FIN 3302 Chapter 06 Study Guide
The portfolio beta is simply the sum of the betas of the individual stocks in the portfolio. TRUE or FALSE
FALSE Page: 208
Portfolio performance is determined mainly by stock selection and market timing, with less emphasis on asset allocation. TRUE or FALSE
FALSE Page: 209
Small company stocks have historically had higher average annual returns than large company stocks, and also a higher risk premium. TRUE or FALSE
TRUE Page: 199
A well-diversified portfolio typically has systematic risk equal to about 40% of the portfolio's total risk. TRUE or FALSE
TRUE Page: 200
Company unique risk can be virtually eliminated with a portfolio consisting of approximately 20 securities. TRUE or FALSE
TRUE Page: 200
The benefits of diversification occur as long as the investments in a portfolio are not perfectly positively correlated. TRUE or FALSE
TRUE Page: 200
The relevant risk to an investor is that portion of the variability of returns that cannot be diversified away. TRUE or FALSE
TRUE Page: 200
A security with a beta of one has a required rate of return equal to the overall market rate of return. TRUE or FALSE
TRUE Page: 203
A stock with a beta of 1 has systematic or market risk equal to the "typical" stock in the marketplace. TRUE or FALSE
TRUE Page: 203
A stock with a beta of 1.4 has 40% more variability in returns than the average stock. TRUE or FALSE
TRUE Page: 203
Beta is a measurement of the relationship between a security's returns and the general market's returns. TRUE or FALSE
TRUE Page: 203
Beta represents the average movement of a company's stock returns in response to a movement in the market's returns. TRUE or FALSE
TRUE Page: 203
The beta of a T-bill is zero. TRUE or FALSE
TRUE Page: 203
The slope of the characteristic line of a security is that security's beta. TRUE or FALSE
TRUE Page: 203
Diversifying among different kinds of assets is called asset allocation. TRUE or FALSE
TRUE Page: 209
An all-stock portfolio is more risky than a portfolio consisting of all bonds. TRUE or FALSE
TRUE Page: 209-211
a year end value of $48
000 with a 45% probability
The beta of a T-bill is one. TRUE or FALSE
FALSE Page: 203
Total risk equals systematic risk plus unsystematic risk. TRUE or FALSE
TRUE Page: 200
Proper diversification generally results in the elimination of risk. TRUE or FALSE
FALSE Page: 200
41) Assume that you expect to hold a $40
000 investment for one year. It is forecasted to have a year end value of $42,000 with a 30% probability
and a year end value of $60
000 with a 25% probability. What is the expected holding period return for this investment? A) 50% B) 25% C) 23% D) 18%, C) 23% Page: 201
Negative historical returns are not possible during periods of high volatility (high standard deviations of returns) due to the risk-return trade-off. TRUE or FALSE
FALSE Page: 199
Assume that an investment is forecasted to produce the following returns: a 10% probability of a $1,400 return; a 50% probability of a $6,600 return; and a 40% probability of a $1,500 return. What is the expected amount of return this investment will produce? A) $4,040 B) $7,640 C) $12140 D) $1,540,
A) $4,040 (10% × 1,400) + (50% × 6,600) + (40% × 1,500) = 4,040 Page: 189
Wendy purchased 800 shares of Genetics Stock at $3 per share on 1/1/12. Wendy sold the shares on 12/31/12 for $3.45. Genetics stock has a beta of 1.9, the risk-free rate of return is 4%, and the market risk premium is 9%. Wendy's holding period return is A) 15.0%. B) 16.5%. C) 17.6%. D) 21.1%.
A) 15.0%. Page: 201
You hold a portfolio with the following securities: Security Value Beta Expected Return Driscol Corporation 20% 3.20 36.0% Evening Corporation 40% 1.60 20.0% Frolic Corporation 40% .20 6.0% What is the expected return for the portfolio? A) 17.60% B) 20.67% C) 23.54% D) 28.59%
A) 17.60% Page: 208
You are considering investing in a project with the following possible outcomes: States------------------- Probability Investment Returns ------------------------of Occurrence State 1: Economic boom---- 18%------------ 20% State 2: Economic growth-- 42%------------ 16% State 3: Economic decline-- 30%------------ 3% State 4: Depression--------- 10%----------- (-25%) Calculate the expected rate of return and standard deviation of returns for this investment, respectively. A) 8.72%, 12.99% B) 7.35%, 12.99% C) 3.50%, 1.69% D) 2.18%, 1.69%
A) 8.72%, 12.99% Exp. Return = (18% × 20%) + (42% × 16%) + (30% × 3%) + (10% × −25%) = 8.72% Deviation = (18%)(20% − 8.72%)^2 + (42%)(16 - 8.72%)^2 + (30%)(3% − 8.72%)^2 + (10%)(−25% − 8.72%)^2 = 12.99% Standard Deviation = √1.69%=12.99% Page: 194-198
Stock A has the following returns for various states of the economy: State of the Economy Probability Stock A's Return Recession 9% -72% Below Average 16% -15% Average 51% 16% Above Average 14% 35% Boom 10% 85% Stock A's expected return is A) 9.9%. B) 12.7%. C) 13.8%. D) 16.5%.
B) 12.7%. Exp. Return = (9% × −72%) + (16% × −15%) + (51% × 16%) + (14% × 35%) + (10% × 85%) = 12.7% Page: 189
Assume that you have $330,000 invested in a stock that is returning 11.50%, $170,000 invested in a stock that is returning 22.75%, and $470,000 invested in a stock that is returning 10.25%. What is the expected return of your portfolio? A) 15.6% B) 12.9% C) 18.3% D) 14.8%
B) 12.9% 330,000 + 170,000 + 470,000 = 970,000 (330,000 ÷ 970,000 × 11.5%) + (170,000 ÷ 970,000 × 22.75%) + (470,000 ÷ 970,000 × 10.25%) = 12.9% Page: 194-198
A well-diversified portfolio includes investments in 50 securities. The portfolio's systematic risk is likely to be about A) 50% of the total risk. B) 40% of the total risk. C) 25% of the total risk. D) zero because risk is eliminated with a portfolio of 50 securities or more.
B) 40% of the total risk. Page: 200
Which of the following statements is MOST correct concerning diversification and risk? A) Diversification is mainly achieved by the selection of individual securities for each type of asset held in a portfolio. B) Diversification is mainly achieved by the asset allocation decision, not the selection of individual securities within each asset category. C) Large company stocks and small company stocks together in a portfolio lead to dramatic reductions in risk because their returns are negatively correlated. D) Asset allocation is important for pension funds but not for individual investors.
B) Diversification is mainly achieved by the asset allocation decision, not the selection of individual securities within each asset category. Page: 200
Which of the following investments is clearly preferred to the others for an investor who is not holding a well-diversified portfolio? Investment - k̄ ---- σ A -----------18% - -20% B------------20% - -20% C------------20% - -22% A) Investment A B) Investment B C) Investment C D) Cannot be determined without information regarding the risk-free rate of return.
B) Investment B Investment B the expected return is the same as the standard deviation Page: 195
You must add one of two investments to an already well- diversified portfolio. Security A Expected Return = 14% Standard Deviation of Returns = 15.8% Beta = 1.8 Security B Expected Return = 14% Standard Deviation of Returns = 19.7% Beta = 1.5 If you are a risk-averse investor, which one is the better choice? A) Security A B) Security B C) Either security would be acceptable. D) Cannot be determined with information given
B) Security B Page: 194-198
15) You are thinking of adding one of two investments to an already well- diversified portfolio. Security A Expected Return = 14% Standard Deviation of Returns = 16% Beta = 1.2 Security B Expected Return = 16% Standard Deviation of Returns = 20% Beta = 1.2 If you are a risk-averse investor, which one is the better choice? A) Security A B) Security B C) Either security would be acceptable because they have the same beta. D) Security B, but only if Security B's required return is greater than 12%.
B) Security B Security B has a higher expected return and the same risk level of 1.2 A = 14% ÷ 16% = 88% B = 16% ÷ 20% = 80% Page: 195
If you were to use the standard deviation as a measure of investment risk, which of the following has historically been the least risky investment? A) common stock of large firms B) U.S. Treasury bills C) common stock of small firms D) long-term government bonds
B) U.S. Treasury bills Page: 199
The category of securities with the highest historical risk premium is A) large company stocks. B) small company stocks. C) government bonds. D) small company corporate bonds.
B) small company stocks. Page: 199
A stock's beta is a measure of its A) unsystematic risk. B) systematic risk. C) company-unique risk. D) diversifiable risk.
B) systematic risk. Page: 203
Most stocks have betas between A) -1.00 and 1.00. B) 0.00 and 1.00. C) 0.60 and 1.60. D) 1.00 and 2.00.
C) 0.60 and 1.60. Page: 204
If you hold a portfolio made up of the following stocks: Investment Value Beta Stock X $4,000 1.5 Stock Y $5,000 1.0 Stock Z $1,000 .5 What is the beta of the portfolio? A) 1.33 B) 1.24 C) 1.15 D) 1.00
C) 1.15 Page: 208
Assume that you expect to hold a $20,000 investment for one year. It is forecasted to have a year end value of $21,000 with a 30% probability; a year end value of $24,000 with a 45% probability; and a year end value of $30,000 with a 25% probability. What is the standard deviation of the holding period return for this investment? A) 12.06% B) 14.36% C) 16.84% D) 33.45%
C) 16.84% Page: 194-198
Stock W has the following returns for various states of the economy: State of the Economy Probability Stock W's Return Recession 10% -30% Below Average 20% -2% Average 40% 10% Above Average 20% 18% Boom 10% 40% Stock W's standard deviation of returns is A) 10%. B) 14%. C) 17%. D) 20%
C) 17%. Exp. Return = (10% × −30%) + (20% × −2%) + (40% × 10%) + (20% × 18%) + (10% × 40%) = 8.2% Deviation = (10%)(−30% − 8.2%)^2 + (20%)(−2% − 8.2%)^2 + (40%)(10% − 8.2%)^2 + (20%)(18% − 8.2%)^2 + (10%)(40% − 8.2%)^2 = 3% Standard Deviation = √3%=17% Page: 194-198
The prices for the National Gasworks Corporation for the second quarter of 2012 are given below. The price of the stock on April 1, 2012 was $130. Find the holding period return for an investor who purchased the stock on April 1, 2012 and sold it the last day of June 2012. Month End Price April $125.00 May 138.50 June 132.75 A) -4.2% B) -3.7% C) 2.1% D) 3.7%
C) 2.1% Page: 201
Assume that an investment is forecasted to produce the following returns: a 20% probability of a 12% return; a 50% probability of a 16% return; and a 30% probability of a 19% return. What is the standard deviation of return for this investment? A) 5.89% B) 16.1% C) 2.43% D) 15.7%
C) 2.43% Exp. Return = (20% × 12%) + (50% × 16%) + (30% × 19) = 16% Deviation = (20%)(12% − 16%)^2 + (50%)(16% - 16%)^2 + (30%)(19% − 16%)^2 = 0.06% Standard Deviation = √0.06%=2.43% Page: 194-198
Stock W has the following returns for various states of the economy: State of the Economy Probability Stock W's Return Recession 9% -72% Below Average 16% -15% Average 51% 16% Above Average 14% 35% Boom 10% 85% Stock W's standard deviation of returns is A) 12%. B) 29%. C) 37%. D) 43%.
C) 37%. Exp. Return = (9% × −72%) + (16% × −15%) + (51% × 16%) + (14% × 35%) + (10% × 85%) = 12.7% Deviation = (9%)(−72% − 12.7%)^2 + (16%)(−15 - 12.7%)^2 + (51%)(16% − 12.7%)^2 + (14%)(35% − 12.7%)^2 + (10%)(85% − 12.7%)^2 = 14% Standard Deviation = √14%=37% Page: 194-198
Stock A has the following returns for various states of the economy: State of the Economy Probability Stock A's Return Recession 10% -30% Below Average 20% -2% Average 40% 10% Above Average 20% 18% Boom 10% 40% Stock A's expected return is A) 5.4%. B) 7.2%. C) 8.2%. D) 9.6%
C) 8.2%. Exp. Return = (10% × −30%) + (20% × −2%) + (40% × 10%) + (20% × 18%) + (10% × 40%) = 8.2% Page: 189
slope of the characteristic line
C) beta
An investor currently holds the following portfolio: Amount Invested - 8,000 shares of Stock A $16,000 Beta = 1.3 15,000 shares of Stock B $48,000 Beta = 1.8 25,000 shares of Stock C $96,000 Beta = 2.2 The investor is worried that the beta of his portfolio is too high, so he wants to sell some stock C and add stock D, which has a beta of 1.0, to his portfolio. If the investor wants his portfolio to have a beta of 1.72, how much stock C must he replace with stock D? A) $18,000 B) $24,000 C) $31,000 D) $36,000
D) $36,000 Page: 208
Assume that an investment is forecasted to produce the following returns: a 30% probability of a 12% return; a 50% probability of a 16% return; and a 20% probability of a 19% return. What is the expected percentage return this investment will produce? A) 33.3% B) 16.1% C) 9.5% D) 15.4%
D) 15.4% (30% × 12%) + (50% × 16%) + (20% × 19%) = 15.4% Page: 189
Assume that you have $100,000 invested in a stock that is returning 14%, $150,000 invested in a stock that is returning 18%, and $200,000 invested in a stock that is returning 15%. What is the expected return of your portfolio? A) 13.25% B) 14.97% C) 15.67% D) 15.78%
D) 15.78% 100,000 + 150,000 + 200,000 = 450,000 (100,000 ÷ 450,000 × 14%) + (150,000 ÷ 450,000 × 18%) + (200,000 ÷ 450,000 × 15%) = 15.78% Page: 194-198
Which of the following investments is clearly preferred to the others for a risk-averse investor? Investment --- k̄ ------- σ -----A -------- 14%----- 2% -----B -------- 22% ---- 20% -----C -------- 18% ---- 16% A) Investment A B) Investment B C) Investment C D) Cannot be determined without additional information
D) Cannot be determined without additional information Page: 195
You are considering investing in Ford Motor Company. Which of the following are examples of diversifiable risk? I. Risk resulting from possibility of a stock market crash. II. Risk resulting from uncertainty regarding a possible strike against Ford. III. Risk resulting from an expensive recall of a Ford product. IV. Risk resulting from interest rates decreasing. A) I only B) I and IV C) I, II, III, IV D) II, III
D) II, III II. Risk resulting from uncertainty regarding a possible strike against Ford. III. Risk resulting from an expensive recall of a Ford product. Page: 200
Of the following, which differs in meaning from the other three? A) systematic risk B) market risk C) undiversifiable risk D) asset-unique risk
D) asset-unique risk Page: 200
Stock W has an expected return of 12% with a standard deviation of 8%. If returns are normally distributed, then approximately two-thirds of the time the return on stock W will be A) between 12% and 20%. B) between 8% and 12%. C) between -4% and 28%. D) between 4% and 20%.
D) between 4% and 20%. 12% ± 8% 12% − 8% = 4% 12% + 8% = 20% Page: 195
Investment A has an expected return of 14% with a standard deviation of 4%, while investment B has an expected return of 20% with a standard deviation of 9%. Therefore, A) a risk averse investor will definitely select investment A because the standard deviation is lower. B) a rational investor will pick investment B because the return adjusted for risk (20% - 9%) is higher than the return adjusted for risk for investment A ($14% - 4%). C) it is irrational for a risk-averse investor to select investment B because its standard deviation is more than twice as big as investment A's, but the return is not twice as big. D) rational investors could pick either A or B, depending on their level of risk aversion.
D) rational investors could pick either A or B, depending on their level of risk aversion. Page: 195
Beta is a statistical measure of A) unsystematic risk. B) total risk. C) the standard deviation. D) the relationship between an investment's returns and the market return.
D) the relationship between an investment's returns and the market return. Page: 203
Beginning with an investment in one company's securities, as we add securities of other companies to our portfolio, which type of risk declines? A) systematic risk B) market risk C) non-diversifiable risk D) unsystematic risk
D) unsystematic risk Page: 200
24) Bay LandInc. has the following distribution of returns: State -------Return ------ Probability Boom -------- 0 ------------- 0.30 Normal ----- 0.15 ------------ 0.40 Bust --------- 0.3 ------------ 0.30 Assuming that these returns are normally distributed, what is the probability that Bay Land, Inc. will return less than 3.38%? Show all work, and clearly explain and state your answer.
Exp. Return = (0 × .30) + (0.15 × .40) + (.30 × .30) = .15 std. Dev. = [(0 - .15)2(0.3) + (.15 - .15)^2(0.4) + (.30 - .15)2(0.3)]1/2 = 0.1162 = 11.62% Because 2/3 of the returns fall within one standard deviation of the mean (for a normal probability distribution), 1/3 do not. One-half of that one third (or 1/6) falls in the tail below one standard deviation below the mean (below 15% - 11.62% = 3.38%), thus the answer is 1/6, or 16.7%. Note, some students may have learned 68% fall within one standard deviation of the mean. Page: 194-198
Accounting profits is the most relevant variable the financial manager uses to measure returns. TRUE or FALSE
FALSE Page: 188
You are given the following probability distribution for XYZ common stock's returns during the next year, which are assumed to be normally distributed. Show all work below, and complete the following: Return Probability 12% 20% 16% 60% 20% 20% a. Calculate the standard deviation of the returns, and round to the nearest one-half percent. b. Draw a graphical representation of XYZ's normal distribution below (ye old bell-shaped curve). LABEL THE AXES OF THE GRAPH OR THE FOLLOWING RESULTS WILL BE MEANINGLESS. Using your result in part A for the standard deviation (rounded to the nearest one-half percent) explain and indicate on the graph, the probability that XYZ will return more than 13.5%, assuming a normal distribution.
GRAPH: a. Calculate the standard deviation of the returns, and round to the nearest one-half percent. a. Exp. Return = (.12 × .2) + (.16 × .6) + (.2 × .2) = .16 Std. Dev. = [(.12 - .16)2(0.2) + (.16 - .16)2(0.6) + (.20 - .16)2(0.2)]1/2 = .0253 = 2.53% rounded to 2.5% b. Draw a graphical representation of XYZ's normal distribution below (ye old bell-shaped curve). LABEL THE AXES OF THE GRAPH OR THE FOLLOWING RESULTS WILL BE MEANINGLESS. Using your result in part A for the standard deviation (rounded to the nearest one-half percent) explain and indicate on the graph, the probability that XYZ will return more than 13.5%, assuming a normal distribution. b. The graph should have probability as the vertical axis and return (outcome, value of the variable, etc.) as the horizontal axis. It should be bell-shaped and centered at the 16% mean. 13.5% is one standard deviation below the mean. The text indicates that 2/3 of outcomes fall within one standard deviation of the mean for a normal probability distribution, so 2/3 of outcomes fall within 13.5% and 18.5%. Since one-half of the remaining 1/3 would be in the upper tail more than one standard deviation above the mean, 1/6 would fall above 16% + 2.5% = 18.5%. Thus, 2/3 + 1/6 = 5/6, or roughly 83% lie above 13.5%. Note, some students may have learned 68% fall within one standard deviation of the mean. Page: 194-198
How is risk defined?
Risk means different things to different people, depending on the context and on how they feel about taking chances. While certainly acknowledging these different kinds of risk, we limit our attention to the risk inherent in an investment. In this context, risk is the potential variability in future cash flows. The wider the range of possible events that can occur, the greater the risk. Page: 191, 192
The realized rate of return, or holding period return, is equal to the holding period dollar gain divided by the price at the beginning of the period. TRUE or FALSE
TRUE Page: 188
The expected rate of return from an investment is equal to the expected cash flows divided by the initial investment. TRUE or FALSE
TRUE Page: 189
Variation in the rate of return of an investment is a measure of the riskiness of that investment. TRUE or FALSE
TRUE Page: 191, 192
Unique security risk can be eliminated from an investor's portfolio through diversification. TRUE or FALSE
TRUE Page: 200
You are considering a security with the following possible rates of return: Probability ---- Return (%) --- 0.15 ----------- 9.5 --- 0.25 ---------- 13.6 --- 0.50 ---------- 14.9 --- 0.10 ----------- 25.3 a. Calculate the expected rate of return. b. Calculate the standard deviation of the returns.
a. Calculate the expected rate of return. Expected Return = (0.15)(9.5) + (0.25)(13.6) + (0.50)(14.9) + (0.1)(25.3) = 14.81% b. Calculate the standard deviation of the returns. Std. Dev. = [(9.5 - 14.81)2(0.15) + (13.6 - 14.81)^2(0.25) + (14.9 - 14.81)^2(0.5) + (25.3 - 14.81)^2(0.1)]^1/2 = 3.95% Page: 194-198
27) You are considering the three securities listed below. Returns Probability Stock A Stock B Stock C 20% 2% -3% 5% 50% 10% 8% 8% 30% 15% 20% 12% a. Calculate the expected return for each security. b. Calculate the standard deviation of returns for each security. c. Compare Stock A with Stocks B and C. Is Stock A preferred over the others?
a. Calculate the expected return for each security. RA = (.2)(2%) + (.5)(10%) + (.3)(15%) = 9.9% RB = (.2)(-3%) + (.5)(8%) + (.3)(20%) = 9.4% RC = (.2)(5%) + (.5)(8%) + (.3)(12%) = 8.6% b. Calculate the standard deviation of returns for each security. Std.Dev.A = (2%-9.9%)^2(.2) + (10%-9.9%)^2(.5) + (15%-9.9%)^2(.3) = 4.5% Std.Dev.B = (-3%-9.4%)^2(.2) + (8%-9.4%)^2(.5) + (20%-9.4%)^2(.3) = 8.1% Std.Dev.C = (5%-8.6%)^2(.2) + (8%-8.6%)^2(.5) + (12%-8.6%)^2(.3) = 2.5% c. Compare Stock A with Stocks B and C. Is Stock A preferred over the others? Stock A dominates stock B because A has a higher expected return and a lower standard deviation. Stock A has a higher expected return than stock C, but also a higher standard deviation, so the choice between A and C depends on the level of risk aversion. Page: 194-198
You are considering buying some stock in Continental Grain. Which of the following are examples of non-diversifiable risks? I. Risk resulting from a general decline in the stock market. II. Risk resulting from a possible increase in income taxes. III. Risk resulting from an explosion in a grain elevator owned by Continental. IV. Risk resulting from a pending lawsuit against Continental. A) I and II B) III and IV C) I only D) II, III, and IV
A) I and II I. Risk resulting from a general decline in the stock market. II. Risk resulting from a possible increase in income taxes. Page: 200
Which of the following is/are true? A) Most of the unsystematic risk is removed by the time a portfolio contains 30 stocks. B) Two points on the Characteristic Line are the T-bill and the market portfolio. C) The greater the total risk of an asset, the greater the expected return. D) All securities have a beta between 0 and 1.
A) Most of the unsystematic risk is removed by the time a portfolio contains 30 stocks. Page: 200
Which of the following statements is MOST correct concerning diversification and risk? A) Risk-averse investors often choose companies from different industries for their portfolios because the correlation of returns is less than if all the companies came from the same industry. B) Risk-averse investors often select portfolios that include only companies from the same industry group because the familiarity reduces the risk. C) Only wealthy investors can diversify their portfolios because a portfolio must contain at least 50 stocks to gain the benefits of diversification. D) Proper diversification generally results in the elimination of risk.
A) Risk-averse investors often choose companies from different industries for their portfolios because the correlation of returns is less than if all the companies came from the same industry. Page: 200
You must add one of two investments to an already well- diversified portfolio. Security A Expected Return = 14% Standard Deviation of Returns = 15.0% Beta = 1.5 Security B Expected Return = 12% Standard Deviation of Returns = 11% Beta = 1.5 If you are a risk-averse investor, which one is the better choice? A) Security A B) Security B C) Either security would be acceptable. D) Cannot be determined with information given
A) Security A Page: 194-198
You are considering a sales job that pays you on a commission basis or a salaried position that pays you $50,000 per year. Historical data suggests the following probability distribution for your commission income. Which job has the higher expected income? Commission Probability of Occurrence $15,000 0.10 $35,000 0.20 $48,000 0.40 $67,000 0.16 $80,000 0.14 A) The salary of $50,000 is greater than the expected commission of $49,620. B) The salary of $50,000 is greater than the expected commission of $48,400. C) The salary of $50,000 is less than the expected commission of $50,050. D) The salary of $50,000 is less than the expected commission of $52,720.
A) The salary of $50,000 is greater than the expected commission of $49,620. Exp. Return = (15,000 × 0.1) + (35,000 × 0.2) + (48,000 × 0.4) + (67,000 × 0.16) + (80,000 × 0.14) = 49,620 Page: 189
Investment A has an expected return of 15% per year, while Investment B has an expected return of 12% per year. A rational investor will choose A) Investment A because of the higher expected return. B) Investment B because a lower return means lower risk. C) Investment A if A and B are of equal risk. D) Investment A only if the standard deviation of returns for A is higher than the standard deviation of returns for B.
C) Investment A if A and B are of equal risk. Page: 195
Rogue Recreation, Inc. has normally distributed returns with an expected return of 15% and a standard deviation of 5%, while Lake Tours, Inc. has normally distributed returns with an expected return of 15% and a standard deviation of 15%. Which of the following is true? A) Lake Tours' investors are not being adequately compensated for relevant risk. B) Rogue Rec is likely to experience returns larger than those of Lake Tours. C) Lake Tours is more likely to have negative returns than Rogue Rec. D) Rational investors will prefer Lake Tours, Inc. over Rogue Recreation, Inc.
C) Lake Tours is more likely to have negative returns than Rogue Rec. Rogue Recreation, Inc. 15% 5% Lake Tours, Inc. 15% 15% Lake Tours, Inc. the expected return is the same as the standard deviation Page: 195
You are going to invest all of your funds in one of three projects with the following distribution of possible returns: PROJECT 1 ---------------------------Standard Probability-----Return-- Deviation--Beta 50% Chance---- 22% ----- 13%------- 1.1 50% Chance -- (-4%) PROJECT 2 ---------------------------Standard Probability-----Return-- Deviation--Beta 30% Chance---- 36% ----- 21.72%----- 1.0 40% Chance --- 10.5% 30% Chance -- (-20%) PROJECT 3 ---------------------------Standard Probability-----Return-- Deviation--Beta 10% Chance---- 28% ----- 11.29%----- 1.2 70% Chance --- 18% 20% Chance -- (-8%) If you are a risk averse investor, which one should you choose? A) Project 1 B) Project 2 C) Project 3 D) Either Project 1 or Project 2 because they have the same expected return
C) Project 3 Page: 194-195
If we are able to fully diversify, what is the appropriate measure of risk to use? A) expected return B) standard deviation C) beta D) risk-free rate of return
C) beta Page: 203
The relevant variable a financial manager uses to measure returns is A) net income determined using generally accepted accounting principles. B) earnings per share minus dividends per C) cash flows. share. D) dividends.
C) cash flows. share. Page: 188
If you were to use the standard deviation as a measure of investment risk, which of the following has historically been the highest risk investment? A) common stock of large firms B) U.S. Treasury bills C) common stock of small firms D) long-term government bonds
C) common stock of small firms Page: 199
Of the following different types of securities, which is typically considered most risky? A) long-term corporate bonds B) long-term government bonds C) common stocks of large companies D) common stocks of small companies
D) common stocks of small companies Page: 199
Cash flows is the most relevant variable to measure the returns on debt instruments, while GAAP net income is the most relevant variable to measure the returns on common stock. TRUE or FALSE
FALSE Page: 188
Actual returns are always less than expected returns because actual returns are determined at the end of the period and must be discounted back to present value. TRUE or FALSE
FALSE Page: 188, 189
Another name for an asset's expected rate of return is holding-period return. TRUE or FALSE
FALSE Page: 189
The risk-return trade-off that investors face on a day-to-day basis is based on realized rates of return because expected returns involve too much uncertainty. TRUE or FALSE
FALSE Page: 189
Due to strict stock market controls, the most a stock's value can drop in one trading day is 5%. TRUE or FALSE
FALSE Page: 191, 192
A rational investor will always prefer an investment with a lower standard deviation of returns, because such investments are less risky. TRUE or FALSE
FALSE Page: 193
For a well-diversified investor, an investment with an expected return of 10% with a standard deviation of 3% dominates an investment with an expected return of 10% with a standard deviation of 5%. TRUE or FALSE
FALSE Page: 195
Investment A and Investment B both have the same expected return, but Investment A is more risky than Investment B. In the technical jargon of modern portfolio theory, Investment A is said to "dominate" Investment B. TRUE or FALSE
FALSE Page: 195
Historically, investments with the highest returns have the lowest standard deviations because investors do not like risk. TRUE or FALSE
FALSE Page: 199
The market rewards the patient investor, for the period between 1926 and 2016, there has never been a time when an investor lost money if she held an all-large-stock portfolio for ten years. TRUE or FALSE
FALSE Page: 199
Because risk is measured by variability of returns, how long we hold our investments does not matter very much when it comes to reducing risk. TRUE or FALSE
FALSE Page: 200
The characteristic line for any well-diversified portfolio is horizontal. TRUE or FALSE
FALSE Page: 203
Asset allocation is not recommended by financial planners because mixing different types of assets, such as stocks with bonds, makes it more difficult to track performance and adjust portfolios to changing market conditions. TRUE or FALSE
FALSE Page: 209
Adding stocks to a bond portfolio will increase the riskiness of the portfolio because stocks have higher standard deviations of returns than bonds. TRUE or FALSE
FALSE Page: 209-211
