Deck 7: Risk and Return

Question 1

The capital appreciation component of a stock's return considers the change in price of a stock divided by the initial price of the stock.

Answer 1

True

Question 2

The smaller the range of expected future returns, the greater the risk of a given investment as measured by its mean.

Answer 2

False

Question 3

Variance is equal to the square root of standard deviation.

Answer 3

False

Question 4

The income component of return for a common stock comes from the cash dividend a firm pays.

Question 5

The rate of return that investors require for an investment depends on the risk associated with
that investment.

Question 6

The best measure of assessing the risk of an investment is its variance.

Question 7

Robert paid $100 for a stock one year ago. The total return on the stock was 10 percent. This means that the stock must be selling for $110 today.

Question 8

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

Question 9

Whenever the outcome of an event has a number of different possibilities that have equal probability of occurrence, then the expected value of the outcome is equal to the simple average of the individual events.

Question 10

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Question 11

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

Question 12

In order to keep the total return of a stock equal to 100 percent, the income component for that stock must be zero.

Question 13

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

Question 14

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 your expected cash receipt is $9, then there is a 100 percent probability that you will win the wager.

Question 15

If you are calculating the variance and standard deviation of percentage returns on a stock, the variance will always be larger than the standard deviation.

Question 16

If the price of an asset has increased 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 17

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

Question 18

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

Question 19

The variance of a distribution can be negative.

Question 20

If the returns of two stocks are negatively correlated, then one of them must have a negative beta.

Question 21

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

Question 22

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

Question 23

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

Question 24

If the returns on 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 25

If you are building a portfolio, then your goal is to select assets that have a correlation coefficient of one

Question 26

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

Question 27

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

Question 28

If you know the risk-free rate, the market risk-premium, and the beta of a stock, then using the Capital Asset Pricing Model (CAPM) you will be able to calculate the expected rate of return for the stock.

Question 29

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

Question 30

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

Question 31

According to the CAPM, the firm's market risk is expected to remain constant over time.

Question 32

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Question 33

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 34

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 35

Which of the following statements is correct?

A) The greater the risk associated with an investment, the lower the return investors expect from it.
B) When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return.
C) If two investments have the same expected return, investors prefer the riskiest alternative.
D) When choosing between two investments that have the same level of risk, investors prefer the investment with the lower return.

Question 36

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

Question 37

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

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

Question 38

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

Question 39

Utilizing the fact that values of two or more assets 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 40

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

Question 41

Given the historical information in the chapter, which of the following investment classes had the highest average return?

A) Intermediate-Term Government Bonds
B) Long-Term Government Bonds
C) Large U.S. Stocks
D) Small U.S. Stocks

Question 42

Niles is making an investment with an expected return of 12 percent. If the standard deviation of the return is 4.5 percent, and if Niles is investing $100,000, then what dollar amount is Niles 90 percent sure that he will have at the end of the year? (Do not round intermediate computations).

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

Question 43

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

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

Question 44

If a random variable follows 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 45

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

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

Question 46

Ahmet purchased a stock for $45 one year ago. The stock is now worth $65. During the year, the stock paid a dividend of $2.50. What is Ahmet's total return ?

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

Question 47

Julio purchased a stock one year ago for $27. The stock is now worth $32, and the total return to Julio for owning the stock was 37 percent. What is the dollar amount of dividends that he received for owning the stock during the year? Round your final answer to nearest whole dollar.

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

Question 48

Serox stock was selling for $20 two years ago. The stock 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 percent.)

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

Question 49

In a game of chance, the probability of winning $50 is 40 percent and the probability of having to pay $50 is 60 percent. What is the expected value of this game?

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

Question 50

If a random variable follows 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 51

Security Analysts that have evaluated Concordia Corporation, have determined that there is a 15% chance that the firm will generate earnings per share of $2.40; a 60% probability that the firm will generate earnings per share of $3.10; and a 25% probability that the firm will generate earnings per share of $3.80. What are the expected earnings per share for Concordia Corporation? (Round off to the nearest $0.01)

A) $3.10
B) $3.17
C) $2.75
D) $2.91

Question 52

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

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

Question 53

George Wilson purchased Bright Light Industries common stock for $47.50 on January 31, 2016. The firm paid dividends of $1.10 during the last 12 months. George sold the stock today (January 30, 2017) for $54.00. What is George's holding period return?

A) 16.00%
B) 14.00%
C) 11.00%
D) 19.00%

Question 54

Gwen purchased a stock one year ago for $25, and it is now worth $31. The stock paid a dividend of $1.50 during the year. What was the stock's rate of return from dividend income during the year?

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

Question 55

Francis purchased a stock one year ago for $20, and it is now worth $24. The stock paid a dividend of $3 during the year. What was the stock's rate of return from capital appreciation during the year?

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

Question 56

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

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

Question 57

Given the historical information in the chapter, which of the following investment classes had the highest variability in returns?

A) Intermediate-Term Government Bonds
B) Long-Term Government Bonds
C) Large U.S. Stocks
D) Small U.S. Stocks

Question 58

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 90 percent of the goldfish are smaller from such size? Assume a normal distribution for the size of goldfish. Round your final answer to two decimal places.

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

Question 59

You know that the average college student eats 0.75 pounds of food at lunch. If the standard deviation is 0.2 pounds of food, then what is the total amount of food that a cafeteria should have on hand to be 90 percent 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 60

Genaro needs a return of 40 percent 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 61

The risk-free rate of return is currently 3 percent, whereas the market risk premium is 6 percent. If the beta of Lenz, Inc., stock is 1.8, then what is the expected return on Lenz?

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

Question 62

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

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

Question 63

Horse Stock returns have 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? Round your answer to six decimal places.

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

Question 64

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 65

Stock A 's returns have a standard deviation of 0.5, and stock B's returns have standard deviation of 0.6. The correlation coefficient between A and B 0.5. What is the variance of a portfolio composed of 70 percent Stock A and 30 percent Stock B?

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

Question 66

Sayers purchased a stock with a coefficient of variation equal to 0.125. The expected return on the stock is 20 percent. What is the variance of the stock?

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

Question 67

The beta of Elsenore, Inc., stock is 1.6, whereas the risk-free rate of return is 8 percent. If the expected return on the market is 15 percent, then what should investors expect as a return on Elsenore?

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

Question 68

The beta of Ricci Co.'s stock is 3.2, whereas the risk-free rate of return is 9 percent. If the expected return on the market is 18 percent, then what should investors expect as a return on on Ricci Co.?

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

Question 69

The expected return on Mike's Seafood stock is 17.9 percent. If the expected return on the market is 13 percent 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 70

The expected return on Karol Co. stock is 16.5 percent. If the risk-free rate is 5 percent and the beta of Karol Co is 2.3, then what is the risk premium on the market portfolio?

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

Question 71

View Point Industries has forecasted a rate of return of 20.00% if the economy booms (25.00% probability); a rate of return of 15.00% if the economy is in a growth phase (45.00% probability); a rate of return of 2.50% if the economy is in decline (20.00% probability); and a rate of return of -15.00% if the economy is in a depression (10.00% probability). What is View Point's standard deviation of returns? Do not round intermediate computations. Round your final answer to two decimal points.

A) 17.31%
B) 9.25%
C) 15.00%
D) 10.29%

Question 72

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

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

Question 73

The covariance of the returns between Stock A and Stock B is 0.0087. The standard deviation of Stock A is 0.26, and the standard deviation of Stock B is 0.37. What is the correlation coefficient between the returns of the two stocks?

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

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 diversified portfolio.
C) An investor who is not completely diversified.
D) An investor who is so risk-averse that he does not recognize the benefits of diversification.

Question 75

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

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

Question 76

Braniff Ground Services stock has an expected return of 9 percent and a variance of 0.25 percent. What is the coefficient of variation for Braniff? Round your final answer to four decimal places.

A) 0.0278
B) 0.5556
C) 1.8001
D) 36.0002

Question 77

A portfolio with a level of systematic risk that is 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 78

Aquaman's stock returns have a standard deviation of 0.7, and Green Lantern's stock returns have standard deviation of 0.8 The correlation coefficient is 0.1. What is the standard deviation of a portfolio composed of 70 percent Aquaman and 30 percent Green Lantern? Round the answer to five decimal points.

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

Question 79

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 stocks?

A) 0.170200
B) 0.293347
C) 0.340823
D) 0.580199

Question 80

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

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