Deck 4: Return and Risk

Question 1

If the present value of an investment's benefits equals the present value of the investment's costs, then the investor would earn a

A) 0% rate of return.
B) return equal to the discount rate.
C) return greater than the discount rate.
D) negative rate of return.

Answer 1

B

Question 2

The value of an investment paying 4% compounded quarterly will have a value at the end of one year equal to

A) an investment paying 4% compounded annually at the end of 4 years.
B) an investment paying 1% compounded annually at the end of 4 years.
C) an investment paying 2% compounded semi- annually at the end of 1 year.
D) an investment paying 16% compounded annually at the end of 1 year.

Answer 2

B

Question 3

Historically, the real rate of return has tended to be

A) between 1 and 2%.
B) between 2 and 3%.
C) between 3% and 5%.
D) between - 1% and 0%.

Answer 3

A

Question 4

An investment produced annual rates of return of 5%, 12%, 8% and 11%, respectively, over the past four years. What is the standard deviation of these returns?

A) 3.2%.
B) 2.7%.
C) 3.6%.
D) 3.8%.

Question 5

The expected rate of return and standard deviations, respectively for four shares are given below: Which share is clearly least desirable? $$\begin{array} { l } \mathrm { ABC } \quad 9 \% , 3 \% \\\text { CDE } \quad 11 \% , 9 \% \\\text { FGH }\quad 12 \% , 8 \% \\\text { IJK } \quad 14 \% , 10 \% \\\end{array}$$
Which share is clearly least desirable?

A) FGH.
B) IJK.
C) CDE.
D) ABC.

Question 6

Assume that $100 is deposited at the end of each year for five years at 10% compound interest and that no withdrawals are made over the five- year period. Based on this data, which one of the following statements is correct?

A) The present value can be determined by computing the present value of $500 in five years at 10%.
B) The future value will be $550.
C) The present value can be determined by computing the present value of a $100 ordinary annuity for five years at 10%.
D) The present value will be $500.

Question 7

Which one of the following statements is correct concerning the time value of money?

A) The future value interest factor is equal to zero if the interest rate is zero.
B) As the interest rate increases for any given year, the future value interest factor will decrease.
C) The future value of $1 decreases with the passage of time.
D) The future value of $1 at the end of a year is equal to $1 times 1 plus the annual interest rate.

Question 8

Justin invests $4,000 in a savings account for two years. The account pays 2% interest compounded annually. How much interest income will Justin earn on this investment?

A) $81.60
B) $160.00
C) $80.00
D) $161.60

Question 9

Jake purchased 200 shares of ABC stock at $21.25 per share. After nine months, he sold all of his shares at a price of $19.88 a share. Jake received a total of $0.55 per share in dividends during the time he owned the shares. Jake's holding period return is

A) - 3.9%.
B) 9.7%.
C) 2.6%.
D) - 6.4%.

Question 10

To determine the compounded annual rate of return on investments held for more than a year, investors typically use the present- value- based measure known as yield or

A) internal rate of return.
B) inflation- adjusted return.
C) simple return.
D) holding period return.

Question 11

The Sorka Corp. has paid annual dividends of $0.60, $0.63, $0.65, $0.68 and $0.72, respectively, over the past five years. What is the dividend growth rate?

A) 4.7%.
B) 5.9%.
C) 5.2%.
D) 5.4%.

Question 12

Which one of the following is an example of an annuity?

A) The payment of $389 in January, $200 in February and $200 in March.
B) The receipt of $100 a month for three months and then $150 a month for two months.
C) The receipt of $50 in January, March, April, June, August, September and December.
D) The payment of $259 a month for three consecutive years.

Question 13

The required rate of return on the Daisy Corporation's ordinary share is 11%, the current real rate of return in the market is 1%, and the market's risk- free rate of return is 4%. In this case, the risk premium associated with Daisy's stock is

A) 5%.
B) 7%.
C) 8%.
D) 6%.

Question 14

The markets in general are paying a 2% real rate of return. Inflation is expected to be 3%. ABC share commands a 6% risk premium. What is the expected rate of return on ABC share?

A) 11%.
B) 5%.
C) 8%.
D) 2%.

Question 15

When computing an investment's yield using a financial calculator or spreadsheet such as Excel, which of the following should be entered as a negative number?

A) The initial cost of the investment.
B) The price at which the investment is sold.
C) Dividend or interest payments.
D) The number of time periods.

Question 16

The maximum rate of return that can be earned for a given rate of interest occurs when interest is compounded

A) daily.
B) monthly.
C) continuously.
D) annually.

Question 17

Liquidity risk is defined as the risk of

A) having declining price levels affect the reinvestment rate of your current income stream.
B) not being able to sell an investment conveniently and at a reasonable price.
C) having inflation erode the purchasing power of your investment.
D) having to trade a security in a broad market.

Question 18

The risk that the rate of return on an investment will be less than expected due to factors that are independent of the investment, such as political, social or economic events, is called

A) financial risk.
B) business risk.
C) market risk.
D) liquidity risk.

Question 19

A capital loss is computed by

A) subtracting the original cost of an investment from the proceeds received from the sale of that investment.
B) subtracting the original cost of an investment from the proceeds received from the sale of that investment minus any income from the investment.
C) subtracting the original cost of an investment from the proceeds received from the sale of that investment plus any income from the investment.
D) subtracting the proceeds received from the sale of an investment from the original cost of the investment.

Question 20

The stated rate of interest is equal to the true rate of interest when

A) interest is discounted rather than compounded.
B) interest is compounded annually and the period in question is exactly 1 year.
C) interest is compounded annually over a period of several years.
D) interest is compounded continuously over one or more years.

Question 21

The required return on Beta stock is 14%. The risk- free rate of return is 4% and the real rate of return is 2%. How much are investors requiring as compensation for risk?

A) 14%.
B) 10%.
C) 8%.
D) 12%.

Question 22

An investment produced annual rates of return of 4%, 8%, 14% and 6%, respectively, over the past four years. What is the standard deviation of these returns?

A) 4.6%.
B) 4.1%.
C) 3.7%.
D) 4.3%.

Question 23

David has purchased an investment that he expects to produce an annual cash flow of $3,000 for five years. He requires an 8% rate of return compounded annually. What is the maximum amount that David can pay and still earn the required rate of return?

A) $12,936
B) $14,764
C) $15,000
D) $19,008

Question 24

Which one following will lower required rates of return?

A) Lower dividend yields.
B) Lower rates of inflation.
C) Higher rates of inflation.
D) Higher risk premiums.

Question 25

Most investors are risk- averse, which means they

A) refuse to accept any financial risk.
B) gain satisfaction from the excitement of risk.
C) require an increase in return for any increase in risk.
D) invest only in government insured securities.

Question 26

The holding period is a useful way to compare investments because it considers

A) both income and capital gains or losses.
B) the relative size of investments being compared.
C) only capital gains, but not income.
D) the time value of money.

Question 27

Christopher invests $400 today at a 4% rate of return which is compounded annually. What is the future value of this investment after four years?

A) $464
B) $342
C) $468
D) $416

Question 28

The difficulty many investors experienced in selling mortgage based securities during the financial crisis of 2009 is an example of

A) liquidity risk.
B) business risk.
C) credit risk.
D) market risk.

Question 29

The stock of Plomb Co. falls sharply on news that its CEO has drowned in a boating accident while on vacation. This is an example of

A) flotation risk.
B) liquidity risk.
C) accidental risk.
D) event risk.

Question 30

An ordinary annuity has cash flows that occur at the of each time period and are in amount.

A) beginning; constant
B) end; variable
C) beginning; variable
D) end; constant

Question 31

Ashley purchased a share at a price of $27 a share. She received quarterly dividends of $0.75 per share. After one year, Ashley sold the stock at a price of $29.25 a share. What is her percentage total return on this investment?

A) 19.4%
B) 10.3%
C) 11.1%
D) 17.9%

Question 32

Shares in which of the following industries may be impacted by government actions?

A) Housing.
B) Health Care.
C) Defence.
D) All of the above.

Question 33

The present value of $10,000 discounted at 5% per year and received at the end of 5 years is

A) $10,000(1.05)⁵ B) $10,000 (1.05)^1/5
C) $10,000/1.25
D) $10,000/(1.05)⁵

Question 34

When the rate of return is equal to the discount rate

A) the cost of an investment equals the future value of its benefits.
B) the present value of an investment's benefits must be greater than its cost.
C) the cost of an investment equals the present value of its benefits.
D) the cost of an investment equals the sum of its benefits.

Question 35

Inflation tends to have a particularly negative impact on the price of

A) real estate.
B) gold.
C) bonds.
D) crude oil.

Question 36

The risk- free rate is equal to the real rate of return plus

A) a risk premium.
B) the prevailing prime rate.
C) an expected inflation premium.
D) both an inflation and a risk premium.

Question 37

Which one of the following will tend to decrease the rate of return on an investment?

A) Increased assurance of reinvestment rates at the desired rate of return.
B) Reduction in tax rates.
C) Stabilisation of inflation rates at a reasonably low level.
D) Elimination of a tax exemption relevant to the investment.

Question 38

Each of the following investments produces the same rate of return. Which one has the greatest amount of risk?

A) Investment B with a standard deviation of 12%.
B) Investment D with a standard deviation of 19%.
C) Investment C with a standard deviation of 8%.
D) Investment A with a standard deviation of 4%.

Question 39

The holding period return (HPR) can appropriately be used to

A) isolate realised capital gains.
B) determine the required reinvestment rate for long- term investments.
C) compare returns among investments that are held for one year or less.
D) compare the yield on investments held for any time period.

Question 40

When calculating the present value of either a future single sum or a future annuity, the applicable interest rate is usually called the

A) discount rate.
B) compound interest rate.
C) yield-to-maturity.
D) internal rate of return.

Question 41

To calculate the interest rate or growth rate using a spreadsheet or financial calculator, the present value and the future value most have opposite signs.

Question 42

Brittany purchased a stock for $14 a share and sold it six months later for $15.50. While she owned the stock, Britanny received two quarterly dividends of $0.16 per share. Brittany's holding period return on this stock is

A) 17.4%.
B) 19.3%.
C) 13.0%.
D) 15.0%.

Question 43

Over the long term, which one of the following has historically had the lowest average annual rate of return?

A) Long- term corporate bonds.
B) Small- company stocks.
C) Long- term government bonds.
D) Large- company stocks.

Question 44

An investment costs $3,500 today. This investment is expected to produce annual cash flows of $1,200, $1,400, $1,300 and $1,100, respectively, over the next four years. What is the internal rate of return on this investment?

A) 16.2%.
B) 14.6%.
C) 8.1%.
D) 12.4%.

Question 45

For a given stated rate of interest, daily compounding results in a higher true rate of interest than monthly compounding.

Question 46

Which one of the following is an internal characteristic that can affect the value of an investment?

A) War.
B) Use of debt financing.
C) Inflation.
D) Reserve Bank actions.

Question 47

To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, you should use the following EXCEL command.

A) ANN
B) TVM
C) PV
D) RATE

Question 48

To compute the present value of $1,000 discounted at the rate of 5% per year, to be received at the end of 3 years, you should enter the following variables into a financial calculator

A) N=3, i=.05, PV=1000
B) N=3, i=5, FV=1000
C) N=3, i=5, PMT=1000
D) N=3, i=5, PV=1000

Question 49

To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, you should enter the following variables into a financial calculator

A) N=1, i=5, PMT=3000
B) N=3, i=5, FV=3000
C) N=3, i=5, PMT=1000
D) N=3, i=15, PMT=1000

Question 50

The risk associated with a sudden and unforeseen happening that has a significant and usually immediate effect on a firm's financial condition is called

A) market risk.
B) event risk.
C) business risk.
D) speculation.

Question 51

The adage "the sooner one receives a return on a given investment, the better," reflects the financial concept known as the

A) historical dividend theory.
B) total return concept.
C) time value of money.
D) expected yield factor.

Question 52

Jessica bought a share at a price of $11.50. She received a $0.75 dividend and sold the share for $12.50. What is Jessica's capital gain on this investment?

A) $1.00
B) $0.25
C) $1.75
D) $0.75

Question 53

Joshua bought a stock for $17 a share two years ago. The stock does not pay any dividends. Today Joshua sold the stock for $18.50 a share. What was his internal rate of return on this investment?

A) 4.3%.
B) 7.1%.
C) 8.8%.
D) 6.2%.

Question 54

A holding period return is calculated by adding the current income to the capital gains and dividing this sum by the

A) beginning investment value.
B) total income received.
C) selling price of the investment.
D) average investment value.

Question 55

Inflation tends to have a favourable impact on

A) bonds.
B) real estate.
C) ordinary share.
D) preference share.

Question 56

Six years ago, Miguel invested $3,500. Today his investment is worth $5,659. The yield on this investment is

A) 9.7%.
B) 1.4%.
C) 4.2%.
D) 8.3%.

Question 57

In response to the same external force, the return on one investment may increase while the return on another investment may decrease.

Question 58

Roy is going to receive a payment of $5,000 one year from today. He earns an average of 6% on his investments. What is the present value of this payment?

A) $4,821
B) $5,000
C) $4,717
D) $5,300

Question 59

If you invest $2,000 at the end of each year for five years and you earn 7% interest compounded annually, how much will you have accumulated at the end of the fifth year?

A) $12,307
B) $11,501
C) $14,026
D) $10,700

Question 60

The following investment cash flows have been entered into cells B5 through B9 of an EXCEL spreadsheet. B5 $(5,200 ), B6 $2,100, B7 $1,300, B8 $1,800, B9 $1,200, where $5,200 is the cost of the investment and the following amounts are cash flows at the end of years one through four. The correct function for computing the yield on this investment is

A) =irr(B6:B9)+B5.
B) =rate(4,0,- 5200, 1200).
C) =irr(B6:B9).
D) =ytm(B5, B6:B9).

Question 61

If the discount rate is appropriate for the level of risk, a satisfactory investment will have a present value of benefits equal to or greater than than the present value of costs.

Question 62

One reason that the holding period return should not be used to compare long- term investments is that it does not consider the time value of money.

Question 63

The future value is equal to the present value multiplied by the 1 plus the interest rate.

Question 64

The greater the dispersion around an asset's expected return, the greater the risk.

Question 65

The possibility that deflation could affect the rate of return on an investment is referred to as interest rate risk.

Question 66

If the risk- free rate of return is less than the inflation rate, the real rate of return is negative.

Question 67

An interest rate of 6.18% compounded daily is equivalent to 6% compounded annually.

Question 68

Risk can be defined as uncertainty concerning the actual return that an investment will generate.

Question 69

The required return on a risky investment includes a real rate of return, an inflation premium and a risk premium.

Question 70

If you own an investment providing periodic returns, your actual yield on the investment will depend on the reinvestment rate you are able to obtain.

Question 71

Interest rates change as the result of changes in the supply and demand for money.

Question 72

In the short term, share prices tend to rise as inflation rises.

Question 73

An ordinary annuity is defined as an annuity for which the cash flows occur at the beginning of each year or payment period.

Question 74

The return that fully compensates for the risk of an investment is called the risk- free rate of return.

Question 75

Business risk is the risk associated with the amount of debt financing used by a firm.

Question 76

The yield on an investment is the discount rate that produces a present value of benefits greater than the cost of the investment.

Question 77

Investors who limit themselves to risk free and low risk investments can avoid purchasing power risk.

Question 78

Most investors are risk- seeking.

Question 79

Internal factors such as the quality of management and the level of corporate debt affect the rate of return on an individual share.

Question 80

The amount an investor is willing to pay for an investment should be determined by the past performance of the investment.