Chp 7 Finance MC
Use the following table to calculate the expected return for the asset. Return: .05, .1, .15, .25 Probability: .1, .15, .5, .25
15.75% (0.5)(0.1) + (0.1)(0.15) + (0.15)(0.5) + (0.25)(0.25) = 0.1575
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?
$80 $50(0.4) + $100 (0.6) = $80
George Wilson purchased Bright Light Industries common stock for $47.50 on January 31, 2010. The firm paid dividends of $1.10 during the last 12 months. George sold the stock today (January 30, 2011) for $54.00. What is George's holding period return?
16.00% Total Return (R) = (P1-P0+CF1)/P0 = (54-47.50+1.10)/47.50 = 16%
Use the following table to calculate the expected return for the asset. Return .1, .2, .25 Probability .25, .5, .25
18.75% (0.1)(0.25) + (0.2)(0.5) + (0.25)(0.25) = 0.1875
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?
19.20% Expected Return of Elsenore = risk-free rate + Beta(Expected Return on the market - risk free rate) = .08+1.6(.15-.08) = .192
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.?
37.80% Expected Return of RicciCo = risk-free rate + Beta(Expected Return on the market - risk free rate) = .09+3.2(.18-.09) = .378
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. Round your answer to the nearest percent.
38% Total rate of return = ($18-$13)/$13 = 38.46% or 38% (rounded).
The expected return on KarolCo. stock is 16.5 percent. If the risk-free rate is 5 percent and the beta of KarolCo is 2.3, then what is the risk premium on the market?
5.0% Expected Return of KarolCo (ER) = risk-free rate (Rf) + Beta (b)x[Expected Return on the market (ERM)- risk free rate (Rf)]. Risk premium = (ERM - Rf) and (ERM - Rf) = (ER - Rf)/b = (.165-.05)/2.3 = .05
James Burton 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 James from owning the stock? (Round your answer to the nearest whole percent.)
50% Total Return = (65-45+2.50)/45 = 50%
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.)
6% Income rate of return = 1.50/25 = .06
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 Mike's Seafood is 1.7, then what is the risk-free rate?
6.0% ANSWER: Expected Return of Mike's seafood (ER) = risk-free rate (Rf) + Beta (b)x[Expected Return on the market (ERM)- risk free rate (Rf)]. ER = Rf + b x (ERM - Rf) and .179 = Rf + 1.7(.13-Rf) and .179 = 1Rf + (1.7)(.13) - 1.7Rf and .179 = -.7Rf + .221 and Rf =(0.221-0.179 )/(0.7)= .06
L-3 Communications Holdings has a beta of 2. and the expected market return is 0.06. In addition, Treasury bills (risk-free asset) are currently yielding 0.06. Find the expected return for L-3 Communications Holdings.
6.00% Use CAPM where the cost of equity capital = Risk-free rate + Beta*(Market rate - Risk free rate) => the cost of equity capital for L-3 Communications Holdings = 0.06 + 2.*(0.06 - .06) = .06
What is the standard deviation given the following information? Probability: 35%, 30%, 35% Possible Returns: 15%, 30%, 12%
7.7% First find Expected Return = (0.35)*(0.15)+(0.3)*(0.3)+ (0.35)*(0.12) = 0.1845. Then, find Standard Deviation = SQRT[(0.35)*(0.15-0.1845)^2+(0.3)*(0.3-0.1845)^2+ (0.35)*(0.12-0.1845)^2] = .0766 where SQRT means square root.
Which of the following statements is correct?
A beta of 1 tells us that an asset has just as much systematic risk as the market.
The expected return for a portfolio without borrowing
Correct Answer all of the above. should never be greater than the expected return of the asset with highest expected return. may not be an event with even a positive probability of occurrence. should never be less than the expected return of the asset with lowest expected return.
Which of the following statements is correct?
If an asset's price implies that the expected return is greater than that predicted by the CAPM, that asset will plot above the Security Market Line.
Which of the following statement is incorrect?
If two investments have the same expected return, investors prefer the riskiest alternative.
Which of the following statement is incorrect?
If you are building a portfolio, then you desire those assets to have a correlation coefficient of one.
Given the historical information in the chapter, which of the following investment classes had the greatest variability in returns?
Small U.S. Stocks
Which of the following statements is correct?
The best measure of assessing systematic risk within an investment is its beta.
Which of the following statement is incorrect?
The normal distribution is a skewed distribution that is completely described by its correlation coefficient and coefficient of variation.
If you were to compare the returns of an individual stock to a market index, select the answer below that is most true.
The returns of the individual stock will show more variability than those of the market index.
Which of the following represents a plot of the relation between expected return and systemic risk?
The security market line.
Which of the following statements is correct?
The standard deviation is a measure of total risk.
Which of the following statements is correct?
The variance of a distribution cannot be a negative value.
Cummins Inc has a beta of 2.67 and the expected market return is 0.2. In addition, Treasury bills (risk-free asset) are currently yielding 0.05. Find the expected return for Cummins Inc.
Use CAPM where the cost of equity capital = Risk-free rate + Beta*(Market rate - Risk-free rate) and, the cost of equity capital for Cummins Inc = 0.05 + 2.67*(0.2 - .05) = .45
Which of the following statement is incorrect?
With complete diversification, all of the systematic risk is eliminated from the portfolio.
Which of the following is the best measure of the systematic risk in a portfolio?
beta
A portfolio with a level of systematic risk the same as that of the market has a beta that is
equal to one.
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?
-$10 $50(0.4) - $50 (0.6) = -$10
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 coefficient of variation for the stock?
0.000625 CV = Standard Deviation/Expected return and Standard deviation = (CV)(Expected Return) = (.125)(.20) = 0.025. Further, Variance = (Standard Deviation)^2 = (0.025)^2 = .000625
The expected return for the asset below is 18.75 percent. If the return distribution for the asset is described as in the following table, what is the variance for the asset's returns? Returns Probability .1 .25 .2 .5 .25 .25
0.002969 (0.1)(0.25 - 0.1875)2 + (0.2)(0.5 - 0.1875) 2 + (0.25)(0.25 - 0.1875)^2 = 0.002969
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 .13 .3 OK .2 .4 Great .25 .3
0.0467 E(R) = (.30)(.13)+(.40)(.20)+(.30)(.25) = .194 and Standard Deviation = [.30(.13-.194)^2+.40(.20-.194)^2+.3(.25-.194)^2]^(1/2) = .046733 where ^(1/2) represents the square root.
The expected return for the asset shown in the following table is 18.75 percent. If the return distribution for the asset is described as below, what is the standard deviation for the asset's returns? Return: .1, .2, .25 Probability: .25, .5, .25
0.054486 [(0.25)(0.10 - 0.1875)^2 + (0.5)(0.2 - 0.1875)^2 + (0.25)(0.25 - 0.1875)^2]^(1/2) = 0.054486 where ^(1/2) represents the square root.
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 standard deviation of the return distribution for Elrond's investment. State Return Probability Weak .10 .8 OK .17 .1 Great .28 .1
0.0557 E(R) = (.80)(.10)+(.10)(.17)+(.10)(.28) = .125 and Standard Deviation = [.80(.10-.125)^2+.10(.17-125)^2+.1(.28-.125)^2]^(1/2) = .05573 where ^(1/2) represents the square root.
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?
0.5556 Coefficient of Variation (CV) = Standard Deviation/Expected Return = [(.0025)^(1/2)]/.09 = .5556 where ^(1/2) represents the square root.
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?
13.80% Expected Return of Lenz = risk-free rate + Beta(Expected Return on the market - risk free rate) = .03+1.8(.06) = .138 where the expected return on the market must have been .09. Why? Because market risk premium = the expected return on the market - risk free rate = .09 - .03 = .06
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?
2.10 Expected Return of Kiwi = risk-free rate + Beta(Expected Return on the market - risk free rate) and further Beta = (Expected Return of Kiwi - risk free rate)/(the expected Return on the market - risk free rate) = (.166 - .04)/(.10-.04) = 2.10
What is Principal Financial Group's coefficient of variation (CV) of possible returns given that the expected return is .17 and variance is .245717?
2.9159 Remember that CV = Standard Deviation / Expected Return and therefore the square root of variance (standard deviation) is SQRT(.2457) = .4957 and CV = .4957 / .17 = 2.9159
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.)
20% Capital Appreciation Return = Capital gain (loss) = (24-20)/20=0.20
