Ch 5 Finance

4. A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year? A. 1.5% B. 10% C. 7% D. 3% E. None of the options are correct.

A. 5% - 3.5% = 1.5%.

45. You purchased a share of stock for $12. One year later, you received $0.25 as a dividend and sold the share for $12.92. What was your holding-period return? A. 9.75% B. 10.65% C. 11.75% D. 11.25% E. None of the options are correct.

A. ($0.25 + $12.92 - $12)/$12 = 0.0975, or 9.75%.

47. You purchased a share of stock for $65. One year later, you received $2.37 as a dividend and sold the share for $63. What was your holding-period return? A. 0.57% B. -0.2550% C. -0.89% D. 1.63% E. None of the options are correct.

A. ($2.37 + $63 - $65)/$65 = 0.00569, or 0.57%.

75. If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio's excess returns was 25%, the risk premium would be A. 8%. B. 16%. C. 37%. D. 21%. E. 29%.

A. 12 - 4 = 8%.

22. If a portfolio had a return of 18%, the risk-free asset return was 5%, and the standard deviation of the portfolio's excess returns was 34%, the risk premium would be A. 13%. B. 18%. C. 49%. D. 12%. E. 29%.

A. 18 - 5 = 13%.

39. A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 5.7%. What is your approximate annual real rate of return if the rate of inflation was 1.6% over the year? A. 4.1% B. 2.5% C. 2.9% D. 1.6%

A. 5.7% - 1.6% = 4.1%.

37. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 6%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year? A. 4% B. 2% C. 6% D. 3%

A. 6% - 2% = 4%.

3. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 9%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year? A. 5% B. 10% C. 7% D. 3%

A. 9% - 4% = 5%.

13. Ceteris paribus, a decrease in the demand for loans A. drives the interest rate down. B. drives the interest rate up. C. might not have any effect on interest rates. D. results from an increase in business prospects and a decrease in the level of savings.

A. A decrease in demand, ceteris paribus, always drives interest rates down. An increase in business prospects would increase the demand for funds. The savings level affects the supply of, not the demand for, funds.

61. Annual percentage rates (APRs) are computed using A. simple interest. B. compound interest. C. either simple interest or compound interest. D. best estimates of expected real costs. E. None of the options are correct.

A. APRs use simple interest.

32. An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980. What is the holding-period return on his investment? A. 1.02% B. 0.50% C. 1.92% D. 0.01%

A. HPR = ($15 + 980 - 985)/$985 = 0.010152284 = approximately 1.02%.

68. Kurtosis is a measure of A. how fat the tails of a distribution are. B. the downside risk of a distribution. C. the normality of a distribution. D. the dividend yield of the distribution.

A. Kurtosis is a measure of how fat the tails of a distribution are.

27. In words, the real rate of interest is approximately equal to A. the nominal rate minus the inflation rate. B. the inflation rate minus the nominal rate. C. the nominal rate times the inflation rate. D. the inflation rate divided by the nominal rate. E. the nominal rate plus the inflation rate.

A. The actual relationship is (1 + real rate) = (1 + nominal rate)/(1 + inflation rate). This can be approximated by the equation: Real rate = nominal rate inflation rate.

15. Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2015 show That A. stocks offered investors greater rates of return than bonds and bills. B. stock returns were less volatile than those of bonds and bills. C. bonds offered investors greater rates of return than stocks and bills. D. bills outperformed stocks and bonds. E. Treasury bills always offered a rate of return greater than inflation.

A. The historical data show that, as expected, stocks offer a greater return and greater volatility than the other investment alternatives. Inflation sometimes exceeded the T-bill return.

69. When a distribution is positively skewed, A. standard deviation overestimates risk. B. standard deviation correctly estimates risk. C. standard deviation underestimates risk. D. the tails are fatter than in a normal distribution.

A. When a distribution is positively skewed, standard deviation overestimates risk.

35. Over the past year, you earned a nominal rate of interest of 14% on your money. The inflation rate was 2% over the same period. The exact actual growth rate of your purchasing power was A. 11.76%. B. 16.00%. C. 15.02%. D. 14.32%.

A. r = (1 + R)/(1 + I) - 1; 1.14/1.02 - 1 = 11.76%.

7. You purchased a share of stock for $20. One year later, you received $1 as a dividend and sold the share for $29. What was your holding-period return? A. 45% B. 50% C. 5% D. 40% E. None of the options are correct.

B. ($1 + $29 - $20)/$20 = 0.5000, or 50%.

8. You purchased a share of stock for $68. One year later, you received $3.00 as a dividend and sold the share for $74.50. What was your holding-period return? A. 12.5% B. 14.0% C. 13.6% D. 11.8%

B. ($3.00 + $74.50 - $68.00)/$68.00 = 0.1397, or 14.0%.

63. If an investment provides a 1.25% return quarterly, its effective annual rate is A. 5.23%. B. 5.09%. C. 4.02%. D. 4.04%.

B. (1.0125)4 - 1 = 5.09%.

6. If the annual real rate of interest is 2.5%, and the expected inflation rate is 3.7%, the nominal rate of interest would be approximately A. 3.7%. B. 6.2%. C. 2.5%. D. -1.2%.

B. 2.5% + 3.7% = 6.2%.

40. A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 2.5%. What is your approximate annual real rate of return if the rate of inflation was 3.4% over the year? A. 0.9% B. 0.9% C. 5.9% D. 3.4%

B. 2.5% - 3.4% = 0.9%.

38. A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 3%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year? A. 1% B. -1% C. 7% D. 3%

B. 3% - 4% = -1%.

5. If the annual real rate of interest is 5%, and the expected inflation rate is 4%, the nominal rate of interest would be approximately A. 1%. B. 9%. C. 20%. D. 15%.

B. 5% + 4% = 9%.

28. If the Federal Reserve lowers the Fed Funds rate, ceteris paribus, the equilibrium levels of funds lent will __________, and the equilibrium level of real interest rates will ___________. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease E. reverse direction from their previous trends; reverse direction from their previous trends

B. A lower Fed Funds rate would encourage banks to make more loans, which would increase the money supply. The supply curve would shift to the right and the equilibrium level of funds would increase while the equilibrium interest rate would fall.

12. Other things equal, an increase in the government budget deficit A. drives the interest rate down. B. drives the interest rate up. C. might not have any effect on interest rates. D. increases business prospects.

B. An increase in the government budget deficit, other things equal, causes the government to increase its borrowing, which increases the demand for funds and drives interest rates up.

33. An investor purchased a bond 63 days ago for $980. He received $17 in interest and sold the bond for $987. What is the holding-period return on his investment? A. 1.52% B. 2.45% C. 1.92% D. 2.68%

B. HPR = ($17 + 987 - 980)/$980 = .0244898 = approximately 2.45%.

59. You purchase a share of CAT stock for $90. One year later, after receiving a dividend of $4, you sell the stock for $97. What was your holding-period return? A. 14.44% B. 12.22% C. 13.33% D. 5.56%

B. HPR = ([97 - 90] + 4)/90 = 12.22%.

14. The holding-period return (HPR) on a share of stock is equal to A. the capital gain yield during the period plus the inflation rate. B. the capital gain yield during the period plus the dividend yield. C. the current yield plus the dividend yield. D. the dividend yield plus the risk premium. E. the change in stock price.

B. The HPR of any investment is the sum of the capital gain and the cash flow over the period, which for common stock is B.

60. When comparing investments with different horizons, the ____________ provides the more accurate comparison. A. arithmetic average B. effective annual rate C. average annual return D. historical annual average

B. The effective annual rate provides the more accurate comparison of investments with different horizons because it expresses the returns in a common period.

10. Which of the following statement(s) is(are) true? I) The real rate of interest is determined by the supply and demand for funds. II) The real rate of interest is determined by the expected rate of inflation. III) The real rate of interest can be affected by actions of the Fed. IV) The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation. A. I and II only B. I and III only C. III and IV only D. II and III only E. I, II, III, and IV only

B. The expected rate of inflation is a determinant of nominal, not real, interest rates. Real rates are determined by the supply and demand for funds, which can be affected by the Fed.

78. The most common measure of loss associated with extremely negative returns is A. lower partial standard deviation. B. value at risk. C. expected shortfall. D. standard deviation.

B. The most common measure of loss associated with extremely negative returns is value at risk.

34. Over the past year, you earned a nominal rate of interest of 8% on your money. The inflation rate was 3.5% over the same period. The exact actual growth rate of your purchasing power was A. 15.55%. B. 4.35%. C. 5.02%. D. 4.81%. E. 15.04%.

B. r = (1 + R)/(1 + I) - 1; 1.08/1.035 - 1 = 4.35%.

73. If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio's excess returns was 25%, the Sharpe measure would be A. 0.12. B. 0.04. C. 0.32. D. 0.16. E. 0.25.

C. (12 - 4)/25 = 0.32.

41. A year ago, you invested $12,000 in an investment that produced a return of 18%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year? A. 18% B. 2% C. 16% D. 15%

C. 18% - 2% = 16%.

79. Practitioners often use a ________% VaR, meaning that ________% of returns will exceed the VaR, and ________% will be worse. A. 25; 75; 25 B. 75; 25; 75 C. 1; 99; 51 D. 95; 5; 95 E. 80; 80; 20

C. Practitioners often use a 1% VaR, meaning that 99% of returns will exceed the VaR, and 1% will be worse.

67. Skewness is a measure of A. how fat the tails of a distribution are. B. the downside risk of a distribution. C. the symmetry of a distribution. D. the dividend yield of the distribution. E. None of the options are correct.

C. Skewness is a measure of the normality of a distribution.

25. Which of the following factors would not be expected to affect the nominal interest rate? A. The supply of loans B. The demand for loans C. The coupon rate on previously issued government bonds D. The expected rate of inflation E. Government spending and borrowing

C. The nominal interest rate is affected by supply, demand, government actions, and inflation. Coupon rates on previously issued government bonds reflect historical interest rates but should not affect the current level of interest rates.

70. When a distribution is negatively skewed, A. standard deviation overestimates risk. B. standard deviation correctly estimates risk. C. standard deviation underestimates risk. D. the tails are fatter than in a normal distribution.

C. When a distribution is negatively skewed, standard deviation underestimates risk.

52. Over the past year, you earned a nominal rate of interest of 3.6% on your money. The inflation rate was 3.1% over the same period. The exact actual growth rate of your purchasing power was A. 3.6%. B. 3.1%. C. 0.48%. D. 6.7%.

C. r = (1 + R)/(1 + I) - 1; 1.036/1.031% - 1 = 0.484%.

2. Over the past year, you earned a nominal rate of interest of 8% on your money. The inflation rate was 4% over the same period. The exact actual growth rate of your purchasing power was A. 15.5%. B. 10.0%. C. 3.8%. D. 4.8%. E. 15.0%.

C. r = (1 + R)/(1 + I) - 1; 1.08%/1.04% - 1 = 3.8%.

36. Over the past year, you earned a nominal rate of interest of 12.5% on your money. The inflation rate was 2.6% over the same period. The exact actual growth rate of your purchasing power was A. 9.15%. B. 9.90%. C. 9.65%. D. 10.52%.

C. r = (1 + R)/(1 + I) - 1; 1.125/1.026 - 1 = 9.65%.

76. ________ is a risk measure that indicates vulnerability to extreme negative returns. A. Value at risk B. Lower partial standard deviation C. Standard deviation D. Value at risk and lower partial standard deviation E. None of the options are correct.

D Value at risk and lower partial standard deviation are risk measures that indicate vulnerability to extreme negative returns.

64. If an investment provides a 0.78% return monthly, its effective annual rate is A. 9.36%. B. 9.63%. C. 10.02%. D. 9.77%.

D. (1.0078)12 - 1 = 9.77%.

62. If an investment provides a 2% return semi-annually, its effective annual rate is A. 2%. B. 4%. C. 4.02%. D. 4.04%. E. None of the options are correct.

D. (1.02)2 - 1 = 4.04%.

66. If an investment provides a 2.1% return quarterly, its effective annual rate is A. 2.1%. B. 8.4%. C. 8.56%. D. 8.67%.

D. (1.021)4 - 1 = 8.67%.

65. If an investment provides a 3% return semi-annually, its effective annual rate is A. 3%. B. 6%. C. 6.06%. D. 6.09%.

D. (1.03)2 - 1 = 6.09%.

74. If a portfolio had a return of 15%, the risk-free asset return was 5%, and the standard deviation of the portfolio's excess returns was 30%, the Sharpe measure would be A. 0.20. B. 0.35. C. 0.45. D. 0.33. E. 0.25.

D. (15 - 5)/30 = 0.33.

54. If the annual real rate of interest is 3.5%, and the expected inflation rate is 3.5%, the nominal rate of interest would be approximately A. 0%. B. 3.5%. C. 12.25%. D. 7%.

D. 3.5% + 3.5% = 7%.

29. "Bracket Creep" happens when A. tax liabilities are based on real income and there is a negative inflation rate. B. tax liabilities are based on real income and there is a positive inflation rate. C. tax liabilities are based on nominal income and there is a negative inflation rate. D. tax liabilities are based on nominal income and there is a positive inflation rate. E. too many peculiar people make their way into the highest tax bracket.

D. A positive inflation rate typically leads to higher nominal income. Higher nominal income means people will have higher tax liabilities and in some cases will put them in higher tax brackets. This can happen even when real income has declined.

11. Which of the following statement(s) is(are) true? A. Inflation has no effect on the nominal rate of interest. B. The realized nominal rate of interest is always greater than the real rate of interest. C. Certificates of deposit offer a guaranteed real rate of interest. D. None of the options are true.

D. Expected inflation rates are a determinant of nominal interest rates. The realized nominal rate of interest would be negative if the difference between actual and anticipated inflation rates exceeded the real rate. The realized nominal rate of interest would be less than the real rate if the unexpected inflation were greater than the real rate of interest. Certificates of deposit contain a real rate based on an estimate of inflation that is not guaranteed.

23. You purchase a share of Boeing stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding-period return? A. 4.44% B. 2.22% C. 3.33% D. 5.56% E. None of the options are correct.

D. HPR = (92 - 90 + 3)/90 = 5.56%.

16. If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of inflation, A. borrowers gain and savers lose. B. savers gain and borrowers lose. C. both borrowers and savers lose. D. neither borrowers nor savers gain nor lose. E. both borrowers and savers gain.

D. If the described interest rate accurately reflects the rate of inflation, both borrowers and lenders are paying and receiving, respectively, the real rate of interest; thus, neither group gains.

21. The risk premium for common stocks A. cannot be zero, for investors would be unwilling to invest in common stocks. B. must always be positive, in theory. C. is negative, as common stocks are risky. D. cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in theory. E. cannot be zero, for investors would be unwilling to invest in common stocks and is negative, as common stocks are risky.

D. If the risk premium for common stocks were zero or negative, investors would be unwilling to accept the lower returns for the increased risk.

71. If a distribution has "fat tails," it exhibits A. positive skewness. B. negative skewness. C. a kurtosis of zero. D. kurtosis. E. positive skewness and kurtosis.

D. Kurtosis is a measure of the tails of a distribution, or "fat tails."

51. Which of the following measures of risk best highlights the potential loss from extreme negative returns? A. Standard deviation B. Variance C. Upper partial standard deviation D. Value at risk (VaR) E. None of the options are correct.

D. Only VaR measures potential loss from extreme negative returns.

9. Which of the following determine(s) the level of real interest rates? I) The supply of savings by households and business firms II) The demand for investment funds III) The government's net supply and/or demand for funds A. I only B. II only C. I and II only D. I, II, and III

D. The value of savings by households is the major supply of funds; the demand for investment funds is a portion of the total demand for funds; the government's position can be one of either net supplier or net demander of funds. The above factors constitute the total supply and demand for funds, which determine real interest rates.

80. When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the A. most realistic, as it is the most complete measure of risk. B. most pessimistic, as it is the most complete measure of risk. C. most optimistic, as it is the most complete measure of risk. D. most optimistic, as it takes the highest return (smallest loss) of all the cases.

D. When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the most optimistic as it takes the highest return (smallest loss) of all the cases.

1. Over the past year, you earned a nominal rate of interest of 10% on your money. The inflation rate was 5% over the same period. The exact actual growth rate of your purchasing power was A. 15.5%. B. 10.0%. C. 5.0%. D. 4.8%. E. 15.0%.

D. r = (1 + R)/(1 + I) -1; 1.10%/1.05% - 1 = 4.8%.

46. You purchased a share of stock for $120. One year later, you received $1.82 as a dividend and sold the share for $136. What was your holding-period return? A. 15.67% B. 22.12% C. 18.85% D. 13.24% E. None of the options are correct.

E. ($1.82 + $136 - $120)/$120 = 0.1485, or 14.85%.

55. You purchased a share of CSCO stock for $20. One year later, you received $2 as a dividend and sold the share for $31. What was your holding-period return? A. 45% B. 50% C. 60% D. 40% E. None of the options are correct.

E. ($2 + $31 - $20)/$20 = 0.65, or 65%.

72. If a portfolio had a return of 8%, the risk-free asset return was 3%, and the standard deviation of the portfolio's excess returns was 20%, the Sharpe measure would be A. 0.08. B. 0.03. C. 0.20. D. 0.11. E. 0.25.

E. (8 - 3)/20 = 0.25.

26. If a portfolio had a return of 11%, the risk-free asset return was 6%, and the standard deviation of the portfolio's excess returns was 25%, the risk premium would be A. 14%. B. 6%. C. 35%. D. 21%. E. 5%.

E. 11 - 6 = 5%.

43. If the annual real rate of interest is 2.5%, and the expected inflation rate is 3.4%, the nominal rate of interest would be approximately A. 4.9%. B. 0.9%. C. -0.9%. D. 7%. E. None of the options are correct.

E. 2.5% + 3.4% = 5.9%.

42. If the annual real rate of interest is 3.5%, and the expected inflation rate is 2.5%, the nominal rate of interest would be approximately A. 3.5%. B. 2.5%. C. 1%. D. 6.8%. E. None of the options are correct.

E. 3.5% + 2.5% = 6%.

44. If the annual real rate of interest is 4%, and the expected inflation rate is 3%, the nominal rate of interest would be approximately A. 4%. B. 3%. C. 1%. D. 5%. E. None of the options are correct.

E. 4% + 3% = 7%.

53. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 4.3%. What is your approximate annual real rate of return if the rate of inflation was 3% over the year? A. 4.3% B. -1.3% C. 7.3% D. 3% E. None of the options.

E. 4.3% - 3% = 1.3%.

77. ________ is a risk measure that indicates vulnerability to extreme negative returns. A. Value at risk B. Lower partial standard deviation C. Expected shortfall D. None of the options E. None of the options are correct.

E. All of the options are risk measures that indicate vulnerability to extreme negative returns.

30. The holding-period return (HPR) for a stock is equal to A. the real yield minus the inflation rate. B. the nominal yield minus the real yield. C. the capital gains yield minus the tax rate. D. the capital gains yield minus the dividend yield. E. the dividend yield plus the capital gains yield.

E. HPR consists of an income component and a price change component. The income component on a stock is the dividend yield. The price change component is the capital gains yield.

20. If the nominal return is constant, the after-tax real rate of return A. declines as the inflation rate increases. B. increases as the inflation rate increases. C. declines as the inflation rate declines. D. increases as the inflation rate decreases. E. declines as the inflation rate increases and increases as the inflation rate decreases.

E. Inflation rates have an inverse effect on after-tax real rates of return.

81. When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside exposure would be A. expected shortfall. B. value at risk. C. conditional tail expectation. D. expected shortfall and value at risk. E. expected shortfall and conditional tail expectation.

E. When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside exposure would be expected shortfall (or conditional tail expectation).