Deck 7: Introduction to Risk and Return

Question 1

A standard error measures:

A)nominal annual rate of return on a portfolio
B)risk of a portfolio
C)reliability of an estimate
D)real annual rate of return on a portfolio

Answer 1

reliability of an estimate

Question 2

Assume the following data: risk-free rate = 4.0%,average risk premium = 7.7%.
Calculate the required rate of return.

A)5.6%
B)7.6%
C)11.7%
D)30.8%

Answer 2

11.7%

Question 3

Which portfolio has had the highest average risk premium during the period 1900-2011?

A)Common stocks
B)Government bonds
C)Treasury bills
D)None of the answers

Answer 3

Common stocks

Question 4

Which portfolio had the highest average annual return in real terms between 1900 and 2011?

A)Portfolio of U.S.common stocks
B)Portfolio of U.S.government bonds
C)Portfolio of Treasury bills
D)None of the answers

Question 5

For long-term U.S.government bonds,which risk concerns investors the most?

A)Interest rate risk
B)Default risk
C)Market risk
D)Liquidity risk

Question 6

What has been the average annual nominal rate of interest on Treasury bills over the past 111 years (1900-2011)?

A)Less than 1%
B)Between 1% and 2%
C)Between 2% and 3%
D)Greater than 3%

Question 7

Spill Drink Company's stocks had -8%,11%,and 24% rates of return during the last three years respectively; calculate the (arithmetic)average rate of return for the stock.

A)8% per year
B)9% per year
C)10% per year
D)11% per year

Question 8

What has been the average annual real rate of interest on Treasury bills over the past 111 years (from 1900 to 2011)?

A)Less than 2%
B)Between 2% and 3%
C)Between 3% and 4%
D)Greater than 4%

Question 9

Which of the following countries has had the lowest risk premium?

A)U.S.
B)Denmark
C)Italy
D)Germany

Question 10

Which portfolio has had the lowest average annual nominal rate of return during the 1900-2011 periods?

A)Portfolio of small U.S.common stocks
B)Portfolio of U.S.government bonds
C)Portfolio of Treasury bills
D)Portfolio of large U.S.common stocks

Question 11

If the standard deviation of annual returns is 19.8% and the number of years of observation is 107,what is the standard error?

A)4.23%
B)1.91%
C)0.47%
D)19.8%

Question 12

Which of the following provides a correct measure of the opportunity cost of capital regardless of the timing of cash flows?

A)Arithmetic average
B)Geometric average
C)Hyperbolic mean
D)Opportunistic mean

Question 13

One dollar invested in a portfolio of long-term U.S.government bonds in 1900 would have grown in nominal value by the end of year 2011 to:

A)$719
B)$66
C)$74
D)$245

Question 14

What has been the average annual rate of return in real terms for a portfolio of U.S.common stocks between 1900 and 2011?

A)Less than 2%
B)Between 2% and 5%
C)Between 5% and 8%
D)Greater than 8%

Question 15

Which of the following portfolios has the least risk?

A)A portfolio of Treasury bills
B)A portfolio of long-term U.S.government bonds
C)A portfolio of U.S.common stocks of small firms
D)A portfolio of U.S.common stocks of large firms

Question 16

If the average annual rate of return for common stocks is 11.7%,and 4.0% for U.S.Treasury bills,what is the average market risk premium?

A)15.7%
B)4.0%
C)7.7%
D)not enough information provided

Question 17

One dollar invested in a portfolio of U.S.common stocks in 1900 would have grown in nominal value by the end of year 2011 to:

A)$21,978
B)$245
C)$74
D)$6

Question 18

Which of the following is an estimate of standard error?

A)The average annual rate of return divided by the square root of the number of observations
B)The variance divided by the number of observations
C)The standard deviation of returns divided by the square root of the number of observations
D)The variance of returns divided by the square root of the number of observations

Question 19

What has been the average annual nominal rate of return on a portfolio of U.S.common stocks over the past 111 years (from 1900 to 2011)?

A)Less than 2%
B)Between 2% and 5%
C)Between 5% and 11%
D)Greater than 11%

Question 20

For lognormally distributed returns,the annual compound returns equal:

A)the arithmetic average return minus half the variance.
B)the arithmetic average return plus half the variance.
C)the arithmetic average return minus half the standard deviation.
D)the arithmetic average return plus half the standard deviation.

Question 21

Stock X has a standard deviation of return of 10%.Stock Y has a standard deviation of return of 20%.The correlation coefficient between the two stocks is 0.5.If you invest 60% of your funds in stock X and 40% in stock Y,what is the standard deviation of your portfolio?

A)10.3%
B)21.0%
C)12.2%
D)14.8%

Question 22

A statistical measure of the degree to which securities' returns move together is called a:

A)variance
B)correlation coefficient
C)standard deviation
D)geometric average

Question 23

The standard deviation of U.S.returns,from 2005 to the financial crisis four years later,had increased (approximately)by a factor of:

A)2.
B)3.
C)4.
D)6.

Question 24

If the covariance between stock A and stock B is 100,the standard deviation of stock A is 10% and that of stock B is 20%,calculate the correlation coefficient between the two securities.

A)-0.5
B)+1.0
C)+0.5
D)0.0

Question 25

What has been the approximate standard deviation of returns of U.S.common stocks during the period between 1900 and 2011?

A)20.0%
B)33.4%
C)8.9%
D)2.8%

Question 26

As the number of stocks in a portfolio is increased:

A)unique risk decreases and approaches zero
B)market risk decreases
C)unique risk decreases and becomes equal to market risk
D)total risk approaches zero

Question 27

For a two-stock portfolio,the maximum reduction in risk occurs when the correlation coefficient between the two stocks equals:

A)+1.0.
B)-0.5.
C)-1.0.
D)0.0.

Question 28

Mega Corporation has the following returns for the past three years: 8%,12%,and 10%.
Calculate the variance of the returns and the standard deviation of the returns.

A)64 and 8.0%
B)124 and 11.1%
C)4 and 2.0%
D)30 and 10.0%

Question 29

Which portfolio had the highest standard deviation during the period between 1900 and 2011?

A)Common stocks
B)Government bonds
C)Treasury bills
D)None of the answers

Question 30

The type of the risk that can be eliminated by diversification is called:

A)market risk
B)unique risk
C)interest rate risk
D)default risk

Question 31

Unique risk is also called:

A)systematic risk.
B)non-diversifiable risk.
C)firm-specific risk.
D)market risk.

Question 32

For a portfolio of N-stocks,the formula for portfolio variance contains:

A)N variance terms.
B)N(N - 1)/2 variance terms.
C)N² variance terms.
D)N - 1 variance terms.

Question 33

What range of values can correlation coefficients take?

A)zero to + 1
B)-1 to + 1
C)-infinity to + infinity
D)zero to + infinity

Question 34

Stock P and stock Q have had annual returns of -10%,12%,28% and 8%,13%,24%,respectively.Calculate the covariance of return between the securities.

A)-149
B)+149
C)+100
D)-100E

Question 35

Which of the following countries has had the highest risk premium?

A)Germany
B)Denmark
C)Italy
D)U.S.

Question 36

Market risk is also called:
i.systematic risk; II)undiversifiable risk; III)firm-specific risk.

A)I only
B)II only
C)III only
D)I and II only

Question 37

Stock M and Stock N have had the following returns for the past three years: -12%,10%,32%; and 15%,6%,24%,respectively.Calculate the covariance between the two securities.

A)-99
B)+99
C)+250
D)-250E

Question 38

Sun Corporation has had returns of -6%,16%,18%,and 28% for the past four years.Calculate the standard deviation of the returns.

A)11.6%
B)14.3%
C)13.4 %
D)14.0%

Question 39

Stock A has an expected return of 10% per year and stock B has an expected return of 20%.If 40% of a portfolio's funds are invested in stock A,and the rest in stock B,what is the expected return on the portfolio of stock A and stock B?

A)10%
B)20%
C)16%
D)14%

Question 40

Macro Corporation has had the following returns for the past three years,-10%,10%,and 30%.Calculate the standard deviation of the returns.

A)10%
B)20%
C)25%
D)30%

Question 41

What is the beta of a security where the expected return is double that of the stock market,there is no correlation coefficient relative to the U.S.stock market,and the standard deviation of the stock market is .18?

A)0.00
B)1.00
C)1.25
D)2.00

Question 42

The annual returns for three years for stock B were 0%,10%,and 26%.Annual returns for three years for the market portfolio were +6%,18%,and 24%.Calculate the beta for the stock.

A)0.75
B)1.36
C)1.00
D)0.74

Question 43

The covariance between YOHO stock and the S&P 500 is 0.05.The standard deviation of the stock market is 20%.What is the beta of YOHO?

A)0.00
B)1.00
C)1.25
D)1.42

Question 44

The correlation coefficient between stock B and the market portfolio is 0.8.The standard deviation of stock B is 35% and that of the market is 20%.Calculate the beta of the stock.

A)1.0
B)1.4
C)0.8
D)0.7

Question 45

The standard statistical measures of the variability of stock returns are beta and covariance.

Question 46

Beta is a measure of:

A)unique risk.
B)total risk.
C)market risk.
D)liquidity risk.

Question 47

The portfolio risk that cannot be eliminated by diversification is called market risk.

Question 48

A risk premium is the difference between a security's return and the Treasury bill return.

Question 49

For lognormally distributed returns,the annual geometric average return is greater than the arithmetic average return.

Question 50

The beta of the market portfolio is:

A)+1.0.
B)+0.5.
C)0.
D)-1.0.

Question 51

If the standard deviation of returns on the market is 20%,and the beta of a well-diversified portfolio is 1.5,calculate the standard deviation of this portfolio:

A)30%.
B)20%.
C)15%.
D)10%.

Question 52

Diversification reduces the risk of a portfolio because the prices of different securities do not move exactly together.

Question 53

For each additional 1% change in market return,the return on a stock having a beta of 2.2 changes,on average,by:

A)1.00%.
B)0.55%.
C)2.20%.
D)1.10%.

Question 54

For a portfolio of N-stocks,the formula for portfolio variance contains:

A)N covariance terms.
B)N(N - 1)/2 different covariance terms.
C)N² covariance terms.
D)N - 1 covariance terms.

Question 55

Treasury bills typically provide higher average returns,both in nominal terms and in real terms,than long-term government bonds.

Question 56

Which of the following portfolios will have the highest beta?

A)Portfolio of U.S.Treasury bills
B)Portfolio of U.S.government bonds
C)Portfolio containing 50% U.S.Treasury bills and 50% U.S.government bonds
D)Portfolio of U.S.common stocks

Question 57

According to the authors,a reasonable range for the risk premium in the United States is 5% to 8%.

Question 58

The historical nominal returns for stock A were -8%,+10%,and +22%.The nominal returns for the market portfolio were +6%,+18%,and 24% during this same time.Calculate the beta for stock

A)1.64
B)0.61
C)1.00
D)0.50

Question 59

The portfolio risk that cannot be eliminated by diversification is called unique risk.

Question 60

The correlation coefficient between a stock and the market portfolio is +0.6.The standard deviation of return of the stock is 30% and that of the market portfolio is 20%.Calculate the beta of the stock.

A)1.1
B)1.0
C)0.9
D)0.6Cov

Question 61

For the most part,stock returns tend to move together.Thus,pairs of stocks tend to have both positive covariances and correlations.

Question 62

The risk of a well-diversified portfolio depends on the market risk of the securities included in the portfolio.

Question 63

Briefly explain how diversification reduces risk.

Question 64

By purchasing U.S.government bonds,an investor can achieve both a risk-free nominal rate of return and a risk-free real rate of return.

Question 65

If returns on two stocks tended to move in opposite directions,then the covariances and correlations on the two stocks would be negative.

Question 66

A portfolio with a beta of one offers an expected return equal to the market risk premium.

Question 67

A stock having a covariance with the market that is higher than the variance of the market will always have a beta above 1.0.

Question 68

In the formula for calculating the variance of an N-stock portfolio,how many covariance and variance terms are there?

Question 69

The covariance between the returns on two stocks equals the correlation coefficient multiplied by the standard deviations of the two stocks.

Question 70

The variability of a well-diversified portfolio mostly reflects the contributions to risk from the standard deviations of the stocks within that portfolio.

Question 71

Stocks with high standard deviations will necessarily also have high betas.

Question 72

Diversification can reduce portfolio risk even in the case when correlations across stock returns equal zero.

Question 73

The beta of a well-diversified portfolio is equal to the value weighted average beta of the securities included in the portfolio.

Question 74

One can easily calculate the estimated risk premium on stocks via the statistical analysis of historical stock returns.

Question 75

A risk premium generated by comparing stocks to 10-year U.S.Treasury bonds will be smaller than a risk premium generated by comparing stocks to U.S.Treasury bills.

Question 76

Low standard deviation stocks always have low betas.

Question 77

Define the term risk premium.

Question 78

The average beta of all stocks in the market is zero.

Question 79

Regarding stock returns,briefly explain the term variance.

Question 80

The standard deviation of a two-stock portfolio generally equals the value-weighted average of the standard deviations of the two stocks.