Finance Test 2- chapter 7

Susan Bright will get returns of 18%, -20.3%, -14%, 17.6%, and 8.3% in the next five years on her investment in CoffeeTown, Inc. stock, which she purchases for $73,419.66 today. What is the arithmetic average return on her stock if she sells it five years from today? A) 1.92% B) 3.98% C) 6.47% D) 7.11%

A) 1.92%

Roddy Richards invested $12014.88 in Wolverine Meat Distributors (W.M.D.) five years ago. The investment had yearly arithmetic returns of -9.7%, -8.1%, 15%, 7.2%, and 15.4%. What is the geometric average return of Roddy's Richard's investment? A) 3.38% B) 4.63% C) 6.96% D) 8.78%

A) 3.38%

What is the standard deviation of an investment that has the following expected scenario? 18% probability of a recession, 2.0% return; 65% probability of a moderate economy, 9.5% return; 17% probability of a strong economy, 14.2% return. A) 3.68% B) 1.23% C) 8.47% D) 6.66%

A) 3.68%

Marcus Berger invested $9842.33 in Hawkeyehats, Inc. four years ago. He sold the stock today for $11,396.22. What is his arithmetic average return? A) There is insufficient information to derive an answer. B) 2.98% C) 3.73% D) 3.95%

A) There is insufficient information to derive an answer.

Each of the following would tend to weaken the Efficient Market Hypothesis EXCEPT: A) There is publicly available information that Boeing Aircraft has procured a contract to build 25 planes for the U.S. Government and the price of Boeing quickly goes up. B) ACG, Inc. performed well for the past six months, but they just lost a major distribution contract, but the price of ACG stock continues to go up. C) Louisville Slugger, Inc., gets a contract to supply bats for Little League play, a contract it never had before, and stock price remains stable. D) Disney corporation, a growth company, opens a new theme park, which investors expect will do tremendously well, and the stock price stays stable, while Urban Electric Company, which has a set infrastructure, and generates 95% of its earnings from assets it owns, outperforms Disney.

A) There is publicly available information that Boeing Aircraft has procured a contract to build 25 planes for the U.S. Government and the price of Boeing quickly goes up.

Using the following information for McDonovan, Inc.'s stock, calculate their expected return and standard deviation. State Probability Return Boom 20% 40% Normal 60% 15% Recession 20% (20%)

Answer: Ki = Σ(Ki)(Pi) = (.20)(40%) + (.60)(15%) + (.20)(-20%) = 8% + 9% - 4% = 13% σi = (Σ(Ki - K)2Pi).5 σi = ((40%-13%)2(.2) + (15%-13%)2 (.6) + (-20%-13%)2 (.2)).5 = 19.13%

Are markets moving toward being more efficient or toward being less efficient?

Answer: Empirical evidence shows that since about the year 2000 pricing anomalies have diminished considerably. Hedge funds have been trying to exploit pricing inefficiencies, and by doing so, eliminate the inefficiencies. Hence, the market appears to be becoming more efficient over time.

An investor with access to all publicly available information will be able to make higher than expected profit if the market has semi-strong efficiency. TRUE or FALSE

Answer: FALSE

Arithmetic average rate of return takes compounding into effect. TRUE or FALSE

Answer: FALSE

Because returns are more certain for the least risky investments, the required return on these investments should be higher than the required returns on more risky investments. TRUE or FALSE

Answer: FALSE

Expected return and realized return are the same thing. TRUE or FALSE

Answer: FALSE

If a market has weak form efficiency, an investor can make higher than expected profits by studying the past price patterns of a stock. TRUE or FALSE

Answer: FALSE

If an investor holds a stock for three years, the value at the end of three years will always be the initial cost of the stock times (1 + arithmetic average return) to the third power. TRUE or FALSE

Answer: FALSE

Investors are always rewarded for taking higher risk with higher realized returns. TRUE or FALSE

Answer: FALSE

Riskier investments have traditionally had lower returns than less risky investments have had. TRUE or FALSE

Answer: FALSE

The higher the standard deviation, the less risk the investment has. TRUE or FALSE

Answer: FALSE

The holding period return is always positive. TRUE or FALSE

Answer: FALSE

Under the efficient market hypothesis, would securities be properly priced.

Answer: If markets were perfectly efficient, then investors would price a stock based on the company's expected future cash flows, so at any time the security would be properly priced. If good news becomes available, that would tend to increase the expected cash flows to a company, the stock price will go up, meaning that the new price is then the proper price for the stock.

An investor who wishes to hold a stock for five years will be most interested in geometric average rather than in the arithmetic average return. TRUE or FALSE

Answer: TRUE

Even though an investor expects a positive rate of return, it is possible that the actual return will be negative. TRUE or FALSE

Answer: TRUE

Historically, in the United States stocks have had higher returns and greater volatility than have government bonds. TRUE or FALSE

Answer: TRUE

If an individual with inside information can make higher than expected profits, the market is no more than semi-strong form efficient. TRUE or FALSE

Answer: TRUE

If an investor holds a stock for six years, the value at the end of six years will be the initial cost times (1 + geometric average return) to the sixth power. TRUE or FALSE

Answer: TRUE

Investments in emerging markets have higher volatility than do U.S. Stocks. TRUE or FALSE

Answer: TRUE

Investors make different investment choices partially because individuals do not all have the same tolerance for risk. TRUE or FALSE

Answer: TRUE

Less risky investments have lower standard deviations than do more risky investments. TRUE or FALSE

Answer: TRUE

Stock prices go up when there is positive information about a company, and go down when there is negative information about the company. TRUE or FALSE

Answer: TRUE

The expected rate of return is the sum of each possible return times it likelihood of occurrence. TRUE or FALSE

Answer: TRUE

The expected rate of return is the weighted average of the possible returns for an investment. TRUE or FALSE

Answer: TRUE

The risk-return tradeoff tells us that expected returns should be higher on investments that have higher risk. TRUE or FALSE

Answer: TRUE

Treasury Bills have less default risk than do Government Bonds. TRUE or FALSE

Answer: TRUE

Why do the arithmetic average return and the geometric return differ?

Answer: The arithmetic average return does not take what the value of the investment was at the start of each period. Hence, even though a company may have the same arithmetic return for two consecutive years, the dollar amount of those returns will be different in later years than in the first year. For instance, if the investor started with $1,000, and earned 20% the first year, lost 20% the second year, and earned 15% the third year, the average arithmetic return would be 5%, and the 20% gain the first year would be $200, but the 20% loss the second year would be $240. The investment would be worth $1104 after three years, giving an average geometric return of 3.35%, different from the average arithmetic return.

Susan Bright will get returns of 18%, -20.3%, -14%, 17.6%, and 8.3% in the next five years on her investment in CoffeeTown, Inc. stock, which she purchases for $73,419.66 today. What is the geometric average return on her stock if she sells it five years from today? A) -2.33% B) .59% C) 3.67% D) 4.88%

B) .59%

If there is a 20% chance we will get a 16% return, a 30% chance of getting a 14% return, a 40% chance of getting a 12% return, and a 10% chance of getting an 8% return, what is the expected rate of return? A) 12% B) 13% C) 14% D) 15%

B) 13%

Spartan Sofas, Inc. is selling for $50.00 per share today. In one year, Spartan will be selling for $48.00 per share, and the dividend for the year will be $3.00. What is the cash return on Spartan stock? A) 0% B) 2% C) 6% D) 10%

B) 2%

Roddy Richards invested $12014.88 in Wolverine Meat Distributors (W.M.D.) five years ago. The investment had yearly arithmetic returns of -9.7%, -8.1%, 15%, 7.2%, and 15.4%. What is the arithmetic average return of Roddy Richard's investment? A) 2.42% B) 3.96% C) 5.18% D) 15.1%

B) 3.96%

Which of the following best measures the risk of holding an asset in isolation (i.e., stand-alone risk)? A) The mean co-variance B) The standard deviation C) The coefficient of optimization D) The standard asset pricing model E) The correlation

B) The standard deviation

You have invested in a project that has the following payoff schedule: Probability of Payoff Occurrence $40 .15 $50 .20 $60 .30 $70 .30 $80 .05 What is the expected value of the investment's payoff? (Round to the nearest $1.) A) $60 B) $65 C) $58 D) $70

C) $58

Susan Bright will get returns of 18%, -20.3%, -14%, 17.6%, and 8.3% in the next five years on her investment in CoffeeTown, Inc. stock, which she purchases for $73,419.66 today. How much will Susan's stock be worth if she sells it five years from today? A) $71,423.85 B) $73,419.66 C) $75,628.75 D) $80,333.40

C) $75,628.75

You are considering investing in a firm that has the following possible outcomes: Economic boom: probability of 25%; return of 25% Economic growth: probability of 60%; return of 15% Economic decline: probability of 15%; return of -5% What is the expected rate of return on the investment? A) 15.0% B) 11.7% C) 14.5% D) 25.0%

C) 14.5%

1) You purchased the stock of Sargent Motors at a price of $75.75 one year ago today. If you sell the stock today for $89.00, what is your holding period return? A) 35.00% B) 12.50% C) 17.50% D) 25.00%

C) 17.50%

Marcus Berger invested $9842.33 in Hawkeyehats, Inc. four years ago. He sold the stock today for $11,396.22. What is his geometric average return? A) There is insufficient information to derive an answer. B) 2.98% C) 3.73% D) 3.95%

C) 3.73%

You are considering investing in a project with the following possible outcomes: Probability of Investment States Occurrence Returns State 1: Economic boom 15% 16% State 2: Economic growth 45% 12% State 3: Economic decline 25% 5% State 4: Depression 15% -5% Calculate the expected rate of return for this investment. A) 9.8% B) 7.0% C) 8.3% D) 6.3%

C) 8.3%

Roddy Richards invested $12014.88 in Wolverine Meat Distributors (W.M.D.) five years ago. The investment had yearly arithmetic returns of -9.7%, -8.1%, 15%, 7.2%, and 15.4%. How much money did Roddy Richards receive when he sold his shares of W.M.D.? A) $12,014.88 B) $12,398.42 C) $13,663.47 D) $14,184.73

D) $14,184.73