Deck 7: Risk and Return

Question 1

The variance is equal to the square root of the standard deviation.

Answer 1

False

Question 2

The coefficient of variation is a good measure of the amount of risk that an asset will contribute to a diversified portfolio of assets.

Answer 2

False

Question 3

The variance is denominated in squared units, whereas the standard deviation is denominated in the same units as the expected value.

Answer 3

True

Question 4

If the price of an asset has not increased or decreased since the original purchase of the asset, then the total return of the asset (if no dividends were paid during the period) is equal to the capital appreciation component return.

Question 5

The capital appreciation component of a share's return considers the increase in price of a share divided by the end of period price of the share.

Question 6

The normal distribution is completely described by its mean and standard deviation where 50 per cent of the distribution's probability is less than the mean and 50 per cent greater than the mean.

Question 7

If you are calculating the variance and standard deviation of returns for a share, the variance will always be larger than the standard deviation.

Question 8

The variance of a distribution can be a negative value.

Question 9

The standard deviation of a distribution can be a negative value.

Question 10

You have placed a wager such that you will either receive nothing if you lose the bet or you will receive $10 if you win the bet. If the expected cash receipt of the wager is $9, then there is a 100 per cent probability that you will win the wager.

Question 11

The capital appreciation component of a share's return considers the increase in price of a share divided by the beginning of period price of the share.

Question 12

If you are building a portfolio, then you desire assets that have a correlation coefficient of one.

Question 13

The income component of return for an ordinary share comes from the dividend cash flow stream.

Question 14

Robert paid $100 for a share one year ago. The total return on the share was 10 per cent. Therefore, the share must be selling for $110 today.

Question 15

The coefficient of variation divides the variance of the returns of an asset by the expected return of that asset.

Question 16

In order for the total return of a share to be equal to -100 per cent, the income return component for that share must be zero.

Question 17

If the returns for two assets have a correlation coefficient of one, then there are no benefits of diversification by combining these assets in a two-asset portfolio.

Question 18

The appropriate measure of risk for a diversified portfolio is beta.

Question 19

If the expected return of a bet, which is based on a coin toss, is $15, then that means that the outcome of the bet will be a $15 cash inflow to the person making the bet.

Question 20

If the capital appreciation return from owning a share is positive, then the total return from owning the same share can be negative.

Question 21

If the distribution of returns for an asset has a variance of zero, then covariance of returns between that asset and the returns any other asset must equal zero.

Question 22

Ahmet purchased a share for $45 one year ago. The share is now worth $65. During the year, the share paid a dividend of $2.50. What is the total return to Ahmet from owning the share? (Round your answer to the nearest whole per cent.)

A) 5%
B) 44%
C) 35%
D) 50%

Question 23

Gunther earned a 62.5 per cent return on a share that he purchased one year ago. The share is now worth $12, and he received a dividend of $1 during the year. How much did Gunther originally pay for the share?

A) $7.00
B) $7.50
C) $8.00
D) $8.50

Question 24

Francis purchased a share one year ago for $20, and it is now worth $24. The share paid a dividend of $3 during the year. What was the share's rate of return from capital appreciation during the year? (Round your answer to the nearest per cent.)

A) 17%
B) 20%
C) 29%
D) 35%

Question 25

If the covariance between the returns of two assets is equal to zero, then the correlation coefficient must also be zero.

Question 26

The coefficient of variation is useful when deciding which individual shares to add to your diversified portfolio.

Question 27

Utilising the fact that two or more asset values do not always move in the same direction at the same time in order to reduce the risk of a portfolio is called diversification.

Question 28

Given the historical information in the chapter, the beta of a small share should be greater than the beta of a corporate bond.

Question 29

Julio purchased a share one year ago for $27. The share is now worth $32, and the total return to Julio for owning the share was 37 per cent. What is the dollar amount of dividends that he received for owning the share during the year?

A) $4
B) $5
C) $6
D) $7

Question 30

If you are trying to determine whether to purchase Security A or Security B as the only holding in your portfolio, then you can consider the coefficient of variation in order to understand the risk-return relationship of the individual securities.

Question 31

Gwen purchased a share one year ago for $25, and it is now worth $31. The share paid a dividend of $1.50 during the year. What was the share's rate of return income during the year? (Round your answer to the nearest per cent.)

A) 6%
B) 15%
C) 24%
D) 26%

Question 32

If you know the risk-free rate, the market risk-premium, and the beta of a share, then using the CAPM you will be able to calculate the expected rate of return for the share.

Question 33

Complete diversification means that the portfolio is no longer subject to market risk.
b False

Question 34

The market risk-premium is equal to expected return on the market portfolio.

Question 35

Which of the following is the best measure of the systematic risk in a portfolio?

A) variance
B) standard deviation
C) covariance
D) beta

Question 36

Moshe purchased a share for $30 last year. He found out today that he had a -100 per cent return on his investment. Which of the following must be true?

A) The share is worth $30 today.
B) The share is worth $0 today
C) The share paid no dividends during the year.
D) Both b and c must be true.

Question 37

If you were to completely diversify your portfolio by purchasing a portion of every asset in the investment universe, then the expected return of your portfolio is equal to the risk-free rate.

Question 38

The expected return of the market portfolio is equal to the market risk premium.

Question 39

If two assets with return correlation coefficients less than one make up a portfolio, then the portfolio does not take advantage of any diversification benefits.

Question 40

The market risk-premium is equal to the expected return on the market less the risk-free rate of return.

Question 41

Niles is making an investment with an expected return of 12 per cent. If the standard deviation of the return is 4.5 per cent, and if Niles is investing $100,000, then what dollar amount is Niles 95 per cent sure that he will have at the end of the year?

A) $100,000.00
B) $104,597.50
C) $116,500.00
D) $119,402.50

Question 42

Serox shares were selling for $20 two years ago. The share sold for $25 one year ago, and it is currently selling for $28. Serox pays a $1.10 dividend per year. What was the rate of return for owning Serox in the most recent year? (Round to the nearest per cent.)

A) 12%
B) 16%
C) 32%
D) 40%

Question 43

In a game of chance, the probability of winning a $50 is 40 per cent and the probability of losing a $50 prize is 60 per cent. What is the expected value of a prize in the game?

A) -$10
B) $0
C) $10
D) $25

Question 44

The covariance of the returns between Wildcat Stock and Sun Devil Stock is 0.09875. The variance of Wildcat is 0.2116, and the variance of Sun Devil is 0.1369. What is the correlation coefficient between the returns of the two shares?

A) 0.580200
B) 0.293347
C) 0.340823
D) 0.578731

Question 45

The covariance of the returns between Einstein Stock and Bohr Stock is 0.0087. The standard deviation of Einstein is 0.26, and the standard deviation of Bohr is 0.37. What is the correlation coefficient between the returns of the two shares?

A) 0.090437
B) 0.096200
C) 0.90437
D) 0.96200

Question 46

You have invested 40 per cent of your portfolio in an investment with an expected return of 12 per cent and 60 per cent of your portfolio in an investment with an expected return of 20 per cent. What is the expected return of your portfolio?

A) 15.2%
B) 16.0%
C) 16.8%
D) 17.6%

Question 47

If a random variable is drawn from a normal distribution, what is the probability that the random variable is larger than 1.96 standard deviations below the mean?

A) 95.00%
B) 96.25%
C) 97.50%
D) 98.75%

Question 48

In a game of chance, the probability of winning a $50 prize is 40 per cent, and the probability of winning a $100 prize is 60 per cent. What is the expected value of a prize in the game?

A) $50
B) $75
C) $80
D) $100

Question 49

You have invested 20 per cent of your portfolio in Homer, Ltd., 40 per cent in Marge Co., and 20 per cent in Bart Resources. What is the expected return of your portfolio if Homer, Marge, and Bart have expected returns of 2 per cent, 18 per cent, and 3 per cent, respectively?

A) 7.7%
B) 8.2%
C) 8.7%
D) 9.2%

Question 50

Genaro needs to capture a return of 40 per cent for his one-year investment in a property. He believes that he can sell the property at the end of the year for $150,000 and that the property will provide him with rental income of $25,000. What is the maximum amount that Genaro should be willing to pay for the property?

A) $112,500
B) $125,000
C) $137,500
D) $150,000

Question 51

Braniff Ground Services shares have an expected return of 9 per cent and a variance of 0.25 per cent. What is the coefficient of variation for Braniff?

A) 0.0278
B) 0.0556
C) 1.800
D) 36.00

Question 52

You know that the average college student eats 0.75 pounds of food at lunch. If the standard deviation of that eating is 0.2 pounds of food, then what is the total amount of food that a cafeteria should have on hand to be 95 per cent confident that it will not run out of food when feeding 50 college students.

A) 17.90 pounds
B) 21.05 pounds
C) 53.95 pounds
D) 57.10 pounds

Question 53

If you were to compare the returns of an individual share to a market index, select the answer below that is most true.

A) The returns of the individual share will show more variability than those of the market index.
B) The returns of the individual share will show less variability than those of the market index.
C) The returns of the individual share will show the same level of variability than those of the market index, if they have the same beta.
D) None of the above.

Question 54

Sayers purchased a share with a coefficient of variation equal to 0.125. The expected return on the shares is 20 per cent. What is the variance of the share?

A) 0.000625
B) 0.025000
C) 0.625000
D) 0.790500

Question 55

The expected return for a portfolio without borrowing or short selling

A) should never be less than the expected return of the asset with lowest expected return.
B) should never be greater than the expected return of the asset with highest expected return.
C) has a limited range of expected returns.
D) All of the above.

Question 56

Books Brothers shares were priced at $15 per share two years ago. The share sold for $13 last year and now it sells for $18. What was the total return for owning Books Brothers share during the most recent year? Assume that no dividends were paid and round to the nearest per cent.

A) 17%
B) 20%
C) 23%
D) 38%

Question 57

Babs purchased a piece of real estate last year for $85,000. The real estate is now worth $102,000. If Babs needs to have a total return of 25 per cent during the year, then what is the dollar amount of income that she needed to have to reach her objective?

A) $3,750
B) $4,250
C) $4,750
D) $5,250

Question 58

You invested $3,000 in a portfolio with an expected return of 10 per cent and $2,000 in a portfolio with an expected return of 16 per cent. What is the expected return of the combined portfolio?

A) 6.2%
B) 12.4%
C) 13.0%
D) 13.6%

Question 59

If a random variable is drawn from a normal distribution, what is the probability that the random variable is larger than 1.96 standard deviations larger than the mean?

A) 1.25%
B) 2.50%
C) 3.75%
D) 5.00%

Question 60

You have observed that the average size of a particular goldfish is 1.5 inches long. The standard deviation of the size of the goldfish is 0.25 inches. What is the size of a goldfish such that 95 per cent of the goldfish are smaller? Assume a normal distribution for the size of goldfish.

A) 1.01 inches
B) 1.09 inches
C) 1.91 inches
D) 1.99 inches

Question 61

Batman Stock has exhibited a standard deviation in share returns of 0.5, whereas Superman Stock has exhibited a standard deviation of 0.6. The correlation coefficient between the share returns is 0.5. What is the variance of a portfolio composed of 70 per cent Batman and 30 per cent Superman?

A) 0.1549
B) 0.2179
C) 0.4668
D) 0.5500

Question 62

Horse Stock returns have exhibited a standard deviation of 0.57, whereas Mod T Stock returns have a standard deviation of 0.63. The correlation coefficient between the returns is 0.078042. What is the covariance of the returns?

A) 0.028025
B) 0.217327
C) 0.359100
D) 0.993094

Question 63

Explain the difference between systematic and nonsystematic risk.

Question 64

Most of the risk-reduction benefits from diversification can be achieved in a portfolio consisting of

A) 5 to 10 shares
B) 10 to 15 shares
C) 15 to 20 shares
D) 20 to 25 shares

Question 65

Aquaman Stock has exhibited a standard deviation in share returns of 0.7, whereas Green Lantern Stock has exhibited a standard deviation of 0.8. The correlation coefficient between the share returns is 0.1. What is the standard deviation of a portfolio composed of 70 per cent Aquaman and 30 per cent Green Lantern?

A) 0.32122
B) 0.54562
C) 0.56676
D) 0.75000

Question 66

The expected return on Mike's Seafood shares is 10.8 per cent. If the expected return on the market is 10 per cent and the beta for Kiwi is 1.7, then what is the risk-free rate?

A) 4.5%
B) 5.0%
C) 5.5%
D) 6.0%

Question 67

The expected return on Kiwi Computers shares is 16.6 per cent. If the risk-free rate is 4 per cent and the expected return on the market is 10 per cent, then what is Kiwi's beta?

A) 1.26
B) 2.10
C) 2.80
D) 3.15

Question 68

If you were to regress the historical returns of a share on the historical return of a general market index, you would plot the line of best fit through those data points. The slope of that line represents the beta of the share in question. However, in most instances the date points do not lie exactly on that line. Describe why.

Question 69

The expected return on KarolCo. shares is 16.5 per cent. If the risk-free rate is 5 per cent and the beta of KarolCo is 2.3, then what is the risk premium on the market?

A) 2.5%
B) 5.0%
C) 7.5%
D) 10.0%

Question 70

The beta of RicciCo.'s share is 3.2, whereas the risk-free rate of return is 9 per cent. If the expected return on the market is 18 per cent, then what is the expected return on RicciCo.?

A) 28.80%
B) 37.80%
C) 48.60%
D) 57.60%

Question 71

A portfolio with a level of systematic risk the same as that of the market has a beta that is

A) equal to zero.
B) equal to one.
C) less than the beta of the risk-free asset.
D) less than zero.

Question 72

The beta of Elsenore, Ltd., share is 1.6, whereas the risk-free rate of return is 8 per cent. If the expected return on the market is 15 per cent, then what is the expected return on Elsenore?

A) 11.20%
B) 19.20%
C) 24.00%
D) 32.00%

Question 73

The risk-free rate of return is currently 3 per cent, whereas the market risk premium is 6 per cent. If the beta of Lenz, Ltd., share is 1.8, then what is the expected return on Lenz?

A) 8.40%
B) 10.80%
C) 13.80%
D) 19.20%

Question 74

Which of the following investors should be willing to pay the highest price for an asset?

A) An investor with a single-asset portfolio.
B) An investor with a 50-asset portfolio.
C) An investor who is not completely diversified.
D) An investor who is so risk-averse that he does not recognise the benefits of diversification.