370 CH7

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What is Principal Financial Group's coefficient of variation (CV) of possible returns given that the expected return is .17 and variance is .245717?

2.9159

Cummins Inc has a beta of 2.67 and the expected market return is 0.2. In addition, Treasury bills (risk-free asset) are currently yielding 0.05. Find the expected return for Cummins Inc.

45.00%

Given the historical information in the chapter, which of the following investment classes had the greatest variability in returns?

Small US stocks

In a game of chance, the probability of winning a $50 is 40 percent and the probability of losing a $50 prize is 60 percent. What is the expected value of a prize in the game?

-$10

Braniff Ground Services stock has an expected return of 9 percent and a variance of 0.25 percent. What is the coefficient of variation for Braniff?

0.5556

Francis purchased a stock one year ago for $20, and it is now worth $24. The stock paid a dividend of $3 during the year. What was the stock's rate of return from capital appreciation during the year? (Round your answer to the nearest percent.)

20

Correct

-If an asset's price implies that the expected return is greater than that predicted by the CAPM, that asset will plot above the Security Market Line. -The standard deviation is a measure of total risk. -The variance of a distribution cannot be a negative value. -The returns of the individual stock will show more variability than those of the market index. -The best measure of assessing systematic risk within an investment is its beta. -A beta of 1 tells us that an asset has just as much systematic risk as the market. -When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return. -When beta equals zero and there is no systematic risk, and therefore the expected return equals the risk-free rate. -If two investments have the same expected return, investors prefer the lower risk alternative.

Incorrect

-The normal distribution is a skewed distribution that is completely described by its correlation coefficient and coefficient of variation. -Diversification by holding more than one asset with different risk characteristics can reduce the risk of a portfolio. -With complete diversification, all of the systematic risk is eliminated from the portfolio. -If two investments have the same expected return, investors prefer the riskiest alternative. -A beta of 1 indicates a risk-free security, such as a U.S. Treasury bill. -The income component of a stock's return considers the change in price of a stock divided by the initial price of the stock. -In order to keep the total return of a stock equal to 100 percent, the income component for that stock must be zero. -If the capital appreciation return from owning a stock is positive, then the total return from owning the same stock can be negative. -The variance of a distribution can be a negative value. -If the price of an asset has not increased or decreased since the original purchase of the asset, then the total return of the asset (assuming some dividends were paid during the period) is equal to the capital appreciation component return. -The capital appreciation component of return for a common stock comes from the cash dividend a firm pays. -The expected return on the market portfolio is equal to the market risk premium.

What is the standard deviation given the following information? Probability: 25%, 20%, 55% Possible Returns: 24.0%, 36.0%, 9.0%

10.9%

Kohl's Corp has a beta of 2. and the expected market return is 0.09. In addition, Treasury bills (risk-free asset) are currently yielding 0.03. Find the expected return for Kohl's Corp.

15%

What is Linear Technology Corp's coefficient of variation (CV) of possible returns given that the expected return is .13 and variance is .421833?

4.9960

The expected return on KarolCo. stock is 16.5 percent. If the risk-free rate is 5 percent and the beta of KarolCo is 2.3, then what is the risk premium on the market?

5.0%

In a game of chance, the probability of winning a $50 prize is 40 percent, and the probability of winning a $100 prize is 60 percent. What is the expected value of a prize in the game?

ANSWER: $50(0.4) + $100 (0.6) = $80

The expected return for the asset below is 18.75 percent. If the return distribution for the asset is described as in the following table, what is the variance for the asset's returns? Return: .10, .20, .25 Probability: .25, .50, .25

ANSWER: (0.1)(0.25 - 0.1875)2 + (0.2)(0.5 - 0.1875) 2 + (0.25)(0.25 - 0.1875)^2 = 0.002969

Sayers purchased a stock with a coefficient of variation equal to 0.125. The expected return on the stock is 20 percent. What is the coefficient of variation for the stock?

ANSWER: CV = Standard Deviation/Expected return and Standard deviation = (CV)(Expected Return) = (.125)(.20) = 0.025. Further, Variance = (Standard Deviation)^2 = (0.025)^2 = .000625

The beta of Elsenore, Inc., stock is 1.6, whereas the risk-free rate of return is 8 percent. If the expected return on the market is 15 percent, then what is the expected return on Elsenore?

ANSWER: Expected Return of Elsenore = risk-free rate + Beta(Expected Return on the market - risk free rate) = .08+1.6(.15-.08) = .192

The expected return on Kiwi Computers stock is 16.6 percent. If the risk-free rate is 4 percent and the expected return on the market is 10 percent, then what is Kiwi's beta?

ANSWER: Expected Return of Kiwi = risk-free rate + Beta(Expected Return on the market - risk free rate) and further Beta = (Expected Return of Kiwi - risk free rate)/(the expected Return on the market - risk free rate) = (.166 - .04)/(.10-.04) = 2.10

The risk-free rate of return is currently 3 percent, whereas the market risk premium is 6 percent. If the beta of Lenz, Inc., stock is 1.8, then what is the expected return on Lenz?

ANSWER: Expected Return of Lenz = risk-free rate + Beta(Expected Return on the market - risk free rate) = .03+1.8(.06) = .138 where the expected return on the market must have been .09. Why? Because market risk premium = the expected return on the market - risk free rate = .09 - .03 = .06

The expected return on Mike's Seafood stock is 17.9 percent. If the expected return on the market is 13 percent and the beta for Mike's Seafood is 1.7, then what is the risk-free rate?

ANSWER: Expected Return of Mike's seafood (ER) = risk-free rate (Rf) + Beta (b)x[Expected Return on the market (ERM)- risk free rate (Rf)]. ER = Rf + b x (ERM - Rf) and .179 = Rf + 1.7(.13-Rf) and .179 = 1Rf + (1.7)(.13) - 1.7Rf and .179 = -.7Rf + .221 and Rf =(0.221-0.179 )/(0.7)= .06

The beta of RicciCo.'s stock is 3.2, whereas the risk-free rate of return is 9 percent. If the expected return on the market is 18 percent, then what is the expected return on RicciCo.?

ANSWER: Expected Return of RicciCo = risk-free rate + Beta(Expected Return on the market - risk free rate) = .09+3.2(.18-.09) = .378

Gwen purchased a stock one year ago for $25, and it is now worth $31. The stock paid a dividend of $1.50 during the year. What was the stock's rate of return income during the year? (Round your answer to the nearest percent.)

ANSWER: Income rate of return = 1.50/25 = .06

George Wilson purchased Bright Light Industries common stock for $47.50 on January 31, 2010. The firm paid dividends of $1.10 during the last 12 months. George sold the stock today (January 30, 2011) for $54.00. What is George's holding period return?

ANSWER: Total Return (R) = (P1-P0+CF1)/P0 = (54-47.50+1.10)/47.50 = 16%

Books Brothers stock was priced at $15 per share two years ago. The stock sold for $13 last year and now it sells for $18. What was the total return for owning Books Brothers stock during the most recent year? Assume that no dividends were paid. Round your answer to the nearest percent. Correct!

ANSWER: Total rate of return = ($18-$13)/$13 = 38.46% or 38% (rounded).

L-3 Communications Holdings has a beta of 2. and the expected market return is 0.06. In addition, Treasury bills (risk-free asset) are currently yielding 0.06. Find the expected return for L-3 Communications Holdings.

ANSWER: Use CAPM where the cost of equity capital = Risk-free rate + Beta*(Market rate - Risk free rate) => the cost of equity capital for L-3 Communications Holdings = 0.06 + 2.*(0.06 - .06) = .06

Bard C.R. Inc has a beta of 2.67 and the expected market return is 0.12. In addition, Treasury bills (risk-free asset) are currently yielding 0.06. Find the expected return for Bard C.R. Inc.

ANSWER: Use CAPM where the cost of equity capital = Risk-free rate + Beta*(Market rate - Risk-free rate) => the cost of equity capital for Bard C.R. Inc = 0.06 + 2.67*(0.12 - .06) = .22


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