FIN3400 Ch 9 SMARTBOOK

what type of risk exists in a fully-diversified portfolio?

market risk only

lew has a portfolio comprised of $3,000 of stock A, $5,000 of stock B, and $2,000 of stock C. How is the portfolio weight of stock C computed?

$2,000/($3,000+$5,000+$2,000)

Theo purchased a stock at $28 a share and sold it six months later for $23 a share. He received a $0.75 dividend. How is his percentage return calculated?

($23 - $28 + $0.75)/$28

How is the total dollar return on a stock investment calculated?

(Ending stock value-Beginning stock value) + Dividend income

Which of these statements regarding the standard deviation formula is correct? Select all that apply.

-(N - 1) is used when computing historical standard deviations. Rationale: (N - 1) is used when computing historical standard deviations. -The average return is an arithmetic average. -N is the total number of returns.

An arithmetic average return can be which of these? Select all that apply.

-Percentage return -Return for any period of time -Dollar return

Which rate of return is most appropriate for statistical analysis and represents the expected return in any given year?

Arithmetic average return Rationale: The geometric mean return best illustrates historical performance over time.

Which of the following indicates a portfolio is becoming more diversified?

Decreasing portfolio standard deviation

The dollar return on a stock investment includes which of these?

Dividend income and capital gains or losses

How is the capital gain or loss on a stock investment computed?

Ending stock value - Beginning stock value

Modern portfolio theory (MPT) is designed to achieve which one of these?

Highest return for a given level of risk

Which statement is true?

Investing in a single stock is generally riskier than investing in the S&P 500.

_____________ are riskier than Treasury bills.

Long-term Treasury bonds

Based on returns and their volatility for the period 1950-2012, what can be implied about the risk level of long-term Treasury bonds?

Long-term Treasury bonds are riskier than Treasury bills.

Stock investors cannot avoid which type of risk?

Market risk

What determines the weights to be used in computing a portfolio rate of return? Select an answer that applies to both equal and unequal portfolio allocations.

Market value of each security expressed as a percentage of the total portfolio value

What are the characteristics of an efficient portfolio?

Maximum expected return for a given level of risk

How is standard deviation defined in relation to investments?

Measure of past return volatility, or risk

How is correlation defined?

Measure of the co-movement between the returns on two variables

What is the definition of the coefficient of variation?

Measure of total risk to reward

What does a correlation value of zero indicate?

No relationship between the co-movements of the security returns

Which one of these best describes diversification?

Purchasing stocks in eight different industries

What is firm-specific risk?

Risk that affects only one firm or one industry

Which one of these is the correct formula for computing the return on a portfolio comprised of unequal amounts of stocks A, B, and C?

Rp = (wA × RA) + (wB × RB) + (wC × RC)

What benefit is derived from the use of standard deviation when measuring rates of return?

Standard deviation quantifies total risk with higher values representing greater risk.

Which of these will calculate the coefficient of variation (CoV) for a security?

Standard deviation/Average return

Which of these defines correlation?

Statistical value ranging from -1 to +1

Which set of securities will provide the least amount of diversification given their correlation values?

Stocks A and B; 0.49 Rationale: The higher the correlation value, the more the stocks tend to move together and the less diversification that is achieved.

Which one of these defines an arithmetic average return?

Sum of all returns divided by the number of returns

Based on actual performance for the period 1950-2012, which one of the following displayed the least amount of risk and why? Select the best answer.

T-bills as their returns were less volatile.

Which one of these is correct regarding the standard deviation formula?

The deviations must be squared to eliminate all negative values.

How is market risk defined?

The portion of total risk that is attributable to over-all economic factors

how can the percentage return on a stock be defined?

dollar return/ money invested

Modern portfolio theory (MPT) is designed to achieve ________________.

highest return for a given level of risk

the deviations must be squared to eliminate all ______________ .

negative values

Which of the following is another term for market risk?

nondiversifiable risk

what type of relationship exists between risk and expected return?

positive

Risk and expected return are ________ correlated.

positively

how can firm-specific risk be defined?

risk that can be reduced by diversification

how to calculate the coefficient of variation (CoV) for a security?

standard deviation/average return

For the past three years a stock has provided an average return of 11.6 percent with a variance of 0.02789. What is the coefficient of variation (CoV)?

1.44 Rationale: CoV = (0.027891/2)/0.116 = 1.44

A stock returned 13 percent, 8 percent, -16 percent, and 1 percent annually for the past four years, respectively. What is the arithmetic average return?

1.50 percent Rationale: (13% + 8% - 16% + 1%)/4 = 1.5%

Nicholas is less risk-adverse than your average investor; returns are his primary investment concern. Which one of these represents an optimal portfolio for him?

11% return; 8% standard deviation

Luther invested $1,500 in stock A with a return of 11.6 percent, $500 in stock B with a return of 19 percent, and $1,000 in bond C with a return of 6.7 percent. What is the portfolio return?

11.20 percent

Roger purchased a stock for $16 a share. The stock paid a $1 annual dividend and increased in price by $2 a year for the following three years. What is the arithmetic average annual capital gain? The arithmetic average annual total return?

11.20 percent; 16.81 percent Rationale: Average capital gain = ($2/$16 + $2/$18 + $2/$20)/3 = 11.20% Average total return = ($3/16 + $3/$18 + $3/$20)/3 = 16.81%

On a graph with expected return on the vertical axis and standard deviation on the horizontal axis, where is an efficient portfolio located?

At the highest return achievable for any selected standard deviation

The coefficient of variance is Standard Deviation divided by:

Average Return

Based on annual returns for the years 2000-2012, which one of the following exhibited the greatest risk and why?

S&P 500 because the highest annual return was 28.7 percent and the lowest annual return was -35.5 percent.

Which of these best summarizes market performance for the period 1950-2012?

The returns on the S&P 500 were more volatile than long-term Treasury bond returns but produced a higher average return in the long-run.

What does a correlation value of +0.9 indicate?

The stock returns tend to move closely, although not perfectly, together. Rationale: A correlation of +1 indicates stocks moving in sync with each other.

How does correlation relate to total risk?

Total risk can be lowered by eliminating firm-specific risk, which is achieved by combining securities with low, or negative correlations.

Which of the following is considered the risk-free asset?

Treasury Bills

Which of the following is the correct ranking from least risky to most risky?

Treasury bills, long-term Treasury bonds, stocks

True or false: A high-risk investment can underperform a low-risk investment over the short term.

True Rationale: A high risk investment can underperform a low risk investment over the short term.

dollar return

earned includes any capital gain (or loss) that occurred as well as any income that you received over the period.

Which of these is the portion of total risk that is attributable to overall economic factors?

market risk

investing in a single stock can be riskier than ______________.

investing in the S&P500

an investor who purchases a high-risk investment should expect to earn a higher rate of return over which period of time?

long term

what is a geometric mean return?

the equivalent return that is compounded for N periods.

the percentage total return on a stock investment is expressed as a percentage of what?

initial investment

What is the relationship between risk and return?

The higher the risk, the higher the expected return.

A stock provided annual returns of 11.2 percent, 16.8 percent, and 0.3 percent for the past three years. What is the geometric mean return?

9.22 percent Rationale: [(1.112)(1.168)(1.003)](1/3) - 1 = 0.0922 = 9.22%

dollar return =

= capital gain or loss + income = (ending value - beginning value) + income

Which of these sets represents an optimal portfolio? Select all that apply.

-11.5 percent return; 17 percent standard deviation Rationale: This portfolio offers the highest return for the given level of risk. -11 percent return; 15 percent standard deviation Rationale: This portfolio offers the highest return for the given level of risk.

Which of these represents an optimal portfolio comprised of two stocks? Select all that apply.

-14.3 percent return; 24.8 percent standard deviation Rationale: This portfolio has the highest return for this level of risk. -14.9 percent return; 25.4 percent standard deviation Rationale: This portfolio has the highest return for this level of risk.

For the past three years, a stock had annual returns of 14 percent, -32 percent, and 4 percent. What is the average arithmetic return?

-4.67 percent Rationale: (14% - 32% + 4%)/3 = -4.67%

what does standard deviation measure?

total risk

You want to invest in two stocks that will provide you with the most diversified portfolio. You should select the two stocks with which one of these correlation values?

-0.34

The price of a stock at the end of each of the past three years has been $14, $12, and $11 with $11 being the latest price. The stock pays an annual dividend of $1 per share. What is the average annual capital gain for the past two years? The average annual total return?

-11.31 percent; -3.57 percent Rationale: Average annual capital gain = [(-$2/$14) + (-$1/$12)]/2 = -0.1131 = -11.31%; Average annual return = [(-$1/$14) + ($0/$12)]/2 = -0.0357 = -3.57%

Which of the following exemplifies market risk? Select all that apply.

-An increase in inflation Rationale: This is market risk as it affects the entire market. -An increase in taxes Rationale: This is market risk as it affects the entire market. -A decrease in GDP output Rationale: This is market risk at it affects the entire market.

Which of the following are examples of diversifiable risk? Select all that apply.

-Decreased demand for electric cars Rationale: This is firm-specific risk, which is diversifiable. -Fraud committed by company management Rationale: This is firm-specific risk, which is diversifiable.

Which of these correctly describe the returns on long-term Treasury bonds for the period 1950-2012? Select all that apply.

-Higher returns than T-bill returns over the period Rationale: Long-term Treasury bonds produced a higher rate of return than T-bills for the period. -More volatile than T-bill returns on an annual basis Rationale: Long-term Treasury bonds were more volatile than T-bills.

Assume a portfolio with a return of 12 percent with a standard deviation of 18 percent is an efficient portfolio. Which one of these is most apt to also be an efficient portfolio?

13 percent return; 19 percent standard deviation Rationale: This could be an efficient portfolio as both its return and risk levels are higher than the given efficient portfolio.

The S&P 500 had the highest decade average return for which period?

1950s Rationale: The S&P 500 had an average return of 19 percent for the 1990s and 20.9 percent for the 1950s.

The variance of the returns on an individual stock is 0.060565. What is the standard deviation?

24.61 percent Rationale: σ = (0.060565)1/2 = 0.2461 = 24.61%

The annual returns on a stock for the past four years are: 5.2 percent, -16.8 percent, 22.1 percent, and 11.4 percent. What is the geometric mean return?

4.46 percent Rationale: [(1.052)(0.832)(1.221)(1.114)]1/4 -1 = 0.0446 = 4.46%

Marta is risk-adverse, which is her primary investment concern. Which one of these represents an optimal portfolio for her?

8 percent return; 7 percent standard deviation Rationale: Since Marta's main concern is low risk, she should select the portfolio with the highest return given the lowest standard deviation.

For the past three years, a stock returned 11 percent, 6 percent, and 22 percent. What is the standard deviation?

8.19 percent Rationale: Average = (0.11 + 0.06 + 0.22)/3 = 0.13; σ = {[(0.11 - 0.13)2 + (0.06 - 0.13)2 + (0.22 - 0.13)2]/(3 - 1)}1/2 = 0.0819 = 8.19%

Market risk applies to which of the following?

All firms and individuals

How is the term "dollar return" defined?

Amount of profit or loss from an investment expressed in dollars

What does an increase in the coefficient of variation (CoV) for a security indicate?

An increase in the amount of risk per unit of return

The difference in standard deviations between individual companies and the entire market is due to mostly the principle of [BLANK 1]

Blank 1: diversification

Standard deviation squared is known as [BLANK 1]

Blank 1: variance

A stock has a variance of 0.02468, a current price of $28 a share, and an average rate of return of 14.4 percent. How is the coefficient of variation (CoV) computed?

CoV = (0.02468[1/2])/0.144

Which of these is a measure of risk to reward earned by an investment over a specific period of time?

Coefficient of variation

True or false: T-bills are considered to be risk-free because their standard deviation of returns is always zero.

False Rationale: Risk-free assets have low levels of volatility as measured by standard deviation. Over a decade, T-bills generally have a standard deviation less than 3%.

True or false: Total risk can be reduced by combining two perfectly correlated stocks.

False Rationale: Total risk can be lowered by combining securities with low or negative correlation values.

Which rate of return best illustrates the historical performance of a security over time?

Geometric mean return

What is the primary focus of modern portfolio theory (MPT)?

Minimizing portfolio risk for a given level of return

Which statement is true?

The higher the long-term rate of return on an asset class, the higher its risk level. Rationale: Risk and return are directly related.

what is the shape of the efficient frontier and what does this imply?

Upward-sloping; direct relationship between risk and return

Risk, as it is used in the coefficient of variation (CoV), is best defined as a measure of which one of these?

Volatility of returns

Firm specific risk

Which of the following is defined as the portion of total risk that is attributable to firm or industry factors and can be reduced through diversification?

Percentage return

Which of these is the dollar return characterized as a percentage of money invested?

maria bought a stock one year ago for $16 a share. the stock pays quarterly dividends of $0.12 and is currently valued at $17 a share. How is the percentage return computed?

[$17-$16 + (4x0.12)]/$16

standard deviation

a measure of past return volatility, or risk, of an investment.

correlation

a measurement of the co-movement between two variables that ranges between -1 and +1.

market risk applies to _____________.

all firms and individuals

the higher the long-term rate of return on an asset class, _________________.

the higher its risk level

market risk

the portion of total risk that is attributable to overall economic factors.

If you observe a high variability in a stock's returns you can infer that the stock is very risky.

true

There is a positive relationship between risk and return.

true

Total risk is measured by the standard deviation.

true