FNCE3050 Ch. 9 Characterizing Risk and Return
True or false: T-bills are considered to be risk-free because their standard deviation of returns is always zero.
False 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%.
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.
The percentage total return on a stock investment is expressed as a percentage of what?
Initial investment
Market risk applies to which of the following?
All firms and individuals
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 dollar return on a stock investment includes which of these?
Dividend income and capital gains or losses
How can the percentage return on a stock be defined?
Dollar return/Money invested
An arithmetic average return can be which of these? Select all that apply.
Dollar return; Return for any period of time; Percentage return
Modern portfolio theory (MPT) is designed to achieve which one of these?
Highest return for a given level of risk
Which statement is true? (S&P 500)
Investing in a single stock is generally riskier than investing in the S&P 500.
An investor who purchases a high-risk investment should expect to earn a higher rate of return as compared to low-risk investment over which period of time?
Long term
Which of these correctly describe the returns on long-term Treasury bonds for the period 1950-2012? Select all that apply.
More volatile than T-bill returns on an annual basis; Higher returns than T-bill returns over the period
What type of relationship exists between risk and expected return?
Positive
Which one of these best describes diversification?
Purchasing stocks in eight different industries
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 defines correlation?
Statistical value ranging from -1 to +1
Based on annual standard deviation of returns for the years 2000-2009, which one of the following exhibited the greatest risk?
Stocks
Which statement(s) is (are) correct for the period of 1950 to 2015? Select all that apply.
The S&P 500 had a positive average rate of return for the six decades starting with the 1950s; The S&P 500 outperformed long-term Treasury bonds by about 6 percent
How is market risk defined?
The portion of total risk that is attributable to over-all economic factors
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
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)
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; The average return is an arithmetic average; N is the total number of returns
How is the term "dollar return" defined?
Amount of profit or loss from an investment expressed in dollars
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 the following are examples of diversifiable risk? Select all that apply.
Decreased demand for electric cars; Fraud committed by company management
How is the capital gain or loss on a stock investment computed?
Ending stock value - Beginning stock value
What is a geometric mean return?
The equivalent return that is compounded for N periods
Which statement is true? (Asset class)
The higher the long-term rate of return on an asset class, the higher its risk level
What does standard deviation measure?
Total risk
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
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+(4x$0.12)]/$16
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
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 (14%-32%+4%)/3=-4.67%
Which of these is an accurate measure of returns that is used in performance analysis?
Geometric mean return
Stock investors cannot avoid which type of risk?
Market risk
What type of risk exists in a fully-diversified portfolio?
Market risk only
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
How can firm-specific risk be defined?
Risk that can be reduced by diversification
Which of these will calculate the coefficient of variation (CoV) for a security?
Standard deviation/Average return
Which of these represents an optimal portfolio comprised of two stocks? Select all that apply.
14.3 percent return, 24.8 percent standard deviation; 14.9 percent return, 25.4 standard deviation
Which rate of return best illustrates the historical performance of a security over time?
Geometric mean return
The variance of the returns on an individual stock is 0.060565. What is the standard deviation?
24.61 percent o=(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 [(1.052)(0.832)(1.221)(1.114)]^1/4-1=0.0446=4.46%
Marta is risk-averse, which is her primary investment concern. Which one of these represents an optimal portfolio for her?
8 percent return; 7 percent standard deviation
Which one of these is an accurate measure of returns that is used in performance analysis?
Geometric mean return
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
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 Rp=($1,500/$3,000x0.116)+($500/$3,000x0.19)+($1,000/$3,000x0.067)=0.1120=11.20%
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 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%
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 CoV=(0.02789^1/2)/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 (13%+8%-16%+1%)/4=1.5%
A bond has a standard deviation of 10.7 percent and an average rate of return of 6.4 percent. What is the coefficient of variation (CoV)?
1.67 CoV=0.107/0.064=1.67
Which of these sets represents an optimal portfolio? Select all that apply.
11 percent return, 15 percent standard deviation; 11.5 percent return, 17 percent standard deviation
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 Average capital gain= ($2/$16+$2/$18+$2/$20)/3=11.20% Average total return= ($3/$16+$3/$18+$3/$20)/3=16.81%
Which of these represents the optimal portfolio comprised of two stocks? Select all that apply.
14.3 percent return, 24.8 percent standard deviation; 14.9 percent return, 25.4 percent standard deviation
The S&P 500 had the highest decade average return for which period?
1950s
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
Which of the following indicates a portfolio is becoming more diversified?
Decreasing portfolio standard deviation
What is the primary focus of modern portfolio theory (MPT)?
Minimizing portfolio risk for a given level of return
Which set of securities will provide the least amount of diversification given their correlation values?
Stocks A and B; 0.49
