2009 at $50.00 per share and sold it on January 15, 2010 for $40.00 per share.
Refer to Exhibit 1-1. What was your holding period yield?

A) -10%
B) -0.8
C) 25%
D) 0.8
E) -20%

Question 34

Modern portfolio theory assumes that most investors are

A) Risk averse
B) Risk neutral
C) Risk seekers
D) Risk tolerant
E) None of the above

Question 35

What will happen to the security market line (SML) if the following events occur, other things constant: (1) inflation expectations increase, and (2) investors become more risk averse?

A) Shift up and keep the same slope
B) Shift up and have less slope
C) Shift up and have a steeper slope
D) Shift down and keep the same slope
E) Shift down and have less slope

Question 36

The variability of operating earnings is associated with

A) Business risk.
B) Liquidity risk.
C) Exchange rate risk.
D) Financial risk.
E) Market risk.

Question 37

The security market line (SML) graphs the expected relationship between

A) Business risk and financial risk
B) Systematic risk and unsystematic risk
C) Risk and return
D) Systematic risk and unsystematic return
E) None of the above

Question 38

Which of the following is not a component of the required rate of return?

A) Expected rate of inflation
B) Time value of money
C) Risk
D) Holding period return
E) All of the above are components of the required rate of return

Question 39

Unsystematic risk refers to risk that is

A) Undiversifiable
B) Diversifiable
C) Due to fundamental risk factors
D) Due to market risk
E) None of the above

Question 40

Exhibit 1-1
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume you bought 100 shares of NewTech common stock on January 15, 2009 at $50.00 per share and sold it on January 15, 2010 for $40.00 per share.
Refer to Exhibit 1-1. What was your holding period return?

A) -10%
B) -0.8
C) 25%
D) 0.8
E) -20%

Question 41

Exhibit 1-7
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider the following information
Nominal annual return on Canadian T-bills for year 2009 = 3.5%
Nominal annual return on Canadian corporate bonds for year 2009= 4.75%
Nominal annual return on Canadian large-cap stocks for year 2009 = 8.75%
Consumer price index January 1, 2009 = 165
Consumer price index December 31, 2009 = 169
Refer to Exhibit 1-7. Calculate the real rate of return for Canadian large-cap stocks.

A) 7.06%
B) 6.18%
C) 4.75%
D) 3.75%
E) None of the above

Question 42

Exhibit 1-4
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
You have concluded that next year the following relationships are possible: $\begin{array}{llc}\text { Economic Status } & \text { Probability } & \text { Rate of Return } \\\hline \text { Weak Economy } & .15 & -5 \% \\\text { Static Economy } & .60 & 5 \% \\\text { Strong Economy } & .25 & 15 \%\end{array}$

-Refer to Exhibit 1-4. Compute the standard deviation of the rate of return for the one year period.

A) 0.65%
B) 1.45%
C) 4.0%
D) 6.25%
E) 6.4%

Question 43

Exhibit 1-5
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume that during the past year the consumer price index increased by 1.5% percent and the securities listed below returned the following nominal rates of return.
$\begin{array}{l}\text {Canadian T-bils } &2.75 \% \\\text {Canadian corporate bonds } &4.75 \%\end{array}$

-Refer to Exhibit 1-5. If over the past 20 years the annual returns on the S&P 500 market index averaged 12% with a standard deviation of 18%, what was the coefficient of variation?

A) 0.6
B) 0.6%
C) 1.5
D) 1.5%
E) 0.66%

Question 44

Exhibit 1-7
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider the following information
Nominal annual return on Canadian T-bills for year 2009 = 3.5%
Nominal annual return on Canadian corporate bonds for year 2009= 4.75%
Nominal annual return on Canadian large-cap stocks for year 2009 = 8.75%
Consumer price index January 1, 2009 = 165
Consumer price index December 31, 2009 = 169
Refer to Exhibit 1-7. Calculate the real rate of return for Canadian T-bills

A) 2.26%
B) 1.81%
C) -0.5%
D) 1.05%
E) None of the above

Question 45

Exhibit 1-6
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
You are provided with the following information
Nominal return on risk-free asset = 4.5%
Expected return for asset i = 12.75%
Expected return on the market portfolio = 9.25%
Refer to Exhibit 1-6. Calculate the risk premium for the market portfolio

A) 4.5%
B) 8.25%
C) 4.75%
D) 3.5%
E) None of the above

Question 46

Exhibit 1-8
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume that you hold a two stock portfolio. You are provided with the following information on your holdings. $\begin{array}{|l|l|l|l|}\hline \text { Stock } & \text { Shares } & \text { Price }(t) & \text { Price }(t+1) \\\hline 1 & 15 & 10 & 12 \\\hline 2 & 25 & 15 & 16 \\\hline\end{array}$

-Refer to Exhibit 1-8. Calculate the market weights for Stocks 1 and 2 based on period t values

A) 39% for stock 1 and 61% for stock 2
B) 50% for stock 1 and 50% for stock 2
C) 71% for stock 1 and 29% for stock 2
D) 29% for stock 1 and 71% for stock 2
E) None of the above

Question 47

Exhibit 1-7
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider the following information
Nominal annual return on Canadian T-bills for year 2009 = 3.5%
Nominal annual return on Canadian corporate bonds for year 2009= 4.75%
Nominal annual return on Canadian large-cap stocks for year 2009 = 8.75%
Consumer price index January 1, 2009 = 165
Consumer price index December 31, 2009 = 169
Refer to Exhibit 1-7. Calculate the real rate of return for Canadian corporate bonds.

A) 3.06%
B) 2.27%
C) 2.51%
D) 3.5%
E) None of the above

Question 48

Exhibit 1-4
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
You have concluded that next year the following relationships are possible: $\begin{array}{llc}\text { Economic Status } & \text { Probability } & \text { Rate of Return } \\\hline \text { Weak Economy } & .15 & -5 \% \\\text { Static Economy } & .60 & 5 \% \\\text { Strong Economy } & .25 & 15 \%\end{array}$

-Refer to Exhibit 1-4. Compute the coefficient of variation for your portfolio.

A) 0.043
B) 0.12
C) 1.40
D) 0.69
E) 1.04

Question 49

Exhibit 1-7
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider the following information
Nominal annual return on Canadian T-bills for year 2009 = 3.5%
Nominal annual return on Canadian corporate bonds for year 2009= 4.75%
Nominal annual return on Canadian large-cap stocks for year 2009 = 8.75%
Consumer price index January 1, 2009 = 165
Consumer price index December 31, 2009 = 169
Refer to Exhibit 1-7. Compute the rate of inflation for the year 2009

A) 2.42%
B) 4.0%
C) 1.69%
D) 1.24%
E) None of the above

Question 50

Exhibit 1-3
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The common stock of XMen had the following historic prices. $$\begin{array} { l l } \text { Time } & \text { Price of XMen } \\\hline 3 / 01 / 2004 & 50.00 \\3 / 01 / 2005 & 47.00 \\3 / 01 / 2006 & 76.00 \\3 / 01 / 2007 & 80.00 \\3 / 01 / 2008 & 85.00 \\3 / 01 / 2009 & 90.00\end{array}$$

-Refer to Exhibit 1-3. What was your arithmetic mean annual yield for the investment in XMen?

A) 0.1462
B) 0.1247
C) 1.8
D) 0.40
E) 0.25

Question 51

Exhibit 1-5
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume that during the past year the consumer price index increased by 1.5% percent and the securities listed below returned the following nominal rates of return.
$\begin{array}{l}\text {Canadian T-bils } &2.75 \% \\\text {Canadian corporate bonds } &4.75 \%\end{array}$

-Given investments A and B with the following risk return characteristics, which one would you prefer and why? $\begin{array}{lll}\text { Investment } & \text { Expected Return } & \begin{array}{l}\text { Standard Deviation } \\\text { of Expected Returns }\end{array} \\\hline \mathrm{A} & 12.2 \% & 7 \% \\\mathrm{~B} & 8.8 \% & 5 \%\end{array}$

A) Investment A because it has the highest expected return.
B) Investment A because it has the lowest relative risk.
C) Investment B because it has the lowest absolute risk.
D) Investment B because it has the lowest coefficient of variation.
E) Investment A because it has the highest coefficient of variation.

Question 52

Exhibit 1-3
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The common stock of XMen had the following historic prices. $$\begin{array} { l l } \text { Time } & \text { Price of XMen } \\\hline 3 / 01 / 2004 & 50.00 \\3 / 01 / 2005 & 47.00 \\3 / 01 / 2006 & 76.00 \\3 / 01 / 2007 & 80.00 \\3 / 01 / 2008 & 85.00 \\3 / 01 / 2009 & 90.00\end{array}$$

-Refer to Exhibit 1-3. What was your geometric mean annual yield for the investment in XMen?

A) 0.25
B) 0.40
C) 1.8
D) 0.1247
E) 0.1462

Question 53

Exhibit 1-8
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume that you hold a two stock portfolio. You are provided with the following information on your holdings. $\begin{array}{|l|l|l|l|}\hline \text { Stock } & \text { Shares } & \text { Price }(t) & \text { Price }(t+1) \\\hline 1 & 15 & 10 & 12 \\\hline 2 & 25 & 15 & 16 \\\hline\end{array}$

-Refer to Exhibit 1-8. Calculate the HPY for Stock 1.

A) 10%
B) 20%
C) 15%
D) 12%
E) 7%

Question 54

Exhibit 1-3
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The common stock of XMen had the following historic prices. $$\begin{array} { l l } \text { Time } & \text { Price of XMen } \\\hline 3 / 01 / 2004 & 50.00 \\3 / 01 / 2005 & 47.00 \\3 / 01 / 2006 & 76.00 \\3 / 01 / 2007 & 80.00 \\3 / 01 / 2008 & 85.00 \\3 / 01 / 2009 & 90.00\end{array}$$

-Refer to Exhibit 1-3. What was your annual holding period yield (Annual HPY)?

A) 0.1462
B) 0.1247
C) 1.8
D) 0.40
E) 0.25

Question 55

Exhibit 1-5
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume that during the past year the consumer price index increased by 1.5% percent and the securities listed below returned the following nominal rates of return.
$\begin{array}{l}\text {Canadian T-bils } &2.75 \% \\\text {Canadian corporate bonds } &4.75 \%\end{array}$

-Refer to Exhibit 1-5. What are the real rates of return for each of these securities?

A) 4.29% and 6.32%
B) 1.23% and 4.29%
C) 3.20% and 6.32%
D) 1.23% and 3.20%
E) 3.75% and 5.75%

Question 56

Exhibit 1-4
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
You have concluded that next year the following relationships are possible: $\begin{array}{llc}\text { Economic Status } & \text { Probability } & \text { Rate of Return } \\\hline \text { Weak Economy } & .15 & -5 \% \\\text { Static Economy } & .60 & 5 \% \\\text { Strong Economy } & .25 & 15 \%\end{array}$

-Refer to Exhibit 1-4. What is your expected rate of return [E(Ri)] for next year?

A) 4.25%
B) 6.00%
C) 6.25%
D) 7.75%
E) 8.00%

Question 57

Exhibit 1-3
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The common stock of XMen had the following historic prices. $$\begin{array} { l l } \text { Time } & \text { Price of XMen } \\\hline 3 / 01 / 2004 & 50.00 \\3 / 01 / 2005 & 47.00 \\3 / 01 / 2006 & 76.00 \\3 / 01 / 2007 & 80.00 \\3 / 01 / 2008 & 85.00 \\3 / 01 / 2009 & 90.00\end{array}$$

-Refer to Exhibit 1-3. What was your holding period return for the time period 3/1/2004 to 3/1/2009?

A) 0.1247
B) 1.8
C) 0.1462
D) 0.40
E) 0.25

Question 58

Exhibit 1-6
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
You are provided with the following information
Nominal return on risk-free asset = 4.5%
Expected return for asset i = 12.75%
Expected return on the market portfolio = 9.25%
Refer to Exhibit 1-6. Calculate the risk premium for asset i

A) 4.5%
B) 8.25%
C) 4.75%
D) 3.5%
E) None of the above

Question 59

Exhibit 1-8
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume that you hold a two stock portfolio. You are provided with the following information on your holdings. $\begin{array}{|l|l|l|l|}\hline \text { Stock } & \text { Shares } & \text { Price }(t) & \text { Price }(t+1) \\\hline 1 & 15 & 10 & 12 \\\hline 2 & 25 & 15 & 16 \\\hline\end{array}$

-Refer to Exhibit 1-8. Calculate the HPY for Stock 2

A) 5%
B) 6%
C) 7%
D) 8%
E) 10%

Question 60

Exhibit 1-5
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume that during the past year the consumer price index increased by 1.5% percent and the securities listed below returned the following nominal rates of return.
$\begin{array}{l}\text {Canadian T-bils } &2.75 \% \\\text {Canadian corporate bonds } &4.75 \%\end{array}$

-Refer to Exhibit 1-5. If next year the real rates all rise by 10% while inflation climbs from 1.5% to 2.5%, what will be the nominal rate of return on each security?

A) 1.24% and 1.52%
B) 1.35% and 3.52%
C) 3.89% and 6.11%
D) 3.52% and 3.89%
E) 1.17% and 6.11%

Question 61

Exhibit 1-9
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
You purchased 100 shares of GE common stock on January 1, for $29 per share. A year later you received $1.25 in dividends per share and you sold it for $28 per share.
Refer to Exhibit 1-9. Calculate your holding period return (HPR) for this investment in GE stock.

A) 0.9655
B) 1.0086
C) 1.0357
D) 1.0804
E) 1.0973

Question 62

Exhibit 1-8
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Assume that you hold a two stock portfolio. You are provided with the following information on your holdings. $\begin{array}{|l|l|l|l|}\hline \text { Stock } & \text { Shares } & \text { Price }(t) & \text { Price }(t+1) \\\hline 1 & 15 & 10 & 12 \\\hline 2 & 25 & 15 & 16 \\\hline\end{array}$

-Refer to Exhibit 1-8. Calculate the HPY for the portfolio

A) 10.6%
B) 6.95%
C) 13.5%
D) 10%
E) 15.7%

Question 63

Exhibit 1-9
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
You purchased 100 shares of GE common stock on January 1, for $29 per share. A year later you received $1.25 in dividends per share and you sold it for $28 per share.
Refer to Exhibit 1-9. Calculate your holding period yield (HPY) for this investment in GE stock.

A) 0.0345
B) 0.0090
C) 0.0086
D) 0.0643
E) 0.0804

Question 64

Exhibit 10
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The annual rates of return of Stock Z for the last four years are 0.10, 0.15, -0.05, and 0.20, respectively.
Refer to Exhibit 1-10. Compute the arithmetic mean annual rate of return for Stock Z.

A) 0.03
B) 0.04
C) 0.06
D) 0.10
E) 0.40

Question 65

Exhibit 10
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The annual rates of return of Stock Z for the last four years are 0.10, 0.15, -0.05, and 0.20, respectively.
Refer to Exhibit 1-10. Compute the coefficient of variation for Stock Z.

A) 0.837
B) 0.935
C) 1.070
D) 1.145
E) 1.281

Question 66

Exhibit 10
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The annual rates of return of Stock Z for the last four years are 0.10, 0.15, -0.05, and 0.20, respectively.

-Refer to Exhibit 1-10. Compute the standard deviation of the annual rate of return for Stock Z.

A) 0.0070
B) 0.0088
C) 0.0837
D) 0.0935
E) 0.1145

Question 67

Exhibit 10
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The annual rates of return of Stock Z for the last four years are 0.10, 0.15, -0.05, and 0.20, respectively.
Refer to Exhibit 1-10. Compute the geometric mean rate of return for Stock Z.

A) 0.051
B) 0.074
C) 0.096
D) 0.150
E) 1.090