Deck 7: Risk and Return

Question 1

The variance is equal to the square root of the standard deviation.

Answer 1

False

Question 2

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

Answer 2

False

Question 3

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

Answer 3

False

Question 4

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 5

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

Question 6

If the expected return of a bet, which is based on a coin toss, is $15, then that means that the outcome of the bet will be a $15 cash inflow to the person making the bet.

Question 7

The income component of return for a common stock comes from the dividend cash flow stream.

Question 8

If the price of an asset has not increased or decreased 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 9

The capital appreciation component of a stock's return considers the increase in price of a stock divided by the beginning of period price of the stock.

Question 10

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

Question 11

The variance of a distribution can be a negative value.

Question 12

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

Question 13

The best measure of risk within an investment is its variance.

Question 14

The capital appreciation component of a stock's return considers the increase in price of a stock divided by the end of period price of the stock.

Question 15

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

Question 16

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

Question 17

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 18

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

Question 19

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 20

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

Question 21

If you are dealing with percentage returns, then which of the following is generally true?

A) The variance of the return distribution is generally smaller than the standard deviation.
B) The variance of the return distribution is generally larger than the standard deviation.
C) The variance of the return distribution is measured in the same units as expected return.
D) None of the above is generally true.

Question 22

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

Question 23

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

Question 24

If the returns for 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

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

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

Question 26

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 27

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 28

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

Question 29

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 30

Utilizing the fact that two or more asset values 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 31

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

Question 32

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

Question 33

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 a prize in the game?

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

Question 34

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

Question 35

The expected return for a portfolio without borrowing

A) should never be less than the expected return of the asset with lowest expected return.
B) should never be greater than the expected return of the asset with highest expected return.
C) may not be an event with even a positive probability of occurrence.
D) All of the above.

Question 36

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

Question 37

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

Question 38

If you are building a portfolio, then you desire assets that have a correlation coefficient of one.

Question 39

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

Question 40

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

Question 41

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 42

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 the total return to Ahmet from owning the stock? (Round your answer to the nearest whole percent.)

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

Question 43

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 income during the year? (Round your answer to the nearest percent.)

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

Question 44

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?

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

Question 45

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 95 percent sure that he will have at the end of the year?

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

Question 46

If a random variable is drawn from 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 47

Elrond has made an investment that will generate returns that are subject to the state of the economy. Use the following information to calculate the variance of the return distribution for Elrond's investment.
State
Return
Probability
Weak
0)10
0)8
OK
0)17
0)1
Great
0)28
0)1

A) 0.0536
B) 0.0543
C) 0.0550
D) 0.0557

Question 48

Genaro needs to capture 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 49

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 50

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 51

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 95 percent of the goldfish are smaller? Assume a normal distribution for the size of goldfish.

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

Question 52

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

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

Question 53

You know that the average college student eats 0.75 pounds of food at lunch. If the standard deviation of that eating is 0.2 pounds of food, then what is the total amount of food that a cafeteria should have on hand to be 95percent 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 54

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 and round to the nearest percent.

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

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? (Round your answer to the nearest percent.)

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

Question 56

If you were to compare the returns of an individual stock to a market index, select the answer below that is most true.

A) The returns of the individual stock will show more variability than those of the market index.
B) The returns of the individual stock will show less variability than those of the market index.
C) The returns of the individual stock will show the same level of variability than those of the market index, if they have the same beta.
D) None of the above.

Question 57

Tommie has made an investment that will generate returns that are subject to the state of the economy during the year. Use the following information to calculate the standard deviation of the return distribution for Tommie's investment.
State
Return
Probability
Weak
0)13
0)3
OK
0)2
0)4
Great
0)25
0)3

A) 0.0453
B) 0.0467
C) 0.0481
D) 0.0495

Question 58

Which of the following investment classes had the greatest variability in returns for recent historical data?

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

Question 59

Which of the following investment classes had the greatest average return based on recent historical data?

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

Question 60

If a random variable is drawn from 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 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

Most of the risk-reduction benefits from diversification can be achieved in a portfolio consisting of

A) 5 to 10 stocks
B) 10 to 15 stocks
C) 15 to 20 stocks
D) 20 to 25 stocks

Question 63

The beta of RicciCo.'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 is the expected return on RicciCo.?

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

Question 64

Batman Stock has exhibited a standard deviation in stock returns of 0.5, whereas Superman Stock has exhibited a standard deviation of 0.6. The correlation coefficient between the stock returns is 0.5. What is the variance of a portfolio composed of 70 percent Batman and 30 percent Superman?

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

Question 65

A portfolio with a level of systematic risk 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 66

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%

Question 67

Given the returns for two stocks with the following information, calculate the correlation coefficient of the returns for the two stocks. Assume the expected return for Stock 1 is 10.8 percent and 9.7 percent for Stock 2.
Prob
Stock 1
Stock 2
0)4
0)09
0)11
0)5
0)11
0)08
0)1
0)17
0)13

A) 0.230967
B) -0.00002548
C) 0.00032100
D) 0.17671455

Question 68

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 50-asset 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 69

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 is the expected return on Elsenore?

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

Question 70

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 71

Given the returns for two stocks with the following information, calculate the covariance of the returns for the two stocks. Assume the expected return is 10.8 percent for Stock 1 and 9.7 percent for Stock 2.
Prob
Stock 1
Stock 2
0)4
0)09
0)11
0)5
0)11
0)08
0)1
0)17
0)13

A) 0.000094
B) 0.00051600
C) 0.00032100
D) 0.71750786

Question 72

Horse Stock returns have exhibited 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?

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

Question 73

The covariance of the returns between Einstein Stock and Bohr Stock is 0.0087. The standard deviation of Einstein is 0.26, and the standard deviation of Bohr 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

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, respectfully?

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

Question 75

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 76

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 77

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) 0.578731

Question 78

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 79

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?

A) 0.0278
B) 0.5556
C) 1.800
D) 36.00

Question 80

Aquaman Stock has exhibited a standard deviation in stock returns of 0.7, whereas Green Lantern Stock has exhibited a standard deviation of 0.8. The correlation coefficient between the stock returns is 0.1. What is the standard deviation of a portfolio composed of 70 percent Aquaman and 30 percent Green Lantern?

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