Chapter 11 & 12

If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury security should be equal to the real risk-free rate, r*.

True

Which one is the least effective way to reduce a portfolio's risk (volatility of return)?

Buying 20 stocks in Technology industry

Which of the following statements is CORRECT?

If a loan has a nominal annual rate of 8%, then the effective rate will never be less than 8%.

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific" or "unsystematic" events, and their effects on investment risk can in theory be diversified away.

True

Because the maturity risk premium is normally positive, the yield curve is normally upward sloping.

True

Diversification will normally reduce the riskiness of a portfolio of stocks.

True

During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining.

True

Suppose your credit card issuer states that it charges a 19.50% nominal annual rate, but you must make monthly payments, which amounts to monthly compounding. What is the effective annual rate?

(1+.195/12)^12 -1 =21.34%

What real rate of return is earned by a one-year investor in a bond that was purchased for $1,000, has an 7% coupon, and was sold for $959 when the inflation rate was 5.90%?

(70+959-1000*105.9%)/(1000*105.%) = -2.83%

What nominal return was received by an investor when inflation averaged 7.70% and the real rate of return was a negative 2.30%?

1.0522 = 1 + nominal rate of return 5.22% = nominal rate of return (1+9-.023))*(1+.077)-1=.052229 5.22%

Mike Flannery holds the following portfolio: Stock Investment Beta A $150,000 1.40 B $10,000 0.80 C $140,000 1.00 D $75,000 1.20 Total $375,000 What is the portfolio's beta? Do not round your intermediate calculations.

1.19

Jim Angel holds a $200,000 portfolio consisting of the following stocks: Stock . Investment Beta A $50,000 1.20 B $50,000 0.80 C $50,000 1.00 D $50,000 1.20 Total $200,000 What is the portfolio's beta? Do not round your intermediate calculations.

50000/200000*1.20 + 50000/200000*0.80 + 50000/200000*1 + 50000/200000*1.20 =1.050

Market risk can be eliminated * in a stock portfolio through diversification.

False

Which of the following factors would be most likely to lead to an increase in nominal interest rates?

A new technology like the Internet has just been introduced, and it increases investment opportunities.

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

Which of the following bank accounts has the lowest effective annual return?

An account that pays 7% nominal interest with monthly compounding

Which of the following bank accounts has the highest effective annual return?

An account that pays 8% nominal interest with daily (365-day) compounding.

You have the following data on three stocks: Stock Standard Deviation Beta A 20% 0.59 B 10% 0.61 C 12% 1.29 If you are a strict risk minimizer, you would choose Stock ___ if it is to be held in isolation and Stock ___ if it is to be held as part of a well-diversified portfolio.

B; A

You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest?

Bank 5; 6.0% with daily (365-day) compounding.

Which of the following would be most likely to lead to a higher level of interest rates in the economy?

Corporations step up their expansion plans and thus increase their demand for capital.

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by:

Default and liquidity risk difference

An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.

False

Because the maturity risk premium is normally positive, the yield curve must have an upward slope. If you measure the yield curve and find a downward slope, you must have done something wrong.

False

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

False

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

False

Portfolio A has only one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

False

The risk that remains in a stock portfolio after efforts to diversify is known as unique risk.

False

Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that

Maturity risk premiums could help to explain the yield curve's upward slope

What is the variance of return of a three-stock portfolio (with unequal weights 25%, 45%, and 30%) that produced returns of 28%, 33%, and 38%, respectively?

Mean = .25 × 28% + .45 × 33% + .30 × 38% = 33.25% Variance = [.25 × (28 − 33.25) 2 + .45 × (33.25 − 33) 2 + .30 (38 − 33.25) 2 ] = 13.69 percent squared

Suppose the U.S. Treasury issued $50 billion of short-term securities and sold them to the public. Other things held constant, what would be the most likely effect on short-term securities' prices and interest rates?

Prices would decline and interest rates would rise.

Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?

The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%.

Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?

The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.

Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT?

The yield on 10-year Treasury securities must exceed the yield on 7 year Treasury securities.

Which of the following statements is CORRECT?

The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond

"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.

True

A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

True

A market index is used to measure performance of a broad-based portfolio of stocks.

True

An upward-sloping yield curve is often call a "normal" yield curve, while a downward-sloping yield curve is called "abnormal".

True

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

True

If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase.

True

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data.

True

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

True

One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant.

True

Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.

True

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

True

The "yield curve" shows the relationship between bonds' maturities and their yields.

True

The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

True

The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called "interest rate risk" or "price risk".

True

What is the approximate standard deviation of returns if over the past 4 years an investment returned 7.4%, -12.6%, -12.6%, and 14.8%?

mean=(7.4-12.6-12.6+14.8)/4=-.750% variance=[(7.4+.750)^2+2(-12.6+.750)^2+(14.8+.750)^2]/4= 147.2675 SQR 147.2675=12.14%

Charter Bank pays a 5.00% nominal rate on deposits, with monthly compounding. What effective annual rate (EAR) does the bank pay?

r = 5.00%, n = 12 and t = 1 Effective Annual Rate = (1+r/n)^(n*t) - 1 = (1+.05/12)^(12*1) - 1 =5.12%