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
