Exam 5 - FINAN 450

an increase in price

A positive capital gain on a stock results from ___.

immediately

An efficient market is one in which any change in available information will be reflected in the company's stock price ___.

information

An efficient market is one that fully reflects all available ______.

less than

An investment will have a negative NPV when its expected return is _______ ________ what the financial markets offer for the same risk.

two different ways -- geometric average method& arithmetic average method

Average returns can be calculated:

smaller than

Geometric averages are usually ______ arithmetic averages.

quite low

Historically, the real return on Treasury bills has been:

all ; zero

In an efficient market ______ investments have a _____ NPV.

five

Roger Ibbotson and Rex Sinquefield presented year-to-year historical rates of return on ___ types of financial investments.

bell-shaped; symmetrical

Some important characteristics of the normal distribution are that it is:

information flow

Stock prices fluctuate from day to day because of:

market

Systematic risk is also called ______________ risk.

a portfolio's expected return

The calculation of a portfolio beta is similar to the calculation of:

capital gain yield

The percentage change in the price of a stock over a period of time is called its ___________.

variance

The square of the standard deviation is equal to the ____.

surprises

The true risk of any investment comes from _______________ .

it is a graphical depiction of the capital asset pricing model

What does the security market line depict?

true

true or false? Roger Ibbotson and Rex Sinquefield conducted a famous set of studies dealing with rates of return in U.S. financial markets.

ten

A dividend yield of 10% says that, for each dollar we invest, we get ___ cents in dividends.

the percentage of dollars invested in each asset

A portfolio can be described by its portfolio weights which are defined as _____________________.

risk-free rate of return

According to the capital asset pricing model (CAPM), what is the expected return on a security with a beta of zero?

risk premium

Additional compensation for taking risk, over and above the risk free rate

return

An unrealized gain is treated the same as a realized gain when computing the total ____.

small-company common stock large-company common stocks long-term corporate bonds long-term government bonds U.S. Treasury bills

Arrange the following investments from highest to lowest risk (standard deviation) based on what our study of capital market history from 1926-2014 has revealed as shown in Table 10.3:

U.S. Treasury Bills Long-term corporate bonds Large-company stocks Small-company stocks

Arrange the following investments starting from lowest historical risk premium to highest historical risk premium. Large-company stocks Small-company stocks U.S. Treasury Bills Long-term corporate bonds

it may eventually be almost totally eliminated; it is likely to decrease

As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?

systematic; an average risky asset

Beta tells us the amount of ________ risk of an asset or portfolio relative to ______.

1

By definition, what is the beta of the average asset equal to?

income

Dividends are the ______ component of the total return from investing in a stock.

systematic

Even if the portfolio is well diversified, the investor is still exposed to _____ risk.

there is no relationship; unsystematic risk is specifically only to a single company or industry. thus, one company's unsystematic risk will generally be unrelated to another company's systematic risk

How are the unsystematic risks of two different companies in two different industries related?

semi-strong form

If a study of a firm's financial information will not lead to gains in the market, then the market must be at least _____ efficient.

weak-form

If a study of past stock prices and volume to find mis-priced securities will not lead to gains in the market, then the market must be at least _____ efficient.

risk premium; systematic risk

If an asset has a reward-to-risk ratio of 6.0%, that means it has a __________ of 6.0% per unit of _______.

postitive

If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be:

7.5%

If the arithmetic average return is 10% and the variance of returns is 0.05, find the approximate geometric mean.

is highly risky

If the dispersion of returns on a particular security is very spread out from the security's mean return, the security ____.

an efficient market reaction

If the market changes and stock prices instantly and fully reflect new information, which time path does such a change exhibit?

the square root of the variance

If the standard deviation of a portfolio is __________?

$2 x 100 = $200

If you receive a $2 dividend per share on your 100 shares, your total dividend income is ____.

pessimistic

If you use a geometric average to project short-run wealth levels, your results will most likely be _______ .

optimistic

If you use an arithmetic average to project long-run wealth levels, your results will most likely be _______.

you must invest in stocks of more than one corporation

If you wish to create a portfolio of stocks, what is the required minimum number of stocks?

fair

In an efficient market, firms should expect to receive ______ value for securities they sell.

a larger

More volatility in returns produces ______ difference between the arithmetic and geometric averages.

apply to any amount invested; allow comparison against other investments

Percentage returns are more convenient than dollar returns because they:

not change

Systematic risk will ____ when securities are added to a portfolio.

beta

The CAPM can also be used for a portfolio by first determining the portfolio's ____.

the reward for bearing systematic risk the pure time value of money the amount of systematic risk

The CAPM shows that the expected return for an asset depends on which three things?

small-company stocks generated the highest average return T-bills, which had the lowest risk, generated the lowest return small-company stocks had the highest risk level

The Ibbotson SBBI data show that over the long-term, ___.

long term corporate bonds had less risk or variability than stocks U.S. T-bills had the lowest risk or variability

The Ibbotson-Sinquefield data shows that:

long-term corporate bonds had less risk or variability than stocks U.S. T-bills had the lowest risk or variability

The Ibbotson-Sinquefield data shows that:

expected

The ____ return on a portfolio is a combination of the expected returns on the assets in the portfolio.

excess

The ______ rate of return is the difference between the rate of return on a risky asset and the risk-free rate of return.

cost of capital

The appropriate discount rate to use to evaluate a new project is the _____.

return in an average year over a given period

The arithmetic average rate of return measures the ____.

12.1%

The arithmetic mean for large-company stock returns from 1926 to 2017 is:

compare stock returns with the returns on other securities

The average return on the stock market can be used to ___.

initial stock price

The capital gains yield can be found by finding the difference between the ending stock price and the initial stock price and dividing it by the:

1. calculate the expected return 2. calculate the deviation of each return from the expected return 3. square each deviation 4. calculate the average squared deviation

The computation of variance requires 4 steps. Place the steps in the correct order from the first step to the last step.

beginning stock price

The dividend yield for a one-year period is equal to the annual dividend amount divided by the ____.

well-organized

The efficient markets hypothesis contends that _____________ capital markets such as the NYSE are efficient.

risk-free

The excess return is the difference between the rate of return on a risky asset and the ______ rate.

compound

The geometric average ____ return is the average return earned per year over a multiyear period.

compounding

The geometric rate of return takes ______ into account.

cost of capital

The minimum required return on a new project is known as the:

mean ; variance or standard deviation

The normal distribution is completely described by the _______ and ________.

68

The probability of a return being within ± one standard deviation of the mean in a normal distribution is approximately ___ percent.

2.5% The probability of an outcome being within + or -2 standard deviations is 95% so the probability of being below 2 standard deviations = (100%-95%)/2 = 2.5%

The probability of an outcome being at least 2 standard deviations below the mean in a normal distribution is approximately:

Expected return

The return that an investor expected to earn on a risky asset in the future

premium

The risk ___ can be interpreted as the reward for bearing risk.

higher

The risk-return relationship states that a riskier investment should demand a ____________ return.

handsomely rewarded

The second lesson from studying capital market history is that risk is:

greater; greater ;; lower; lower

The second lesson from studying capital market history states that the _______ the potential reward, the _______ the risk

positive

The security market line (SML) shows that the relationship between a security's expected return and its beta is ______.

19.8%

The standard deviation for large-company stock returns from 1926 to 2017 is:

square root of the variance

The standard deviation is ___.

square root

The standard deviation is the ______ of the variance.

that are borne unnecessarily that are diversifiable

The systematic risk principle argues that the market does not reward risks:

capital gains or losses

The total dollar return is the sum of dividends and __________.

dividends ; capital gains

The total dollar return on a stock is the sum of the ____ and the _____.

dividend

The total return percentage is the ___ yield plus the capital gains yield.

unanticipated events & surprises

The true risk of any investment comes from:

dividends

The two potential ways to make money as a stockholder are through _______ and capital appreciation.

standard deviation

The variance and its square root, the ___ ___ , are the most commonly used measures of volatility.

the Security Market Line

To determine the appropriate required return for an investment, we can use _____________________.

mean

To get the average, or ___ return, the yearly returns are summed and then divided by the number of returns.

0.5% 3.5%-3.0%=0.5%

Treasury Bills yielded a nominal average return over 86 years of 3.5% versus an average inflation rate of 3.0% over the same period. This makes the real return on T-bills approximately equal to _____.

True

True or false: A capital gain on a stock is counted as part of the total return whether or not the gain is realized from selling the stock.

True

True or false: A capital loss is the same thing as a negative capital gain.

false; even if the portfolio is well diversified, the investor is still exposed to systematic risk

True or false: A well-diversified portfolio will eliminate all risks.

true

True or false: Adding securities will reduce unsystematic risk only. Systematic risk is unaffected by diversification.

false; more volatility in returns produces a greater difference between the arithmetic and geometric averages.

True or false: Arithmetic and geometric averages are useful because they are not influenced by volatility.

false

True or false: Because T-bills have low risk relative to common stocks, T-bills cannot outperform common stocks.

false ; it is the first step

True or false: Calculating the expected return is the last step in the computation of variance.

false; when a dollar in the future is discounted to the present it is worth less because of the time value of money, but when a news item is discounted, it means that the market already knew about most of the news item

True or false: Discounting a news item is the same as taking the present value of that item.

false; market risk and unsystematic risk are the two components of risky return in the total return equation

True or false: Expected return and inflation are the two components of risky return in the total return equation.

false; historical return data indicated that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio declines

True or false: Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio increases.

true; if enough securities are added, all the unsystematic risk of the securities in the portfolio should cancel one another out

True or false: It is possible for the unsystematic risk of a portfolio to be reduced almost to zero.

false; labor strikes are an example of unsystematic risk

True or false: Labor strikes are an example of systematic risk.

true

True or false: Labor strikes are an example of unsystematic risk.

false; percentage returns are better to use for comparisons versus dollar returns because percentage terms do not depend on the amount you invest

True or false: Percentage returns are difficult to use for comparisons because they depend on the dollar amount invested.

false ; it is the percentage of dollars invested in each asset

True or false: Portfolio weights can be defined as the dollars invested in each asset.

false; the CAPM can also be used for a portfolio by first determining the portfolio's beta

True or false: Since the CAPM equation can be used only for individual securities, it cannot be used with portfolios.

false; without any other information, you can use the average return from a time period as a "best guess" of the return in a given year from that same period.

True or false: The average return of a given period is typically not a good estimate of the returns over that same period.

False; Pt not Dt; (Pt+1 - Pt)/Pt

True or false: The capital gains yield = (Pt+1 - Pt)/Dt

true

True or false: The dividend yield = Dt+1/Pt

false; dividend yield plus the capital gains yield

True or false: The dividend yield minus the capital gains yield is the total return percentage.

true

True or false: The expected return is the return that an investor expects to earn on a risky asset in the future.

false; the expected return on a portfolio is a combination of the expected returns on the assets in the portfolio

True or false: The expected return of a portfolio is a combination of the weights of each asset in a portfolio.

false; the arithmetic average rate of return measures the return in an average year over a given period

True or false: The geometric average rate of return measures the return in an average year over a given period.

true

True or false: The normal distribution is completely described by the average and standard deviation.

true

True or false: The risk premium can be interpreted as a reward for bearing risk

false; the larger the variance of standard deviation is, the more spread out the returns will be.

True or false: The smaller the variance or standard deviation is, the more spread out the returns will be.

false; the standard deviation is the square root of the variance

True or false: The standard deviation is the variance squared.

false; the surprise is the news that influences the unanticipated return on the stock

True or false: The surprise part of any announcement is the information the market uses to form the expectation of the return on the stock.

false; to get the average return, the yearly returns are summed and then divided by the number of returns

True or false: To get the average return, the yearly returns are summed and then multiplied by the number of returns.

true

True or false: Unsystematic risk is specific only to a single company or industry.

a specific firm; firms in a single industry

Unsystematic risk will affect

small-company common stock

Using capital market history as a guide, it would appear the greatest reward would come from investing in _______.

unsystematic risk; market risk

What are the two components of risky return (U) in the total return equation?

Dividends & Capital Gains

What are ways to make money by investing in stocks?

it is the portion of return that depends on information that is currently unknown

What is an uncertain or risky return?

[E(RA) - Rf]/βA

What is the Reward-to-Risk Ratio?

zero

What is the beta of the risk-free asset?

13.6% 4% + 1.2(12% - 4%) = 13.6%

What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4 percent and the expected return on the market is 12 percent?

the risk-free rate

What is the intercept of the security market line (SML)?

the market-risk premium

What is the slope of the security market line (SML)?

W x $Y

What will the dividend income be on W number of shares of XYZ stock if XYZ distributes a $Y per share dividend?

cash

When a company declares a dividend, shareholders generally receive ____.

already knew about most of the news item

When a dollar in the future is discounted to the present it is worth less because of the time value of money, but when a news item is discounted, it means that the market:

investing $100,000 in a combination of stocks and bonds investing $100,000 in a combination of US and Asian stocks investing $100,000 in the stocks of 50 publicly traded corporations

Which of the following are examples of a portfolio?

the outcome of an application currently pending with the Food and Drug Administration The Fed's decision on interest rates at their meeting next week

Which of the following are examples of information that may impact the risky return of a stock?

regulatory changes in tax rates; future rates of inflation

Which of the following are examples of systematic risk?

changes in management; labor strikes

Which of the following are examples of unsystematic risk?

the standard deviation of returns the mean return

Which of the following are needed to describe the distribution of stock returns?

t-bills sometimes outperform common stocks common stocks frequently experience negative returns

Which of the following are true based on the year-to-year returns from 1926-2014?

variance is a measure of the squared deviations of a security's return from its expected return standard deviation is the square root of variance

Which of the following statements is (are) true about variance?

systematic or market risk

Which of the following types of risk is not reduced by diversification?

overreaction and correction

Which type of stock price adjustment time path occurs when there is a bubble (price run up) in the path followed by a decline after the market receives information about the stock?

95

With a normal distribution, the probability that we end up withing two standard deviations is about ___ percent.

company-specific diversifiable unsystematic

______ risk is reduced as more securities are added to the portfolio

systematic

____________ risk is the only risk important to the well diversified investor.

unsystematic risk

a risk that affects a single asset or a small group of assets

systemic risk

a risk that pertains to a large number of assets

total return = expected return + unexpected return

equation for total return