Essentials of Investments 11th Edition by Zvi Bodie Professor - Test Bank Instant Download - Complete Test Bank With Answers Sample Questions Are Posted Below Essentials of Investments, 11e (Bodie) Chapter 5 Risk, Return, and the Historical Record 1) You put up $50 at the beginning of the year for …
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Essentials of Investments 11th Edition by Zvi Bodie Professor – Test Bank
Instant Download – Complete Test Bank With Answers
Sample Questions Are Posted Below
Essentials of Investments, 11e (Bodie)
Chapter 5 Risk, Return, and the Historical Record
1) You put up $50 at the beginning of the year for an investment. The value of the investment grows 4% and you earn a dividend of $3.50. Your HPR was ________.
Answer: D
Explanation: 4% + = 11%
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
2) The ________ measure of returns ignores compounding.
Answer: B
Difficulty: 1 Easy
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
3) If you want to measure the performance of your investment in a fund, including the timing of your purchases and redemptions, you should calculate the ________.
Answer: C
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
4) Which one of the following measures time-weighted returns and allows for compounding?
Answer: A
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
5) Rank the following from highest average historical return to lowest average historical return from 1926 to 2017.
III. Large stocks
Answer: C
Difficulty: 2 Medium
Topic: The Historical Record
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
6) Rank the following from highest average historical standard deviation to lowest average historical standard deviation from 1926 to 2017.
III. Large stocks
Answer: C
Difficulty: 2 Medium
Topic: The Historical Record
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
7) You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. If you desire to forecast performance for next year, the best forecast will be given by the ________.
Answer: C
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
8) The complete portfolio refers to the investment in ________.
Answer: C
Difficulty: 1 Easy
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
9) You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. You always reinvest your dividends and interest earned on the portfolio. Which method provides the best measure of the actual average historical performance of the investments you have chosen?
Answer: B
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
10) The holding period return on a stock is equal to ________.
Answer: B
Difficulty: 1 Easy
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
11) Your timing was good last year. You invested more in your portfolio right before prices went up, and you sold right before prices went down. In calculating historical performance measures, which one of the following will be the largest?
Answer: A
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
12) Published data on past returns earned by mutual funds are required to be ________.
Answer: B
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
13) The arithmetic average of -11%, 15%, and 20% is ________.
Answer: B
Explanation: = 8.00%
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
14) The geometric average of -12%, 20%, and 25% is ________.
Answer: C
Explanation: [(1 + -.12)(1 + .20)(1 + .25)]1/3 – 1 = 9.70%
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
15) The dollar-weighted return is the ________.
Answer: D
Difficulty: 1 Easy
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
16) An investment earns 10% the first year, earns 15% the second year, and loses 12% the third year. The total compound return over the 3 years was ________.
Answer: B
Explanation: (1.10)(1.15)(1 – .12) – 1 = 11.32%
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
17) Annual percentage rates can be converted to effective annual rates by means of the following formula:
Answer: A
Difficulty: 1 Easy
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
18) Suppose you pay $9,700 for a $10,000 par Treasury bill maturing in 3 months. What is the holding-period return for this investment?
Answer: B
Explanation: = 3.09%
Difficulty: 1 Easy
Topic: Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
19) Suppose you pay $9,800 for a $10,000 par Treasury bill maturing in 2 months. What is the annual percentage rate of return for this investment?
Answer: C
Explanation: = 12.24%
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
20) Suppose you pay $9,400 for a $10,000 par Treasury bill maturing in 6 months. What is the effective annual rate of return for this investment?
Answer: C
Explanation: – 1 = 13.17%
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
21) You have an APR of 7.5% with continuous compounding. The EAR is ________.
Answer: C
Explanation: EAR = e.075 – 1 = 7.79%
e = 2.71828
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
22) You have an EAR of 9%. The equivalent APR with continuous compounding is ________.
Answer: B
Explanation: LN[1 + .09] = 8.62%
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
23) The market risk premium is defined as ________.
Answer: A
Difficulty: 1 Easy
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
24) The excess return is the ________.
Answer: B
Difficulty: 1 Easy
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
25) The rate of return on ________ is known at the beginning of the holding period, while the rate of return on ________ is not known until the end of the holding period.
Answer: B
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
26) The reward-to-volatility ratio is given by ________.
Answer: A
Difficulty: 1 Easy
Topic: The Sharpe (Reward-to-Volatility) Ratio
Learning Objective: 05-04 Use the Sharpe ratio to evaluate the performance of a portfolio and provide a guide for capital allocation.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
27) Your investment has a 20% chance of earning a 30% rate of return, a 50% chance of earning a 10% rate of return, and a 30% chance of losing 6%. What is your expected return on this investment?
Answer: D
Explanation: (.2)(30%) + (.5)(10%) + (.3)(-6%) = 9.2%
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
28) Your investment has a 40% chance of earning a 15% rate of return, a 50% chance of earning a 10% rate of return, and a 10% chance of losing 3%. What is the standard deviation of this investment?
Answer: A
Explanation: E(rp) = (.4)(15%) + (.5)(10%) + (.10)(−3%) = 10.7%
σ(rp) = .4(.15 − .107)2 + .5(.10 − .107)2 + .10(−.03 − .107)2
σ(rp) = 5.14%
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
29) During the 1926-2013 period the geometric mean return on small-firm stocks was ________.
Answer: D
Difficulty: 2 Medium
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
30) During the 1926-2013 period the geometric mean return on Treasury bonds was ________.
Answer: A
Difficulty: 2 Medium
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
31) During the 1926-2013 period the Sharpe ratio was greatest for which of the following asset classes?
Answer: B
Difficulty: 2 Medium
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
32) During the 1986-2013 period, the Sharpe ratio was lowest for which of the following asset classes?
Answer: C
Difficulty: 2 Medium
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
33) During the 1926-2013 period which one of the following asset classes provided the lowest real return?
Answer: C
Difficulty: 2 Medium
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
34) Both investors and gamblers take on risk. The difference between an investor and a gambler is that an investor ________.
Answer: B
Difficulty: 1 Easy
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
35) Historical returns have generally been ________ for stocks of small firms as (than) for stocks of large firms.
Answer: C
Difficulty: 1 Easy
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
36) Historically, small-firm stocks have earned higher returns than large-firm stocks. When viewed in the context of an efficient market, this suggests that ________.
Answer: C
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
37) In calculating the variance of a portfolio’s returns, squaring the deviations from the mean results in:
III. A number for which the unit is percentage of returns
Answer: B
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
38) If you are promised a nominal return of 12% on a 1-year investment, and you expect the rate of inflation to be 3%, what real rate do you expect to earn?
Answer: B
Explanation: Real rate = (1.12/1.03) – 1 = 8.74%
Difficulty: 2 Medium
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
39) If you require a real growth in the purchasing power of your investment of 8%, and you expect the rate of inflation over the next year to be 3%, what is the lowest nominal return that you would be satisfied with?
Answer: D
Explanation: Nominal rate = (1.08)(1.03) – 1 = 11.24%
Difficulty: 2 Medium
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
40) One method of forecasting the risk premium is to use the ________.
Answer: C
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
41) Treasury bills are paying a 4% rate of return. A risk-averse investor with a risk aversion of A = 3 should invest entirely in a risky portfolio with a standard deviation of 24% only if the risky portfolio’s expected return is at least ________.
Answer: C
Explanation: A =
3 =
3 × .0576 = E(rp) − .04
E(rp) = .1728 + .04 = 21.28%
Difficulty: 3 Hard
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
42) In the mean standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called the ________.
Answer: A
Difficulty: 2 Medium
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
43) Most studies indicate that investors’ risk aversion is in the range ________.
Answer: B
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
44) Two assets have the following expected returns and standard deviations when the risk-free rate is 5%:
Asset A E(rA) = 10% σA = 20%
Asset B E(rB) = 15% σB = 27%
An investor with a risk aversion of A = 3 would find that ________ on a risk-return basis.
Answer: C
Explanation: Based on the relationship:
A =
The minimum acceptable return is given by:
E(rp) = + rf
For A: E(rA) = (3 × .04) + .05 = 17%
For B: E(rB) = (3 × .0729) + .05 = 26.87%
Difficulty: 3 Hard
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
45) Historically, the best asset for the long-term investor wanting to fend off the threats of inflation and taxes while making his money grow has been ________.
Answer: A
Difficulty: 1 Easy
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
46) The formula is used to calculate the ________.
Answer: A
Difficulty: 1 Easy
Topic: The Sharpe (Reward-to-Volatility) Ratio
Learning Objective: 05-04 Use the Sharpe ratio to evaluate the performance of a portfolio and provide a guide for capital allocation.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
47) A portfolio with a 25% standard deviation generated a return of 15% last year when T-bills were paying 4.5%. This portfolio had a Sharpe ratio of ________.
Answer: C
Explanation: = 0.42
Difficulty: 2 Medium
Topic: The Sharpe (Reward-to-Volatility) Ratio
Learning Objective: 05-04 Use the Sharpe ratio to evaluate the performance of a portfolio and provide a guide for capital allocation.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
48) Consider a Treasury bill with a rate of return of 5% and the following risky securities:
Security A: E(r) = .15; variance = .0400
Security B: E(r) = .10; variance = .0225
Security C: E(r) = .12; variance = .1000
Security D: E(r) = .13; variance = .0625
The investor must develop a complete portfolio by combining the risk-free asset with one of the securities mentioned above. The security the investor should choose as part of her complete portfolio to achieve the best CAL would be ________.
Answer: A
Explanation: A has the steepest slope, found as: Slope = (.15 – .05)/(.04).5 = .5000
Difficulty: 2 Medium
Topic: Passive Strategies and the Capital Market Line
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
49) You purchased a share of stock for $29. One year later you received $2.25 as dividend and sold the share for $28. Your holding-period return was ________.
Answer: C
Explanation: = 4.31%
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
50) Security A has a higher standard deviation of returns than security B. We would expect that:
III. The Sharpe ratio of A will be higher than the Sharpe ratio of B.
Answer: B
Difficulty: 2 Medium
Topic: The Sharpe (Reward-to-Volatility) Ratio
Learning Objective: 05-04 Use the Sharpe ratio to evaluate the performance of a portfolio and provide a guide for capital allocation.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
51) The holding-period return on a stock was 25%. Its ending price was $18, and its beginning price was $16. Its cash dividend must have been ________.
Answer: C
Explanation: HPR = (P1 + DIV – P0)/P0
HPR × P0 = P1 + DIV – P0
HPR × P0 – P1 + P0 = DIV
.25 × $16 – $18 + $16 = $2
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
52) An investor invests 70% of her wealth in a risky asset with an expected rate of return of 15% and a variance of 5%, and she puts 30% in a Treasury bill that pays 5%. Her portfolio’s expected rate of return and standard deviation are ________ and ________ respectively.
Answer: C
Explanation: E(rp) = .7(.15) + .3(.05) = 12%
σ(rp) = = 15.7%
Difficulty: 2 Medium
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
53) The holding-period return on a stock was 32%. Its beginning price was $25, and its cash dividend was $1.50. Its ending price must have been ________.
Answer: C
Explanation: HPR = (P1 + DIV – P0)/P0
HPR × P0 = P1 + DIV – P0
P1 = HPR × P0 – DIV + P0
P1 =.32 × $25 – $1.50 + 25 = $31.50
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
54) Consider the following two investment alternatives: First, a risky portfolio that pays a 15% rate of return with a probability of 40% or a 5% rate of return with a probability of 60%. Second, a Treasury bill that pays 6%. The risk premium on the risky investment is ________.
Answer: B
Explanation: Risk premium = [.4(.15) + .6(.05)] – .06 = .03
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
55) Consider the following two investment alternatives: First, a risky portfolio that pays a 20% rate of return with a probability of 60% or a 5% rate of return with a probability of 40%. Second, a Treasury bill that pays 6%. If you invest $50,000 in the risky portfolio, your expected profit after one year would be ________.
Answer: B
Explanation: E(rp) = (.6 × 20%) + (.4 × 5%) = 14%
Ending value = $50,000(1.14) = $57,000
Profit = $57,000 – 50,000 = $7,000
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
56) You invest $10,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 15% and a standard deviation of 21% and a Treasury bill with a rate of return of 5%. How much money should be invested in the risky asset to form a portfolio with an expected return of 11%?
Answer: A
Explanation: 15y + 5(1 – y) = 11; y = 60%; .60(10,000) = $6,000
Difficulty: 3 Hard
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
57) You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. ________ of your complete portfolio should be invested in the risky portfolio if you want your complete portfolio to have a standard deviation of 9%.
Answer: C
Explanation: σc = y × σp
9% = y × 20%
y = 9/20 = 45%
Difficulty: 1 Easy
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
58) You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. A portfolio that has an expected value in 1 year of $1,100 could be formed if you ________.
Answer: A
Explanation: $1,100 = y × (1,000)(1.16) + (1 – y)1,000(1.06), so y =.4
Difficulty: 3 Hard
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
59) You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. The slope of the capital allocation line formed with the risky asset and the risk-free asset is approximately ________.
Answer: C
Explanation: Slope = (16 – 6)/20 = .50
Difficulty: 2 Medium
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
60) You have $500,000 available to invest. The risk-free rate, as well as your borrowing rate, is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should ________.
Answer: D
Explanation: y × .16 + (1 – y) × .08 = .22
.16 y – .08 y + .08 = .22
.08 y = .14
y = 1.75
Put 1.75 × $500,000 = $875,000 in the risky asset by borrowing $375,000.
Difficulty: 3 Hard
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
61) The return on the risky portfolio is 15%. The risk-free rate, as well as the investor’s borrowing rate, is 10%. The standard deviation of return on the risky portfolio is 20%. If the standard deviation on the complete portfolio is 25%, the expected return on the complete portfolio is ________.
Answer: D
Explanation: σc = y × σp = .25
σc = y × .20 = .25
y = .25/.20 = 1.25
1 − y = −.25
E(rc) = 1.25 × 15% − .25 × 10% = 16.25%
Difficulty: 3 Hard
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
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62) You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 11%, you should invest ________ of your complete portfolio in Treasury bills.
Answer: A
Explanation: .11 = Wf (.05) + (1 − Wf)[(.6)(.14) + (.4)(.10)]
Wf = .19
Difficulty: 3 Hard
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
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63) You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 8%, you should invest approximately ________ in the risky portfolio. This will mean you will also invest approximately ________ and ________ of your complete portfolio in security X and Y, respectively.
Answer: C
Explanation: E(rp) = .6(14) + .4(10) = 12.4%
.08 = wrp(.124) + (1 – wrp)(.05)
wrp ≈ 40%
wx in complete portfolio = .40(.60) = 24%
wy in complete portfolio = .40(.40) = 16%
Difficulty: 3 Hard
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
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64) You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. If you decide to hold 25% of your complete portfolio in the risky portfolio and 75% in the Treasury bills, then the dollar values of your positions in X and Y, respectively, would be ________ and ________.
Answer: B
Explanation: X = 1,000(.25)(.6) = 150
Y = 1,000(.25)(.4) = 100
Difficulty: 2 Medium
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
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65) You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. The dollar values of your positions in X, Y, and Treasury bills would be ________, ________, and ________, respectively, if you decide to hold a complete portfolio that has an expected return of 8%.
Answer: B
Explanation: .08(1,000) = F(.05) + (1,000 − F)[.6(.14) + .4(.10)]
F = 595
X = (1,000 − 595)(.6) = 243
Y = (1,000 − 595)(.4) = 162
Difficulty: 3 Hard
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Apply
AACSB: Analytical Thinking
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66) You have the following rates of return for a risky portfolio for several recent years:
2013 35.23%
2014 18.67%
2015 −9.87%
2016 23.45%
If you invested $1,000 at the beginning of 2013, your investment at the end of 2016 would be worth ________.
Answer: B
Explanation: $1,000(1.3523)(1.1867)(1 + -.0987)(1.2345) = $1,785.56
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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67) You have the following rates of return for a risky portfolio for several recent years:
2013 35.23%
2014 18.67%
2015 −9.87%
2016 23.45%
The annualized (geometric) average return on this investment is ________.
Answer: D
Explanation: (1.78556)(1/4) = 1.156
1.156 – 1 = 15.6%
Difficulty: 3 Hard
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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68) A security with normally distributed returns has an annual expected return of 18% and standard deviation of 23%. The probability of getting a return between -28% and 64% in any one year is ________.
Answer: B
Explanation: Note that the expected return minus 2 standard deviations is 18% – (2 × 23%) = -28% and the expected return plus 2 standard deviations is 18% + (2 × 23%) = 64%. The probability of a return falling within ± 2 standard deviations is 95.44%.
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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69) The Manhawkin Fund has an expected return of 16% and a standard deviation of 20%. The risk-free rate is 4%. What is the reward-to-volatility ratio for the Manhawkin Fund?
Answer: B
Explanation: (16 – 4)/20 = .6
Difficulty: 2 Medium
Topic: The Sharpe (Reward-to-Volatility) Ratio
Learning Objective: 05-04 Use the Sharpe ratio to evaluate the performance of a portfolio and provide a guide for capital allocation.
Bloom’s: Apply
AACSB: Analytical Thinking
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70) From 1926 to 2013 the world stock portfolio offered ________ return and ________ volatility than the portfolio of large U.S. stocks.
Answer: B
Difficulty: 2 Medium
Topic: The Historical Record
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
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71) The price of a stock is $55 at the beginning of the year and $50 at the end of the year. If the stock paid a $3 dividend and inflation was 3%, what is the real holding-period return for the year?
Answer: C
Explanation: Nominal return on stock: (50 + 3)/55 – 1 = -3.64%
Real return: (1 + R) = (1 + r)(1 + i)
1 + r = (1 – .0364)/(1.03) = .935
R = .935 – 1 = -.0644
Difficulty: 3 Hard
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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72) The price of a stock is $38 at the beginning of the year and $41 at the end of the year. If the stock paid a $2.50 dividend, what is the holding-period return for the year?
Answer: C
Explanation: HPR = (41 – 38 + 2.50)/38 = .1447
Difficulty: 1 Easy
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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73) You invest all of your money in 1-year T-bills. Which of the following statements is (are) correct?
III. Your nominal Sharpe ratio is zero.
Answer: B
Difficulty: 2 Medium
Topic: The Sharpe (Reward-to-Volatility) Ratio
Learning Objective: 05-04 Use the Sharpe ratio to evaluate the performance of a portfolio and provide a guide for capital allocation.
Bloom’s: Remember
AACSB: Analytical Thinking
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74) Which one of the following would be considered a risk-free asset in real terms as opposed to nominal?
Answer: D
Difficulty: 2 Medium
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
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75) What is the geometric average return of the following quarterly returns: 3%, 5%, 4%, and 7%?
Answer: C
Explanation: Return = (1.03 × 1.04 × 1.05 × 1.07).25 – 1 = .0474
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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76) What is the geometric average return over 1 year if the quarterly returns are 8%, 9%, 5%, and 12%?
Answer: C
Explanation: Return = (1.05 × 1.08 × 1.09 × 1.12).25 – 1 = .0847
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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77) If the nominal rate of return on investment is 6% and inflation is 2% over a holding period, what is the real rate of return on this investment?
Answer: A
Explanation: 1 + r = (1 + R)/(1 + i) – 1
1 + r = 1.06/1.02 – 1 = .0392
Difficulty: 2 Medium
Topic: Inflation and Real Rates of Return
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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78) According to historical data, over the long run which of the following assets has the best chance to provide the best after-inflation, after-tax rate of return?
Answer: C
Difficulty: 1 Easy
Topic: The Historical Record
Learning Objective: 05-02 Use either historical data on the past performance of stocks and bond’s or forward-looking scenario analysis to characterize the risk and return features of these investments.
Bloom’s: Remember
AACSB: Analytical Thinking
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79) The buyer of a new home is quoted a mortgage rate of .5% per month. What is the APR on the loan?
Answer: C
Explanation: APR = .5% × 12 = 6%
Difficulty: 1 Easy
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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80) A loan for a new car costs the borrower .8% per month. What is the EAR?
Answer: D
Explanation: 1.00812 – 1 = 10.03%
Difficulty: 2 Medium
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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81) The CAL provided by combinations of 1-month T-bills and a broad index of common stocks is called the ________.
Answer: C
Difficulty: 1 Easy
Topic: Asset Allocation across Risky and Risk-Free Portfolios
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Remember
AACSB: Analytical Thinking
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82) Which of the following arguments supporting passive investment strategies is (are) correct?
III. Passive investors are guaranteed to earn higher rates of return than active investors over sufficiently long time horizons.
Answer: B
Difficulty: 2 Medium
Topic: Passive Strategies and the Capital Market Line
Learning Objective: 05-03 Determine the expected return and risk of portfolios that are constructed by combining risky assets with risk-free investments in Treasury bills.
Bloom’s: Remember
AACSB: Analytical Thinking
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83) You have the following rates of return for a risky portfolio for several recent years. Assume that the stock pays no dividends.
| Year | Beginning of Year Price | # of Shares Bought or Sold | ||||
| 2014 | $ | 50.00 | 100 bought | |||
| 2015 | $ | 55.00 | 50 bought | |||
| 2016 | $ | 51.00 | 75 sold | |||
| 2017 | $ | 54.00 | 75 sold | |||
What is the geometric average return for the period?
Answer: C
Explanation: yr1 = 10% yr2 = 7.27% yr3 = 5.88%
[(1.10)(1 + -.0727)(1.0588)]⅓ – 1 = 2.60%
Difficulty: 3 Hard
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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84) You have the following rates of return for a risky portfolio for several recent years. Assume that the stock pays no dividends.
| Year | Beginning of Year Price | # of Shares Bought or Sold | ||||
| 2014 | $ | 50.00 | 100 bought | |||
| 2015 | $ | 55.00 | 50 bought | |||
| 2016 | $ | 51.00 | 75 sold | |||
| 2017 | $ | 54.00 | 75 sold | |||
What is the dollar-weighted return over the entire time period?
Answer: B
Explanation: + + +
IRR = .744%
Difficulty: 3 Hard
Topic: Rates of Return
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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85) If you believe you have a 60% chance of doubling your money, a 30% chance of gaining 15%, and a 10% chance of losing your entire investment, what is your expected return?
Answer: C
Explanation: (.60 × 100%) + (.30 × 15%) + (.10 × -100%) = 54.5%
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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86) The normal distribution is completely described by its ________.
Answer: A
Difficulty: 1 Easy
Topic: Risk and Risk Premiums
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
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87) Which measure of downside risk predicts the worst loss that will be suffered with a given probability?
Answer: C
Difficulty: 1 Easy
Topic: Risk and Risk Premiums
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Remember
AACSB: Analytical Thinking
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88) What is the VaR of a $10 million portfolio with normally distributed returns at the 5% VaR? Assume the expected return is 13% and the standard deviation is 20%.
Answer: D
Explanation: VaR = 13 – 1.64485(20%)= -19.90%
Difficulty: 2 Medium
Topic: Risk and Risk Premiums
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
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89) Your great aunt Zella invested $100 in 1925 in a portfolio of large U.S. stocks that earned a compound return of 10% annually.If she left that money to you, how much would be in the account 92 years later in 2017?
Answer: C
Explanation: $100(1.10)92 = 642,875.74
Keystrokes: 100 PV, 10 i/yr, 92 n, Solve for FV = 642,875.74
Difficulty: 2 Medium
Topic: The Historical Record
Learning Objective: 05-01 Compute various measures of return on multiyear investments.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
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