Deck 11: Risk and Return in Capital Markets

Question 1

Two poker machines offer to double your money 3 times out of 5. Machine A takes $10 bets an? Machine B takes $100 bets on each occasion. A risk-averse investor prefers to bet on

A) machine A.
B) machine B.
C) does not matter
D) none of the above

Answer 1

machine A.

Question 2

When investing for a long horizon, investors care about the volatility of returns and not the volatility of returns.

A) cumulative, average
B) mean, average
C) average, cumulative
D) mean, cumulative

Answer 2

cumulative, average

Question 3

Which of the following statements is TRUE?

A) Portfolios of smaller cap shares are typically less volatile than individual small cap shares.
B) On average, smaller cap shares have lower volatility than Treasury notes.
C) On average, smaller cap shares have lower returns than larger cap shares.
D) On average, Treasury notes have higher returns than world shares.

Answer 3

Portfolios of smaller cap shares are typically less volatile than individual small cap shares.

Question 4

Fortescue had realised returns of 10%, 25%, -20%, and -15% over four quarters. What is the quarterly standard deviation of returns for Fortescue?

A) 23.13%
B) 21.21%
C) 25.32%
D) 19.67%

Question 5

Which of the following investments offered the highest average annual return over the twentyyears to June 2012?

A) Australian property
B) Australian cash
C) Australian shares
D) Australian bonds

Question 6

A security returns 5%, 4%, 3%, and 6% over four years. The standard deviation of returns of thesecurity is

A) 1.51%.
B) 1.29%.
C) 1.11%.
D) 1.00%.

Question 7

Which of the following statements is FALSE?

A) When we combine many shares in a large portfolio, the firm-specific risks for each share will average out and be diversified.
B) The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk.
C) The volatility in a large portfolio will decline until only the systematic risk remains.
D) Fluctuations of a share's returns that are due to firm-specific news are common risks.

Question 8

The geometric average annual return for a large capitalisation share portfolio is 12% for ten yearsand 5% per year for the next five years. The geometric average annual return for the entire 15-year period is

A) 10.23%.
B) 9.11%.
C) 9.62%.
D) 9.95%.

Question 9

The risk premium of a share is not affected by it?

A) unsystematic risk.
B) undiversifiable risk.
C) systematic risk.
D) typical risk.

Question 10

Use the table for the question(s) below.
Consider the following price and dividend data for Cockatoo Limited:
$\begin{array} { l c c } \hline \text { Date } & \text { Price (\$) } & \text { Dividend (\$) } \\\hline \text { December 31, 2011 } & \$ 14.64 & \\\hline \text { January 26, 2012 } & \$ 13.35 & \$ 0.10 \\\hline \text { April 28, 2012 } & \$ 9.14 & \$ 0.10 \\\hline \text { July 29, 2012 } & \$ 10.74 & \$ 0.10 \\\hline \text { October 28, 2012 } & \$ 8.02 & \$ 0.10 \\\hline \text { December 30, 2012 } & \$ 7.72 & \\\hline\end{array}$

-Assume that you purchased Cockatoo shares at the closing price on 31 December 2011 and sold it after the dividend had been paid at the closing price on 26 January 2012. Your dividend yield for this period is closest to:

A) 0.75%
B) -8.80%
C) 0.70%
D) -8.15%

Question 11

Independent risk is more closely related t?

A) unsystematic risk.
B) common risk.
C) systematic risk.
D) diversification risk.

Question 12

Suppose you bought a $75 share a month ago. It paid a dividend of $0.50 today and then you sold itfor $70. What was your return on the investment?

A) -7.00%
B) -8.00%
C) -6.99%
D) -6.00%

Question 13

Use the table for the question(s) below.
Consider the following realised annual returns:
$\begin{array} { l c c } \hline \text { Year-end } & \begin{array} { c } \text { All Ords } \\\text { Realised } \\\text { Return }\end{array} & \begin{array} { c } \text { Westpac } \\\text { Realised } \\\text { Return }\end{array} \\\hline 2003& 23.6 \% & 46.3 \% \\\hline 2004 & 24.7 \% & 26.7 \% \\\hline 2005 & 30.5 \% & 86.9 \% \\\hline 2006 & 9.0 \% & 23.1 \% \\\hline 2007 & - 2.0 \% & 0.2 \% \\\hline 2008 & - 17.3 \% & - 3.2 \% \\\hline 2009 & - 24.3 \% & - 27.0 \% \\\hline 2010 & 32.2 \% & 27.9 \% \\\hline 2011 & 4.4 \% & - 5.1 \% \\\hline 2012 & 7.4 \% & - 11.3 \% \\\hline &\end{array}$

-The average annual return on Westpac from 2003 to 2012 is closest to?

A) 18.7%
B) 29.9%
C) 16.40%
D) 18.2%

Question 14

Suppose the quarterly arithmetic average return for a security is 5% per quarter and the securitygives a return of 10% each over the next two quarters. The arithmetic average return over the six quarters is

A) 6.67%.
B) 7.5%.
C) 10%.
D) 9%.

Question 15

There is an overall relationship between and -larger stocks have a lower volatility overall.

A) mean, standard deviation
B) risk aversion, size
C) volatility, mean
D) size, risk

Question 16

Fortescue Mining had realised returns of 5%, 15%, -10%, and -5% over four quarters. What is the quarterly standard deviation of returns for Fortescue?

A) 11.09%
B) 10.31%
C) 9.91%
D) 10.71%

Question 17

In general, it is possible to eliminate ?

A) systematic
B) unsystematic
C) unsystematic and systematic
D) none of the above

Question 18

Which of the following statements is FALSE?

A) Volatility seems to be a reasonable measure of risk when evaluating returns on large portfolios and the returns of individual securities.
B) Investments with higher volatility have rewarded investors with higher average returns.
C) Riskier investments must offer investors higher average returns to compensate them for the extra risk they are taking on.
D) Investments with higher volatility should have a higher risk premium and, therefore, higher returns.

Question 19

A portfolio of shares can achieve diversification benefits if the shares that comprise the portfolio ar?

A) susceptible to common risks only.
B) not perfectly correlated.
C) perfectly correlated.
D) both B & C

Question 20

McCoy paid a one-time special dividend of $3.20 on 18 October 2012. Suppose you bought McCoy stock for $47.00 on 18 July 2012, and sold it immediately after the dividend was paid for $63.32. What was your realised return from holding McCoy?

A) 6.8%
B) 41.5%
C) 34.7%
D) 4.15%

Question 21

Use the information for the question(s) below.
Consider an economy with two types of firms, S and U. S firms always move together, but U firms move independently of each other. For both types of firms there is a 70% probability that the firm will have a 20% return and a 30% probability that
the firm will have a -30% return.
What is the expected return for an individual firm?

A) 3%
B) 5%
C) -5%
D) 14%

Question 22

Use the table for the question(s) below.
Consider the following price and dividend data for Cockatoo Limited:
$\begin{array} { l c c } \hline \text { Date } & \text { Price (\$) } & \text { Dividend (\$) } \\\hline \text { December 31, 2011 } & \$ 14.64 & \\\hline \text { January 26, 2012 } & \$ 13.35 & \$ 0.10 \\\hline \text { April 28, 2012 } & \$ 9.14 & \$ 0.10 \\\hline \text { July 29, 2012 } & \$ 10.74 & \$ 0.10 \\\hline \text { October 28, 2012 } & \$ 8.02 & \$ 0.10 \\\hline \text { December 30, 2012 } & \$ 7.72 & \\\hline\end{array}$

-Assume that you purchased Cockatoo shares at the closing price on 31 December 2011 and sold it after the dividend had been paid at the closing price on 26 January 2012. Your total return rate (yield) for this period is closest to:

A) 0.70%
B) -8.80%
C) -8.13%
D) 0.75%

Question 23

Tabcorp share prices gave a realised return of 20%, 10%, 10%,and 15% over four successive quarters. What is the annual realised return for Tabcorp for the year?

A) 71.25%
B) 55.00%
C) 60.00%
D) 66.98%

Question 24

Investors demand a higher return for investments that have larger fluctuations in values becaus?

A) they do not like risk.
B) they invest for the long term.
C) they are risk seeking.
D) none of the above

Question 25

Which of the following statements is FALSE?

A) On average, larger cap shares have higher volatility than smaller cap shares.
B) On average, smaller cap shares have higher returns than larger cap shares.
C) Portfolios of large cap shares are typically less volatile than individual large cap shares.
D) On average, Treasury notes have lower returns than corporate bonds.

Question 26

The standard deviation of returns of: I. small capitalisation shares is higher than that of large capitalisation shares. II. large capitalisation shares is lower than that of corporate bonds. III. corporate bonds is higher than that of Australian treasuries. Which statement is true?

A) I and III
B) I only
C) I, II, and III
D) I and II

Question 27

Rational investor?

A) prefer
B) are averse to
C) are indifferent to
D) none of the above

Question 28

Suppose that an investment gave a realised return of 20% over a two-year time period and a 10% return over the third year. The geometric average annual return is

A) 11.20%.
B) 16.55%.
C) 9.70%.
D) 14.96%.

Question 29

Your investment over one year yielded a capital gains yield of 5% and no dividend yield. If the sale price was $119 per share, what was the cost of the investment?

A) $126.25
B) $117.25
C) $111.67
D) $113.33

Question 30

IGM Realty had a price of $30, $30, $35, $33, and $25 at the end of the last five quarters. If IGM pays a dividend of $2 at the end of each quarter, what is the annual realised return on IGM?

A) 7.10%
B) 8.09%
C) 7.6%
D) 8.61%

Question 31

As we increase the number of shares in a portfolio, the standard deviation of returns of the portfolio

A) decreases.
B) increases.
C) remains unchanged.
D) none of the above

Question 32

Bear Inc.'s share price closed at $100, $105, $56, $30, $2 over five successive weeks. The weekly standard deviation of the stock price calculated from this sample is

A) $29.76.
B) $44.43.
C) $35.23.
D) $50.25.

Question 33

While seems to be a reasonable measure of risk when evaluating a large portfolio, the of an individual security does not explain the size of its average return.

A) mode, volatility
B) the mean return, standard deviation
C) volatility, volatility
D) none of the above

Question 34

The S&P/ASX 200 index delivered a return of 15%, 20%, 20%, -25% over four successive years. What is the arithmetic average annual return per year?

A) 6.5%
B) 7.5%
C) 8.5%
D) 9.5%

Question 35

Which of the following types of risk does NOT belong?

A) unsystematic risk
B) idiosyncratic risk
C) unique risk
D) market risk

Question 36

Which of the following types of risk does NOT belong?

A) undiversifiable risk
B) systematic risk
C) idiosyncratic risk
D) market risk

Question 37

Suppose you bought a $100 share a month ago. It paid a dividend of $1 today and then you sold it for $100. What was your dividend yield and capital gains yield on the investment?

A) 1%, 0%
B) 3%, 1%
C) 2%, 1%
D) 0%, 1%

Question 38

You purchased HIH shares at a price of $30 per share. Its price was $20 after six months and the company declared bankruptcy at the end of the next six months. The realised return over the last year is

A) -100%.
B) -75%.
C) -99%.
D) -150%.

Question 39

Use the table for the question(s) below.
Consider the following realised annual returns:
$\begin{array} { l c c } \hline \text { Year-end } & \begin{array} { c } \text { All Ords } \\\text { Realised } \\\text { Return }\end{array} & \begin{array} { c } \text { Westpac } \\\text { Realised } \\\text { Return }\end{array} \\\hline 2003 & 23.6 \% & 46.3 \% \\\hline 2004 & 24.7 \% & 26.7 \% \\\hline 2005 & 30.5 \% & 86.9 \% \\\hline 2006 & 9.0 \% & 23.1 \% \\\hline 2007 & - 2.0 \% & 0.2 \% \\\hline 2008 & - 17.3 \% & - 3.2 \% \\\hline 2009 & - 24.3 \% & - 27.0 \% \\\hline 2010 & 32.2 \% & 27.9 \% \\\hline 2011 & 4.4 \% & - 5.1 \% \\\hline 2012 & 7.4 \% & - 11.3 \% \\\hline &\end{array}$

-The average annual return on the All Ords from 2003 to 2012 is closest to?

A) 4.00%
B) 9.75%
C) 7.10%
D) 8.75%

Question 40

Investments with high returns are expected to hav?

A) no relation to variability.
B) high variability.
C) inverse relationship with variability.
D) low variability.

Question 41

Tabcorp share prices gave a realised return of 5%, -5%, 10%, and -10% over four successive quarters. What is the annual realised return for Tabcorp for the year?

A) 0.00%
B) 1.25%
C) 2.50%
D) -1.25%

Question 42

Assume that the average annual historical return for shares that comprise the Australian All Ordinaries index is 12%, and the standard deviation of returns is 20%. Based on these numbers what is a 95% prediction interval for 2012 returns?

A) -10%,40%
B) -15%, 35%
C) -20%,35%
D) -28%, 52%

Question 43

Use the table for the question(s) below.
Consider the following price and dividend data for Cockatoo Limited:
$\begin{array} { l c c } \hline \text { Date } & \text { Price (\$) } & \text { Dividend (\$) } \\\hline \text { December 31, 2011 } & \$ 14.64 & \\\hline \text { January 26, 2012 } & \$ 13.35 & \$ 0.10 \\\hline \text { April 28, 2012 } & \$ 9.14 & \$ 0.10 \\\hline \text { July 29, 2012 } & \$ 10.74 & \$ 0.10 \\\hline \text { October 28, 2012 } & \$ 8.02 & \$ 0.10 \\\hline \text { December 30, 2012 } & \$ 7.72 & \\\hline\end{array}$

-Assume that you purchased Cockatoo shares at the closing price on 31 December 2011 and sold it at the closing price on 30 December 2012. Your realised annual return for the year 2012 is closest to:

A) -45.1%
B) -48.5%
C) -47.3%
D) -44.5%

Question 44

If the returns on a share index can be characterised by a normal distribution with mean 12%, the probability that returns will be lower than 12% over the next period equals

A) 25%.
B) 50%.
C) 46%.
D) 33%.

Question 45

McCoy paid a one-time special dividend of $3.20 on 18 October 2012. Suppose you bought McCoy stock for $47.00 on 18 July 2012, and sold it immediately after the dividend was paid for $63.32. What was your capital gain yield from holding McCoy?

A) 41.5%
B) 4.15%
C) 6.8%
D) 34.7%

Question 46

The S&P/ASX 200 index delivered a return of 20%, -10%, 25%, and 5% over four successive years. What is the arithmetic average annual return per year?

A) 15%
B) 11%
C) 12%
D) 10%

Question 47

Because investors can eliminate unsystematic risk "for free" by diversifying their portfolios, they a risk premium for bearing it.

A) are indifferent about
B) do not require
C) require
D) none of the above

Question 48

Suppose you bought a $60 share a month ago. It paid a dividend of $0.70 today and then you sold it for $65. What was your return on the investment?

A) 9.00%
B) 8.25%
C) 9.50%
D) 9.75%

Question 49

You own shares in Darling that were purchased at a price of $21 per share. Gorilla has offered to purchase Darling and buy your shares at a price of $31 per share. What will be your return if you tender your shares to Gorilla and the deal is completed?

A) 43.34%
B) 47.62%
C) 49.65%
D) 33.45%

Question 50

You purchase a 30-year, zero-coupon bond for a price of $20. The bond will pay back $100 after 30 years and make no interim payments. The annual compounded return (geometric average return) on this investment is

A) 4.78%.
B) 5.31%.
C) 6.54%.
D) 5.51%.

Question 51

Which of the following is NOT a systematic risk?

A) the risk that the economy slows, reducing demand for your firm's products
B) the risk that oil prices rise, increasing production costs
C) the risk that your new product will not receive regulatory approval
D) the risk that the Reserve Bank raises interest rates

Question 52

Use the information for the question(s) below.
Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a potential "blockbuster" drug before
the Therapeutic Goods Administration (TGA) waiting for approval. If approved, Big Cure's blockbuster drug will produce $1
billion in net income for Big Cure. Little Cure has ten separate, less important drugs before the TGA waiting for approval. If
approved, each of Little Cure's drugs would produce $100 million in net income for Little Cure. The probability of the TGA
approving a drug is 50%
What is the expected payoff for Big Cure's Blockbuster drug?

A) $1 billion
B) $500 million
C) $100 million
D) $0

Question 53

Greg purchased stock in Cockatoo Limited at a price of $89 per share one year ago. The company was acquired by Wombat Investments at a price of $10 per share. What is Greg's return on his investment?

A) -96.25%
B) -88.76%
C) -79.00%
D) -85.45%

Question 54

Many former employees at Enron, an energy trading and supply company, had a large part of their portfolio invested in Enron stock. These employees were bearing a high degree of risk.

A) systematic
B) unsystematic
C) non-diversifiable
D) market specific

Question 55

Suppose you bought a $60 share a month ago. It paid a dividend of $0.37 today and then you sold it for $61. What was your return on the investment?

A) 9.98%
B) 9.59%
C) 8.80%
D) 9.01%

Question 56

Assume that the average annual historical return for shares that comprise the Australian All Ordinaries index is 10.5%, and the standard deviation of returns is 18.5%. Based on these numbers what is a 95% prediction interval for 2012 returns?

A) -10%, 10%
B) -37%, 37%
C) -18.5%, 18.5%
D) -26.5%, 47.5%

Question 57

Which of the following statements is FALSE?

A) The geometric average return is a better description of the long-run historical performance of an investment.
B) We should use the arithmetic average return when we are trying to estimate an investment's expected return over a future horizon based on its past performance.
C) The geometric average return will always be above the arithmetic average return, and the difference grows with the volatility of the annual returns.
D) The compounded geometric average return is most often used for comparative purposes.

Question 58

If asset A's return is exactly two times asset B's return, then following risk return tradeoff, the standard deviation of asset A should be _ times the standard deviation of asset B.

A) 1
B) 4
C) 2
D) 3

Question 59

Which of the following is NOT a diversifiable risk?

A) the risk that oil prices rise, increasing production costs
B) the risk that the CEO is killed in a plane crash
C) the risk of a product liability lawsuit
D) the risk of a key employee being hired away by a competitor

Question 60

The S&P/ASX 200 index delivered a return of 20%, 10%, -25%, and -5% over four successive years. What is the arithmetic average annual return per year?

A) 3%
B) 5%
C) -5%
D) 0%

Question 61

Fortescue Mining had realised returns of 10%, 20%, 20%, and 10% over four quarters. What is the quarterly standard deviation of returns for Fortescue calculated from this sample?

A) 5.77%
B) 5.99%
C) 5.00%
D) 5.11%

Question 62

Which of the following investments offered the lowest average annual return over the twenty years to June 2012?

A) Australian shares
B) Australian bonds
C) Australian property
D) Australian cash

Question 63

What care, if any, should be taken when selecting shares for an investment portfolio?

Question 64

Apple's share price jumped when it announced that its revenue had increased because of the successful launch of iPad and the increased sales of Macbook laptops. This is an example of

A) market risk.
B) systematic risk.
C) unsystematic risk.
D) both A & C

Question 65

Is volatility a reasonable measure of risk when evaluating the investment in a single share?

Question 66

The risk premium of a security is determined by its risk and does not depend on its risk.

A) diversifiable, diversifiable
B) systematic, undiversifiable
C) systematic, unsystematic
D) all of the above

Question 67

Which of the following statements is FALSE?

A) Smaller company shares have lower volatility than larger stocks.
B) Investors would not choose to hold a portfolio that is more volatile unless they expected to earn a higher return.
C) The shares of the largest companies are typically more volatile than a portfolio of large cap shares.
D) Expected return should rise proportionately with volatility.

Question 68

Common risk is also calle?

A) independent risk.
B) uncorrelated risk.
C) correlated risk.
D) diversifiable risk.

Question 69

Is it accurate to state that as we add more shares of different firms to a portfolio, its risk gets eliminated to zero?

Question 70

Historically, shares have delivered a return on average compared to bonds but have experienced fluctuations in values.

A) lower, lower
B) lower, higher
C) higher, lower
D) higher, higher

Question 71

Suppose you bought a $98 share a month ago. It paid a dividend of $0.47 today and then you sold it for $99. What was your dividend yield and capital gains yield on the investment?

A) 0.47%, 1.02%
B) 0.47%, 1.08%
C) 0.45%, 1.09%
D) 1.02%, 1.12%

Question 72

Use the information for the question(s) below.
Consider an economy with two types of firms, S and U. S firms always move together, but U firms move independently of
each other. For both types of firms there is a 70% probability that the firm will have a 20% return and a 30% probability that
the firm will have a -30% return.
The standard deviation for the return on an individual firm is closest to?

A) 23.0%
B) 15.0%
C) 10.0%
D) 5.25%

Question 73

Is volatility a reasonable measure of risk when evaluating large portfolios?

Question 74

Tabcorp share prices gave a realised return of 20%, 10%, -10%, and -10% over four successive quarters. What is the annual realised return for Tabcorp for the year?

A) 6.92%
B) 10.00%
C) 7.91%
D) 11.31%

Question 75

Assume that the average annual historical return for shares that comprise the Australian All Ordinaries index is 10%, and the standard deviation of returns is 20%. Based on these numbers, what is a 95% prediction interval for 2012 returns?

A) -30%,40%
B) -20%,40%
C) -30%, 50%
D) -15%,25%

Question 76

If the Reserve Bank were to change from an expansionary to contractionary monetary policy, this would be an example of

A) systematic risk.
B) diversification risk.
C) independent risk.
D) unsystematic risk.

Question 77

Use the table for the question(s) below.
Consider the following price and dividend data for Cockatoo Limited:
$\begin{array} { l c c } \hline \text { Date } & \text { Price (\$) } & \text { Dividend (\$) } \\\hline \text { December 31, 2011 } & \$ 14.64 & \\\hline \text { January 26, 2012 } & \$ 13.35 & \$ 0.10 \\\hline \text { April 28, 2012 } & \$ 9.14 & \$ 0.10 \\\hline \text { July 29, 2012 } & \$ 10.74 & \$ 0.10 \\\hline \text { October 28, 2012 } & \$ 8.02 & \$ 0.10 \\\hline \text { December 30, 2012 } & \$ 7.72 & \\\hline\end{array}$

-Assume that you purchased Cockatoo shares at the closing price on 31 December 2011 and sold it after the dividend had been paid at the closing price on 26 January 2012. Your capital gains rate (yield) for this period is closest to:

A) -8.80%
B) -8.15%
C) 0.75%
D) 0.70%

Question 78

Suppose you bought a $100 share a month ago. It paid a dividend of $2 today and then you sold it for $99. What was your dividend yield and capital gains yield on the investment?

A) 2%, -1%
B) -2%, 1%
C) 2%, 1%
D) 1%, 2%

Question 79

If a share pays dividends at the end of each quarter, with realised returns of R1, R2, R3, and R4
each quarter, then the annual realised return is calculated as

A)Rannual = (1 + R1)(1 + R2)(1 + R3)(1 + R4).
B)Rannual = (1 + R1)(1 + R2)(1 + R3)(1 + R4) - 1.
C) $R _ { \text {annual } } = \frac { R _ { 1 } + R _ { 2 } + R _ { 3 } + R _ { 4 } } { 4 }$
D) Rannual = R1 + R2 + R3 + R4.

Question 80

If returns on security A are more volatile than the returns on security B, the geometric average return of security A is _ the geometric average return of security B when their arithmetic average return is the same.

A) the same as
B) lower than
C) higher than
D) cannot say for sure