Question 1

Treasury notes are paying a 4% rate of return. A risk averse investor with a risk aversion of A = 3 should invest in a risky portfolio with a standard deviation of 24% only if the risky portfolio's expected return is at least ________.

Accepted Answer

A) 8.67% 
B) 9.84% 
C) 12.64% 
D) 14.68%

Question 2

Your timing was good last year. You invested more in your portfolio right before prices went up and you sold right before prices went down. In calculating historical performance measures which one of the following will be the largest?

Accepted Answer

A) Dollar-weighted return 
B) Geometric average return 
C) Arithmetic average return 
D) Mean holding period return

Question 3

You are considering investing $1000 in a complete portfolio. The complete portfolio is composed of Treasury notes that pay 5% and a risky portfolio, P, constructed with two risky securities X and Y. The optimal weights of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14% and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 11%, you should invest ________ of your complete portfolio in Treasury notes.

Accepted Answer

A) 19% 
B) 25% 
C) 36% 
D) 50%

Question 4

Your investment has a 40% chance of earning a 15% rate of return, a 50% chance of earning a 10% rate of return and a 10% chance of losing 3%. What is the standard deviation of this investment?

Accepted Answer

A) 5.14% 
B) 7.59% 
C) 9.29% 
D) 8.43%

Question 5

You are considering investing $1000 in a complete portfolio. The complete portfolio is composed of Treasury notes that pay 5% and a risky portfolio, P, constructed with two risky securities X and Y. The optimal weights of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14% and Y has an expected rate of return of 10%. The dollar values of your positions in X, Y, and Treasury notes would be ________, ________ and ________ respectively if you decide to hold a complete portfolio that has an expected return of 8%.

Accepted Answer

A) $162, $595, $243 
B) $243, $162, $595 
C) $595, $162, $243 
D) $595, $243, $162

Question 6

Suppose you pay $9700 for a $10 000 par Treasury bond maturing in three months. What is the holding period return for this investment?

Accepted Answer

A) 3.01% 
B) 3.09% 
C) 12.42% 
D) 16.71%

Question 7

You invest $1000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bond with a rate of return of 6%. You should invest ________ of your complete portfolio in the risky portfolio if you want your complete portfolio to have a standard deviation of 9%.

Accepted Answer

A) 100% 
B) 90% 
C) 45% 
D) 10%

Question 8

The excess return is the ________.

Accepted Answer

A) rate of return that can be earned with certainty 
B) rate of return in excess of the Treasury bond rate 
C) rate of return to risk aversion 
D) index return

Question 9

The rate of return on ________ is known at the beginning of the holding period while the rate of return on ________ is not known until the end of the holding period.

Accepted Answer

A) risky assets, Treasury notes 
B) Treasury notes, risky assets 
C) excess returns, risky assets 
D) index assets, bonds

Question 10

You have the following rates of return for a risky portfolio for several recent years:  The annualised average return on this investment is ________.

Accepted Answer

A) 16.15% 
B) 16.87% 
C) 21.32% 
D) 15.60%

Question 11

You have $500 000 available to invest. The risk-free rate as well as your borrowing rate is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should ________.

Accepted Answer

A) invest $125 000 in the risk-free asset 
B) invest $375 000 in the risk-free asset 
C) borrow $125 000 
D) borrow $375 000

Question 12

Consider the following two investment alternatives. First, a risky portfolio that pays 15% rate of return with a probability of 40% or 5% with a probability of 60%. Second, a Treasury bond that pays 6%. The risk premium on the risky investment is ________.

Accepted Answer

A) 1% 
B) 3% 
C) 6% 
D) 9%

Question 13

An investment earns 10% the first year, 15% the second year and loses 12% the third year. Your total compound return over the three years was ________.

Accepted Answer

A) 41.68% 
B) 11.32% 
C) 3.64% 
D) 13.00%

Question 14

You have calculated the historical dollar-weighted return, annual geometric average return and annual arithmetic average return. You always reinvest your dividends and interest earned on the portfolio. Which method provides the best measure of the actual average historical performance of the investments you have chosen?

Accepted Answer

A) Dollar-weighted return 
B) Geometric average return 
C) Arithmetic average return 
D) Index return

Question 15

You have calculated the historical dollar-weighted return, annual geometric average return and annual arithmetic average return. If you desire to forecast performance for next year, the best forecast will be given by the ________.

Accepted Answer

A) dollar-weighted return 
B) geometric average return 
C) arithmetic average return 
D) index return

Question 16

You invest $1000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bond with a rate of return of 6%. The slope of the capital allocation line formed with the risky asset and the risk-free asset is ________.

Accepted Answer

A) 1.40 
B) 0.80 
C) 0.50 
D) 0.40

Question 17

The return on the risky portfolio is 15%. The risk-free rate as well as the investor's borrowing rate is 10%. The standard deviation of return on the risky portfolio is 20%. If the standard deviation on the complete portfolio is 25%, the expected return on the complete portfolio is ________.

Accepted Answer

A) 6.00% 
B) 8.75 % 
C) 10.00% 
D) 16.25%

Question 18

The geometric average of -12%, 20% and 25% is ________.

Accepted Answer

A) 8.42% 
B) 11.00% 
C) 9.70% 
D) 18.88%

Question 19

One method to forecast the risk premium is to use the ________.

Accepted Answer

A) coefficient of variation of analysts' earnings forecasts 
B) variations in the risk-free rate over time 
C) average historical excess returns for the asset under consideration 
D) average abnormal return on the index portfolio

Question 20

The market risk premium is defined as ________.

Accepted Answer

A) the difference between the return on an index fund and the return on Treasury notes 
B) the difference between the return on a small firm mutual fund and the return on the Standard and Poor's 500 index 
C) the difference between the return on the risky asset with the lowest returns and the return on Treasury notes 
D) the difference between the return on the highest yielding asset and the lowest yielding asset

Exam 5: Risk and Return: Past and Prologue