Deck 7: Risk and Return

Question 1

An increase in the Treasury bill rate__________the required rate of return on common stock.

A) increases
B) has no effect on
C) decreases
D) cannot be determined by

Answer 1

increases

Question 2

If a person's required return decreases for an increase in risk, that person is said to be

A) risk-indifferent.
B) risk-averse.
C) risk-seeking.
D) risk-aware.

Answer 2

risk-seeking.

Question 3

If a person requires greater return when risk increases, that person is said to be

A) risk-indifferent.
B) risk-averse.
C) risk-seeking.
D) risk-aware.

Answer 3

risk-averse.

Question 4

An investor wants to invest $30,000 today in a stock today that has an expected average compoundrate of return of 7.7% annually over the next five years. If all dividends are reinvested, what will bethe value of this investment at the end of the five-year period if the expectation about future returns is correct?

A) $45,525
B) $41,550
C) $46,975
D) $43,471

Question 5

Combining negatively correlated assets having the same expected return results in a portfolio with__________level of expected return and __________level of risk.

A) the same; a higher
B) the same; a lower
C) a higher; a lower
D) a lower; a higher

Question 6

A collection of assets is called

A) an investment.
B) a diversity.
C) a portfolio.
D) a grouping.

Question 7

The risk premium a Canadian common stock is commonly calculated as the difference between the stock's rate of return and the __________ ?

A) Canada Savings Bonds Rate of return
B) Prime rate
C) T-bill rate
D) Bank of Canada Rate

Question 8

In the capital asset pricing model, the beta coefficient is a measure of__________ risk and an index ofthe degree of movement of an asset's return in response to a change in__________ .

A) nondiversifiable; the market return
B) diversifiable; the bond index rate
C) nondiversifiable; the Treasury Bill rate
D) diversifiable; the prime rate

Question 9

Which of the following companies would have the lowest systematic risk?

A) Air Canada
B) Bombardier
C) Sears
D) Petro-Canada

Question 10

Risk aversion is the behavior exhibited by managers who require a greater than proportional

A) decrease in return, for a given increase in risk.
B) increase in return, for a given increase in risk.
C) increase in return, for a given decrease in risk.
D) decrease in return, for a given decrease in risk.

Question 11

Combining two assets having perfectly negatively correlated returns will result in the creation of aportfolio with an overall risk that

A) decreases to a level below that of either asset.
B) increases to a level above that of either asset.
C) stabilizes to a level between the asset with the higher risk and the asset with the lower risk.
D) remains unchanged.

Question 12

$$\begin{array}{l}\text { Expected Return (\%) }\\\begin{array} { c c c c } \text { Year } & \text { Asset A } & \text { Asset B } & \text { Asset C } \\\hline 1 & 6 & 8 & 6 \\2 & 7 & 7 & 7 \\3 & 8 & 6 & 8\end{array}\end{array}$$

-The correlation of returns between Asset A and Asset B can be characterized as (See Figure 7.1)

A) perfectly negatively correlated.
B) uncorrelated.
C) perfectly positively correlated.
D) cannot be determined.

Question 13

Which of the following industries' have the lowest beta?

A) Restaurants
B) Tourism
C) Telecommunications
D) Utilities

Question 14

Over the past 4 years, a common stock has had the following rates of return: 2.3%, 12.2%, -3.6% and7.9%. The arithmetic mean rate of return over these 4 years is

A) 3.4%
B) 5.3%
C) 4.7%
D) 6.1%

Question 15

The beta of a portfolio is

A) is the weighted average of the betas of the individual assets in the portfolio.
B) irrelevant, only the betas of the individual assets are important.
C) does not change over time.
D) the sum of the betas of all assets in the portfolio.

Question 16

An increase in nondiversifiable risk

A) would cause an increase in the beta and would increase the required return.
B) would cause an increase in the beta and would lower the required return.
C) would have no effect on the beta and would, therefore, cause no change in the required return.
D) would cause a decrease in the beta and would, therefore, lower the required rate of return.

Question 17

A beta coefficient of +1 represents an asset that

A) is more responsive than the market portfolio.
B) has the same response as the market portfolio.
C) is unaffected by market movement.
D) is less responsive than the market portfolio.

Question 18

A common approach of estimating the variability of returns involving forecasting the pessimistic, most likely, and optimistic returns associated with the asset is called

A) break-even analysis.
B) marginal analysis.
C) financial statement analysis.
D) sensitivity analysis.

Question 19

Government of Canada t-bill rate of return is widely used as the risk-free rate of return. If the average rate of return on Government of Canada t-bills is 5.3% and the average rate of return on a Canadian common stock is 11.7%, then the stock's risk premium is:

A) 12.3%
B) 6.4%
C) 17.0%
D) 2.2%

Question 20

Last year Mike bought 100 shares of Dallas Corporation common stock for $53 per share. Duringthe year he received dividends of $1.45 per share. The stock is currently selling for $60 per share.What rate of return did Mike earn over the year?

A) 14.1 percent
B) 13.2 percent
C) 15.9 percent
D) 11.7 percent

Question 21

Combining two negatively correlated assets to reduce risk is known as

A) risk aversion.
B) diversification.
C) valuation.
D) liquidation.

Question 22

An example of an external factor that affects a corporation's risk or beta, and hence required rate of return would be

A) a financing mix.
B) a change in top management.
C) an asset mix.
D) inflation.

Question 23

Combining positively correlated assets having the same expected return results in a portfolio with___________level of expected return and ___________level of risk.

A) a higher; a lower
B) the same; a lower
C) a lower; a higher
D) the same; a higher

Question 24

As randomly selected securities are combined to create a portfolio, the ___________ risk of the portfolio decreases until 10 to 20 securities are included. The portion of the risk eliminated is___________risk, while that remaining is ___________risk.

A) total; diversifiable; nondiversifiable
B) relevant; irrelevant; total
C) diversifiable; nondiversifiable; total
D) total; nondiversifiable; diversifiable

Question 25

Asset P has a beta of 0.9. The risk-free rate of return is 8 percent, while the return on the marketportfolio of assets is 14 percent. The asset's required rate of return is

A) 6.0 percent.
B) 10 percent.
C) 5.4 percent.
D) 13.4 percent.

Question 26

Unsystematic risk is not relevant, because

A) it does not change.
B) it can be eliminated through diversification.
C) it cannot be eliminated through diversification.
D) it cannot be estimated.

Question 27

ABC Company's stock had an initial price of $50 per share and paid a dividend of $4 per share during the year. Calculate the total rate of return for ABC Company's stock assuming an ending share price of $45.

A) 8%
B) -2%
C) -10%
D) 2%

Question 28

If the TSX's historical average return and standard deviation are 13% and 17%, respectively, what isthe expected return next year using a 95% confidence interval?

A) -21% to 47%
B) -38% to 64%
C) 13% to 17%
D) -4% to 30%

Question 29

The___________ of an asset is the change in value plus any cash distributions expressed as apercentage of the initial price or amount invested.

A) risk
B) return
C) probability
D) value

Question 30

In the capital asset pricing model, the beta coefficient is a measure of

A) unsystematic risk.
B) economic risk.
C) nondiversifiable risk.
D) diversifiable risk.

Question 31

You are going to invest $20,000 in a portfolio consisting of assets X, Y, and Z, as follows:
$\begin{array}{ccccc}&\text { Annual }\\\text { Asset }&\text {Return }&\text {Probability}&\text { Beta}&\text { Proportion }\\\hline\mathrm{X} & 10 \% & 0.50 & 1.2 & 0.333 \\\mathrm{Y} & 8 \% & 0.25 & 1.6 & 0.333 \\\mathrm{Z} & 16 \% & 0.25 & 2.0 & 0.333\end{array}$

-The beta of the portfolio in Figure 7.2, containing assets X, Y, and Z, is

A) 2.0.
B) 2.4.
C) 1.6.
D) 1.5.

Question 32

An investment advisor has recommended a $50,000 portfolio containing assets R, J, and K; $25,000will be invested in asset R, with an expected annual return of 12%; $10,000 will be invested in assetJ, with an expected annual return of 18%; and $15,000 will be invested in asset K, with an expected annual return of 8%. The expected annual return of this portfolio is

A) 10.00%.
B) 12.00%.
C) 12.67%.
D) unable to be determined from the information provided.

Question 33

In the capital asset pricing model, the general risk preferences of investors in the marketplace are reflected by

A) the slope of the security market line.
B) the risk-free rate.
C) the level of the security market line.
D) the difference between the security market line and the risk-free rate.

Question 34

Combining two assets having perfectly positively correlated returns will result in the creation of a portfolio with an overall risk that

A) decreases to a level below that of either asset.
B) increases to a level above that of either asset.
C) remains unchanged.
D) stabilizes to a level between the asset with the higher risk and the asset with the lower risk.

Question 35

Stock XYZ has a beta of 1.2 and an expected return of 14%; the risk-free asset (T-bills) currently earns 4%. If the portfolio of the two assets has a beta of 1.6, what are the portfolio weights?

A) risk-free asset = 33%, stock XYZ = 67%
B) risk-free asset = 0%, stock XYZ = 100%
C) risk-free asset = 133%, stock XYZ = -33%
D) risk-free asset = -33%, stock XYZ = 133%

Question 36

If a person's required return does not change when risk increases, that person is said to be

A) risk-aware.
B) risk-averse.
C) risk-seeking.
D) risk-indifferent.

Question 37

A portfolio with equal amounts invested in the five big Canadian banks would

A) be considered a well-diversified portfolio.
B) eliminate systematic risk.
C) provide for a very high expected return with minimal risk.
D) be a highly correlated portfolio of stocks.

Question 38

The ___________is a measure of relative dispersion used in comparing the risk of assets with differing expected returns.

A) mean
B) coefficient of variation
C) chi square
D) standard deviation

Question 39

$$\begin{array}{l}\text { Expected Return (\%) }\\\begin{array} { c c c c } \text { Year } & \text { Asset A } & \text { Asset B } & \text { Asset C } \\\hline 1 & 6 & 8 & 6 \\2 & 7 & 7 & 7 \\3 & 8 & 6 & 8\end{array}\end{array}$$

-If you were to create a portfolio designed to reduce risk by investing equal proportions in each of two different assets, which portfolio would you recommend?

A) Assets A and C
B) Assets A and B
C) none of the available combinations
D) cannot be determined

Question 40

War, inflation, and the condition of the foreign markets are all examples of

A) economic risk.
B) diversifiable risk.
C) nondiversifiable risk.
D) unsystematic risk.

Question 41

The portion of an asset's risk that is attributable to firm-specific, random causes is called

A) systematic risk.
B) unsystematic risk.
C) non-diversifiable risk.
D) none of the above.

Question 42

The ___________is the extent of an asset's risk. It is found by subtracting the pessimistic outcome from the optimistic outcome.

A) return
B) probability distribution
C) range
D) standard deviation

Question 43

Asset Y has a beta of 1.2. The riskfree rate of return is 6 percent, while the return on the market portfolio of assets is 12 percent. The asset's market risk premium is

A) 10 percent.
B) 6.0 percent.
C) 7.2 percent.
D) 13.2 percent.

Question 44

An increase in the beta of a corporation indicates ____________, and, all else being the same, results in___________.

A) an increase in risk; a higher required rate of return and hence a lower share price.
B) an increase in risk; a lower required rate of return and hence a higher share price.
C) a decrease in risk; a lower required rate of return and hence a higher share price.
D) a decrease in risk; a higher required rate of return and hence a lower share price.

Question 45

Risk that affects all firms is called

A) diversifiable risk.
B) total risk.
C) nondiversifiable risk.
D) management risk.

Question 46

The relevant portion of an asset's risk attributable to market factors that affect all firms is called

A) unsystematic risk.
B) systematic risk.
C) diversifiable risk.
D) none of the above.

Question 47

If the Canadian bond market's historical average return and standard deviation were 8% and 11%, respectively, what is the expected return next year using a 68% confidence interval?

A) -3% to 19%
B) 8% to 11%
C) -14% to 30%
D) -25% to 41%

Question 48

The beta of the market

A) is less than 1.
B) is 1.
C) is greater than 1.
D) cannot be determined.

Question 49

Perfectly __________correlated series move exactly together and have a correlation coefficient of__________, while perfectly __________correlated series move exactly in opposite directions and have acorrelation coefficient of__________ .

A) negatively; -1; positively; +1
B) positively; +1; negatively; -1
C) negatively; +1; positively; -1
D) positively; -1; negatively; +1

Question 50

Which of the following is an example of systematic risk?

A) the death of a firm's key scientist.
B) a hail storm in Northern Alberta
C) the geopolitical uncertainty in the Middle East
D) a fire at a fish processing plant in Newfoundland

Question 51

An efficient portfolio is one that

A) maximizes risk for a given level of return.
B) maximizes return at all risk levels.
C) maximizes return for a given level of risk.
D) minimizes return for a given level of risk.

Question 52

___________risk represents the portion of an asset's risk that can be eliminated by combining assets with less than perfect positive correlation.

A) Nondiversifiable
B) Diversifiable
C) Total
D) Systematic

Question 53

An investment banker has recommended a $100,000 portfolio containing assets B, D, and F. $20,000will be invested in asset B, with a beta of 1.5; $50,000 will be invested in asset D, with a beta of 2.0;and $30,000 will be invested in asset F, with a beta of .5. The beta of the portfolio is __________.

A) 1.33
B) 1.25
C) 1.45
D) unable to be determined from the information provided

Question 54

Carl is considering investing in a Canadian common stock with a 16.5% historic annual rate of return. The stock is 25% more risky than the portfolio of Canadian common stocks. Government of Canada t-bills currently yield 4%, and a portfolio of Canadian stock has a risk premium of 6%. What should be Carl's minimum acceptable rate of return if he invests in this stock?

A) 20.5%
B) 11.5%
C) 10.5%
D) 22.5%

Question 55

Yankee Transport Inc. earned the following total returns over the last 10 years: 1%, -6%, -2%, 8%,8%, 7%, 10%, 11%, 9%, and 12%. The 10-year average return and standard deviation for Yankee is

A) 5.93% and 6.31%, respectively.
B) 5.80% and 6.03%, respectively.
C) 4.81% and 5.83%, respectively.
D) 5.89% and 7.03%, respectively.

Question 56

Which of the following industries' have the highest beta?

A) Telecommunications
B) Food wholesalers
C) Utilities
D) Banking

Question 57

Each of the following are measures of risk EXCEPT

A) the stock's variance and standard deviation.
B) the stock's beta.
C) the stock's range in expected returns under different economic conditions.
D) all of the above are measures of risk

Question 58

The___________ portfolio maximizes return for a given level of risk, or minimizes risk for a given level of return.

A) coefficient
B) risk-indifferent
C) efficient
D) continuous

Question 59

A beta coefficient of -1 represents an asset that

A) is more responsive than the market portfolio.
B) is unaffected by market movement.
C) is less responsive than the market portfolio.
D) has the same response as the market portfolio but in opposite direction.

Question 60

Stock XYZ has a beta of 1.2 and an expected return of 14%; the risk-free asset (T-bills) currentlyearns 4%. If the portfolio of the two assets has a beta of 0.8, what are the portfolio weights?

A) risk-free asset = 67%, stock XYZ = 33%
B) risk-free asset = 33%, stock XYZ = 67%
C) risk-free asset = 3%, stock XYZ = 97%
D) risk-free asset = 50%, stock XYZ = 50%

Question 61

The portfolio with a standard deviation of zero (See Figure 7.1)

A) is comprised of Assets A and B.
B) is comprised of Assets A and C.
C) is not possible.
D) cannot be determined.

Question 62

Strikes, lawsuits, regulatory actions, and increased competition are all examples of

A) economic risk.
B) diversifiable risk.
C) nondiversifiable risk.
D) systematic risk.

Question 63

A beta coefficient of 0 represents an asset that

A) is unaffected by market movement.
B) is less responsive than the market portfolio.
C) is more responsive than the market portfolio.
D) has the same response as the market portfolio.

Question 64

Mary is considering investing in Lensgate Industries Ltd., a Canadian common stock with a historic annual rate of return of 9%. The stock is as risky as the portfolio of Canadian common stocks. If Government of Canada t-bills currently yield 4% and a portfolio of Canadian common stocks has a risk premium of 6%, what should be Mary's minimum acceptable rate of return if she invests in this stock?

A) 14%
B) 10%
C) 9%
D) 6%

Question 65

An investor wants to invest $10,000 today in a stock with an expected compound rate of return of7% annually over the next five years. She intends to reinvest all dividends. What will be the valueof her investment (rounded to the nearest dollar) at the end of the five-year period if her expectation about future rates of returns is correct?

A) $14,693
B) $12,800
C) $13,435
D) $14,111

Question 66

As risk aversion increases

A) investors' required rate of return will increase.
B) a firm's beta will increase.
C) a firm's beta will decrease.
D) investors' required rate of return will decrease.

Question 67

A Canadian common stock had the following rates of return in the past four years: 3%, 8%, 5% and-4%. The variance for the rate of return over this 4-year period is

A) 26
B) 42
C) 36
D) 32

Question 68

Suppose a stock had an initial price of $88 per share, paid a dividend of $8 during the year and had an ending price of $98. What was the capital gain yield?

A) 20.45%
B) 10.20%
C) 11.36%
D) 9.09%

Question 69

A stock has a mean rate of return of 5% and a standard deviation of 9. The range with a 95%probability of covering the true mean rate of return for this stock is:

A) -13%, 23%
B) -6%, 16%
C) -4%, 14%
D) -16%, 26%

Question 70

In general, the lower (less positive and more negative) the correlation between asset returns,

A) the lower the potential profit.
B) the less the assets have to be monitored.
C) the less the potential diversification of risk.
D) the greater the potential diversification of risk.

Question 71

Given the information in Figure 7.2, what is the expected annual return of this portfolio?

A) 11.7%
B) 11.0%
C) 11.4%
D) 10.0%

Question 72

The range that has a 68% probability of covering the true mean is calculated as

A) mean ± (1 ÷ standard deviation
B) mean ± (1 × standard deviation)
C) mean ± (1 - standard deviation)
D) mean ± (1 + standard deviation)

Question 73

Over the past 4 years, a common stock has had the following rates of return: 3.5%, 10.6%, -5.5% and8.6%. The geometric mean rate of return (rounded to one decimal) over these 4 years is

A) 5.6%
B) 6.4%
C) 4.1%
D) 4.7%

Question 74

A Canadian common stock had the following rates of return in the past four years: 7%, 8%, -2%and 11%. The standard deviation (rounded to one decimal) for the rate of return over this 4-yearperiod is

A) 6.2
B) 4.8
C) 5.6
D) 5.3

Question 75

The beta of the portfolio in Figure 7.2 indicates this portfolio

A) has an undetermined amount of risk compared to the market.
B) has the same risk as the market.
C) has less risk than the market.
D) has more risk than the market.

Question 76

__________probability distribution shows all possible outcomes and associated probabilities for a given event.

A) A continuous
B) An expected value
C) A bar chart
D) A discrete

Question 77

Examples of events that increase risk aversion include

A) assassination of a key political leader.
B) the outbreak of war.
C) a stock market crash.
D) all of the above.

Question 78

In the capital asset pricing model, an increase in inflationary expectations will be reflected by

A) a parallel shift downward in the security market line.
B) an increase in the slope of the security market line.
C) a decrease in the slope of the security market line.
D) a parallel shift upward in the security market line.

Question 79

Prime-grade commercial paper will most likely have a higher annual return than

A) a common stock.
B) an investment-grade bond.
C) a Treasury bill.
D) a preferred stock.

Question 80

If a person wants a well-diversified portfolio, they should

A) invest within no more than two or three industries.
B) invest in only high expected return investments.
C) invest globally.
D) invest only in Canada.