Deck 10: Capital Markets and the Pricing of Risk

Question 1

Use the table for the question(s)below.
Consider the following Price and Dividend data for General Electric Company:

Assume that you purchased General Electric Company stock at the closing price on December 31,2008 and sold it after the dividend had been paid at the closing price on January 26,2009.Your dividend yield for this period is closest to:

A)-8.15%
B)0.75%
C)0.70%
D)-8.80%

Answer 1

0.70%

Question 2

Which of the following investments offered the highest overall return over the past eighty years?

A)Treasury Bills
B)S&P 500
C)Small stocks
D)Corporate bonds

Answer 2

Small stocks

Question 3

Use the table for the question(s)below.
Consider the following probability distribution of returns for Alpha Corporation:

The expected return for Alpha Corporation is closest to:

A)6.67%
B)5.00%
C)10%
D)0.00%

Answer 3

5.00%

Question 4

Which of the following statements is TRUE?

A)Small stocks have outperformed the S&P 500 in every year since 1925.
B)The S&P 500 is more volatile than corporate bonds.
C)Corporate bonds underperformed inflation during most years since 1925.
D)Treasury Bills outperformed inflation during every year since 1925.

Question 5

Suppose an investment is equally likely to have a 35% return or a -20% return.The standard deviation on the return for this investment is closest to:

A)38.9%
B)0%
C)19.4%
D)27.5%

Question 6

Which of the following statements is FALSE?

A)When an investment is risky,there are different returns it may earn.
B)In finance,the variance of a return is also referred to as its volatility.
C)The expected or mean return is calculated as a weighted average of the possible returns,where the weights correspond to the probabilities.
D)The variance is a measure of how "spread out" the distribution of the return is.

Question 7

Which of the following investments had the largest fluctuations in overall return over the past eighty years?

A)Small stocks
B)S&P 500
C)Corporate bonds
D)Treasury Bills

Question 8

Use the table for the question(s)below.
Consider the following probability distribution of returns for Alpha Corporation:

The variance of the return on Alpha Corporation is closest to:

A)5.00%
B)4.75%
C)3.625%
D)3.75%

Question 9

Which of the following investments offered the lowest overall return over the past eighty years?

A)Small stocks
B)Treasury Bills
C)S&P 500
D)Corporate bonds

Question 10

Which of the following statements is FALSE?

A)The standard deviation is the square root of the variance.
B)Because investors dislike only negative resolutions of uncertainty,alternative measures that focus solely on downside risk have been developed,such as the semi-variance and the expected tail loss.
C)While the variance and the standard deviation are the most common measures of risk,they do not differentiate between upside and downside risk.
D)While the variance and the standard deviation both measure the variability of the returns,the variance is easier to interpret because it is in the same units as the returns themselves.

Question 11

Which of the following statements is FALSE?

A)The standard error provides an indication of how far the sample average might deviate from the expected return.
B)The 95% confidence interval for the expected return is defined as the Historical Average Return plus or minus three standard errors.
C)We can use a security's historical average return to estimate its actual expected return.
D)The standard error is the standard deviation of the average return.

Question 12

Suppose an investment is equally likely to have a 35% return or a -20% return.The variance on the return for this investment is closest to:

A).151
B).0378
C)0
D).075

Question 13

Which of the following statements is FALSE?

A)The variance increases with the magnitude of the deviations from the mean.
B)The variance is the expected squared deviation from the mean.
C)Two common measures of the risk of a probability distribution are its variance and standard deviation.
D)If the return is riskless and never deviates from its mean,the variance is equal to one.

Question 14

Suppose an investment is equally likely to have a 35% return or a -20% return.The expected return for this investment is closest to:

A)7.5%
B)15%
C)5%
D)10%

Question 15

Which of the following equations is INCORRECT?

A)Var(R)=
B)SD(R)=
C)Var(R)= P_R × (R - E[R])²
D)E[R] = P_R × R

Question 16

If a stock pays dividends at the end of each quarter,with realized returns of R₁,R₂,R₃,and R₄ each quarter,then the annual realized return is calculated as:

A)R_annual =
B)R_annual = (1 + R₁)(1 + R₂)(1 + R₃)(1 + R₄)
C)R_annual = (1 + R₁)(1 + R₂)(1 + R₃)(1 + R₄)- 1
D)R_annual = R₁ + R₂ + R₃ + R₄

Question 17

Which of the following statements is FALSE?

A)The expected return is the return that actually occurs over a particular time period.
B)If you hold the stock beyond the date of the first dividend,then to compute you return you must specify how you invest any dividends you receive in the interim.
C)The average annual return of an investment during some historical period is simply the average of the realized returns for each year.
D)The realized return is the total return we earn from dividends and capital gains,expressed as a percentage of the initial stock price.

Question 18

Which of the following statements is FALSE?

A)The compounded geometric average return is most often used for comparative purposes.
B)We should use the arithmetic average return when we are trying to estimate an investment's expected return over a future horizon based on its past performance.
C)The geometric average return will always be above the arithmetic average return and the difference grows with the volatility of the annual returns.
D)The geometric average return is a better description of the long-run historical performance of an investment.

Question 19

The standard deviation of the return on Alpha Corporation is closest to:

A)22.4%
B)19.0%
C)21.8%
D)19.4%

Question 20

Which of the following statements is FALSE?

A)We measure the degree of estimation error statistically through the standard error of the estimate.
B)When focusing on the returns of a single security,its common practice to assume that all dividends are immediately invested at the risk-free rate.
C)We estimate the standard deviation or volatility as the square root of the variance.
D)We estimate the variance by computing the average squared deviation from the average realized return.

Question 21

The geometric average annual return on the Index from 2000 to 2009 is closest to:

A)9.75%
B)8.75%
C)7.10%
D)8.35%

Question 22

The geometric average annual return on Stock A from 2000 to 2009 is closest to:

A)12.4%
B)16.7%
C)13.2%
D)17.8%

Question 23

Use the table for the question(s)below.
Consider the following realized annual returns:

Suppose that you want to use the 10 year historical average return on the Market to forecast the expected future return on the Market.Calculate the 95% confidence interval for your estimate of the expect return.

Question 24

Use the table for the question(s)below.
Consider the following realized annual returns:

Suppose that you want to use the 10 year historical average return on Stock B to forecast the expected future return on Stock B.Calculate the 95% confidence interval for your estimate of the expect return.

Question 25

The standard deviation of the returns on Stock A from 2000 to 2009 is closest to:

A)33.2%
B)16.4%
C)31.5%
D)11.0%

Question 26

Use the table for the question(s)below.
Consider the following realized annual returns:

Using the data provided in the table,calculate the average annual return,the variance of the annual returns,and the standard deviation of the average returns for Stock B from 2000 to 2009.

Question 27

Suppose that you want to use the 10 year historical average return on the Index to forecast the expected future return on the Index.The standard error of your estimate of the expected return is closest to:

A)19.4%
B)3.8%
C)6.2%
D)1.95%

Question 28

Suppose that you want to use the 10 year historical average return on Stock A to forecast the expected future return on Stock A.The standard error of your estimate of the expected return is closest to:

A)16.4%
B)3.32%
C)10.49%
D)33.20%

Question 29

Suppose that you want to use the 10 year historical average return on Stock A to forecast the expected future return on Stock A.The 95% confidence interval for your estimate of the expect return is closest to:

A)13.2% to 19.5%
B)-4.5% to 37.4%
C)6.5% to 26.3%
D)-15.0% to 47.9%

Question 30

Use the table for the question(s)below.
Consider the following realized annual returns:

The average annual return on the Index from 2000 to 2009 is closest to:

A)7.10%
B)4.00%
C)9.75%
D)8.75%

Question 31

Use the table for the question(s)below.
Consider the following realized annual returns:

Using the data provided in the table,calculate the average annual return,the variance of the annual returns,and the standard deviation of the average returns for the market from 2000 to 2009.

Question 32

Use the table for the question(s)below.
Consider the following Price and Dividend data for General Electric Company:

Assume that you purchased Ford Motor Company stock at the closing price on December 31,2008 and sold it at the closing price on December 30,2009.Your realized annual return for the year 2009 is closest to:

A)-45.1%
B)-44.5%
C)-48.5%
D)-47.3%

Question 33

Use the table for the question(s)below.
Consider the following realized annual returns:

The variance of the returns on the Index from 2000 to 2009 is closest to:

A).0450
B).3400
C).1935
D).0375

Question 34

Use the table for the question(s)below.
Consider the following realized annual returns:

The variance of the returns on Stock A from 2000 to 2009 is closest to:

A).3145
B).0990
C).1100
D).9890

Question 35

Use the table for the question(s)below.
Consider the following Price and Dividend data for General Electric Company:

Assume that you purchased General Electric Company stock at the closing price on December 31,2008 and sold it after the dividend had been paid at the closing price on January 26,2009.Your total return rate (yield)for this period is closest to:

A)0.75%
B)-8.80%
C)0.70%
D)-8.15%

Question 36

The standard deviation of the returns on the Index from 2000 to 2009 is closest to:

A)19.5%
B)20.5%
C)3.8%
D)8.8%

Question 37

Use the table for the question(s)below.
Consider the following Price and Dividend data for J.P.Morgan Chase:

Assume that you purchased J.P.Morgan Chase stock at the closing price on December 31,2008 and sold it at the closing price on December 30,2009.Calculate your realized annual return is for the year 2005.

Question 38

Use the table for the question(s)below.
Consider the following Price and Dividend data for General Electric Company:

Assume that you purchased General Electric Company stock at the closing price on December 31,2008 and sold it after the dividend had been paid at the closing price on January 26,2009.Your capital gains rate (yield)for this period is closest to:

A)0.75%
B)0.70%
C)-8.80%
D)-8.15%

Question 39

Suppose that you want to use the 10 year historical average return on the Index to forecast the expected future return on the Index.The 95% confidence interval for your estimate of the expect return is closest to:

A)-9.6% to 27.3%
B)6.8% to 10.7%
C)-3.5% to 21.1%
D)4.9% to 12.7%

Question 40

Use the table for the question(s)below.
Consider the following realized annual returns:

The average annual return on Stock A from 2000 to 2009 is closest to:

A)29.9%
B)16.40%
C)18.2%
D)18.7%

Question 41

Which of the following statements is FALSE?

A)Expected return should rise proportionately with volatility.
B)Investors would not choose to hold a portfolio that is more volatile unless they expected to earn a higher return.
C)Smaller stocks have lower volatility than larger stocks.
D)The largest stocks are typically more volatile than a portfolio of large stocks.

Question 42

The standard deviation of the overall payoff to Bank A is closest to:

A)$689,000
B)$751,000
C)$2,179,000
D)$2,375,000

Question 43

Common risk is also called:

A)diversifiable risk.
B)correlated risk.
C)uncorrelated risk.
D)independent risk.

Question 44

Use the table for the question(s)below.
Consider the following average annual returns:

What is the excess return for corporate bonds?

A)2.7%
B)1.3%
C)-5.7%
D)0%

Question 45

Use the table for the question(s)below.
Consider the following average annual returns:

What is the excess return for Treasury Bills?

A)0%
B)-8.4%
C)-2.7%
D)-1.4%

Question 46

Which pharmaceutical company faces less risk?

Question 47

Use the table for the question(s)below.
Consider the following average annual returns:

What is the excess return for the S&P 500?

A)5.7%
B)7.0%
C)0%
D)8.4%

Question 48

Which of the following is NOT a diversifiable risk?

A)The risk that oil prices rise,increasing production costs
B)The risk of a product liability lawsuit
C)The risk that the CEO is killed in a plane crash
D)The risk of a key employee being hired away by a competitor

Question 49

The standard deviation of Little Cure's average net income for their ten new drugs is closest to:

A)$50 million
B)$25 million
C)$16 million
D)$500 million

Question 50

Which of the following statements is TRUE?

A)Portfolios with lower volatility have historically rewarded investors with higher average returns.
B)Individual stocks with higher volatility have consistently rewarded investors with higher average returns.
C)Volatility seems to be a reasonable measure of risk when evaluating returns on large portfolios.
D)Volatility seems to be a reasonable measure of risk when evaluating returns on individual stocks.

Question 51

What is the expected payoff for Little Cure's ten drugs?

A)$500 million
B)$100 million
C)$1 billion
D)$0

Question 52

Which of the following statements is FALSE?

A)Portfolios with higher volatility have historically rewarded investors with higher average returns.
B)Investments with higher volatility should have a higher risk premium and therefore higher returns.
C)Volatility seems to be a reasonable measure of risk when evaluating returns on large portfolios and the returns of individual securities.
D)Riskier investments must offer investors higher average returns to compensate them for the extra risk they are taking on.

Question 53

Do expected returns for individual stocks increase proportionately with volatility?

Question 54

The excess return is the difference between the average return on a security and the average return for:

A)Treasury Bonds.
B)a portfolio of securities with similar risk.
C)a broad based market portfolio like the S&P 500 index.
D)Treasury Bills.

Question 55

The expected overall payoff to Bank A is:

A)$5,000,000
B)$6,000,000
C)$94,000,000
D)$95,000,000

Question 56

Use the table for the question(s)below.
Consider the following average annual returns:

What is the excess return for the portfolio of small stocks?

A)10.0%
B)15.7%
C)18.4%
D)17.0%

Question 57

What is the expected payoff for Big Cure's Blockbuster drug?

A)$100 million
B)$0
C)$1 billion
D)$500 million

Question 58

The expected overall payoff to Bank B is:

A)$5,000,000
B)$6,000,000
C)$94,000,000
D)$95,000,000

Question 59

The standard deviation of the overall payoff to Bank B is closest to:

A)$751,000
B)$2,179,000
C)$2,375,000
D)$21,794,000

Question 60

What is the standard deviation of Big Cure's average net income for their new blockbuster drug?

A)$0
B)$1 billion
C)$100 million
D)$500 million

Question 61

The expected return on security "Y" is closest to:

A)0%
B)4%
C)10%
D)15%

Question 62

The expected return on security with a beta of 1.2 is closest to:

A)4.8%
B)8.0%
C)8.8%
D)9.6%

Question 63

What is the expected return for an individual firm?

A)14%
B)3%
C)5%
D)-5%

Question 64

The beta for security "Y" is closest to:

A)-1.00
B)-0.25
C)0.00
D)0.25

Question 65

Consider a portfolio that consists of an equal investment in 20 firms.For each of these firms,there is a 70% probability that the firms will have a 16% return and a 30% that they will have a -8% return.Each of these firms' returns is independent of all others.The standard deviation of this portfolio is closest to:

A)2.5%
B)4.2%
C)8.8%
D)11.0%

Question 66

Which of the following statements is FALSE?

A)Firm-specific news is good or bad news about the company itself.
B)Firms are affected by both systematic and firm-specific risk.
C)When firms carry both types of risk,only the firm-specific risk will be diversified when we combine many firms' stocks into a portfolio.
D)The risk premium for a stock is affected by its idiosyncratic risk.

Question 67

Which of the following is NOT a systematic risk?

A)The risk that oil prices rise,increasing production costs
B)The risk that the Federal Reserve raises interest rates
C)The risk that the economy slows,reducing demand for your firm's products
D)The risk that your new product will not receive regulatory approval

Question 68

The expected return on the market portfolio is closest to:

A)0%
B)4%
C)8%
D)16%

Question 69

The risk-free rate is closest to:

A)0%
B)4%
C)8%
D)16%

Question 70

The beta for security "X" is closest to:

A)0
B)0.80
C)1.00
D)1.25

Question 71

Which of the following types of risk doesn't belong?

A)Market risk
B)Unique risk
C)Idiosyncratic risk
D)Unsystematic risk

Question 72

The expected return on security with a beta of 0 is closest to:

A)-4.0%
B)0.0%
C)3.2%
D)4.0%

Question 73

The standard deviation for the return on a portfolio of 20 type S firms is closest to:

A)5.10%
B)23.0%
C)15.0%
D)5.25%

Question 74

The beta for security "Z" is closest to:

A)-1.00
B)-0.25
C)0.00
D)0.25

Question 75

Which of the following statements is FALSE?

A)Because investors are risk averse,they will demand a risk premium to hold unsystematic risk.
B)Over any given period,the risk of holding a stock is that the dividends plus the final stock price will be higher or lower than expected,which makes the realized return risky.
C)The risk premium for diversifiable risk is zero,so investors are not compensated for holding firm-specific risk.
D)Because investors can eliminate firm-specific risk "for free" by diversifying their portfolios,they will not require a reward or risk premium for holding it.

Question 76

Which of the following types of risk doesn't belong?

A)Idiosyncratic risk
B)Undiversifiable risk
C)Market risk
D)Systematic risk

Question 77

Which of the following statements is FALSE?

A)Fluctuations of a stock's returns that are due to firm-specific news are common risks.
B)The volatility in a large portfolio will decline until only the systematic risk remains.
C)When we combine many stocks in a large portfolio,the firm-specific risks for each stock will average out and be diversified.
D)The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk.

Question 78

The standard deviation for the return on an portfolio of 20 type I firms is closest to:

A)5.25%
B)5.10%
C)15.0%
D)23.0%

Question 79

The standard deviation for the return on an individual firm is closest to:

A)23.0%
B)5.25%
C)15.0%
D)10.0%

Question 80

The expected return on security with a beta of 0.8 is closest to:

A)0.0%
B)3.2%
C)6.4%
D)7.2%