Investments 10th Edition By Bodie - Test Bank Instant Download - Complete Test Bank With Answers Sample Questions Are Posted Below Chapter 05 Risk, Return, and the Historical Record Multiple Choice Questions 1. Over the past year you earned a nominal rate of interest of 10% on your money. The …
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Investments 10th Edition By Bodie – Test Bank
Instant Download – Complete Test Bank With Answers
Sample Questions Are Posted Below
Chapter 05
Risk, Return, and the Historical Record
Multiple Choice Questions
| 1. | Over the past year you earned a nominal rate of interest of 10% on your money. The inflation rate was 5% over the same period. The exact actual growth rate of your purchasing power was
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| 2. | Over the past year you earned a nominal rate of interest of 8% on your money. The inflation rate was 4% over the same period. The exact actual growth rate of your purchasing power was
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| 3. | A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 9%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year?
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| 4. | A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year?
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| 5. | If the annual real rate of interest is 5% and the expected inflation rate is 4%, the nominal rate of interest would be approximately
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| 6. | If the annual real rate of interest is 2.5% and the expected inflation rate is 3.7%, the nominal rate of interest would be approximately
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| 7. | You purchased a share of stock for $20. One year later you received $1 as a dividend and sold the share for $29. What was your holding-period return?
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| 8. | You purchased a share of stock for $68. One year later you received $3.00 as a dividend and sold the share for $74.50. What was your holding-period return?
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| 9. | Which of the following determine(s) the level of real interest rates?
I) The supply of savings by households and business firms
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| 10. | Which of the following statement(s) is(are) true?
I) The real rate of interest is determined by the supply and demand for funds.
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| 11. | Which of the following statement(s) is(are) true?
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| 12. | Other things equal, an increase in the government budget deficit
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| 13. | Ceteris paribus, a decrease in the demand for loanable funds
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| 14. | The holding-period return (HPR) on a share of stock is equal to
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| 15. | Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2012 show that
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| 16. | If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of inflation,
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| 17. | You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected holding-period return for KMP stock?
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| 18. | You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected standard deviation for KMP stock?
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| 19. | You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected variance for KMP stock?
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| 20. | If the nominal return is constant, the after-tax real rate of return
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| 21. | The risk premium for common stocks
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| 22. | If a portfolio had a return of 18%, the risk-free asset return was 5%, and the standard deviation of the portfolio’s excess returns was 34%, the risk premium would be
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| 23. | You purchase a share of Boeing stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding-period return?
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| 24. | Toyota stock has the following probability distribution of expected prices one year from now:
If you buy Toyota today for $55 and it will pay a dividend during the year of $4 per share, what is your expected holding-period return on Toyota?
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| 25. | Which of the following factors would not be expected to affect the nominal interest rate?
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| 26. | If a portfolio had a return of 11%, the risk-free asset return was 6%, and the standard deviation of the portfolio’s excess returns was 25%, the risk premium would be
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| 27. | In words, the real rate of interest is approximately equal to
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| 28. | If the Federal Reserve lowers the discount rate, ceteris paribus, the equilibrium levels of funds lent will __________ and the equilibrium level of real interest rates will ___________.
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| 29. | What has been the relationship between T-Bill rates and inflation rates since the 1980s?
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| 30. | “Bracket Creep” happens when
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| 31. | The holding-period return (HPR) for a stock is equal to
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| 32. | You have been given this probability distribution for the holding-period return for Cheese, Inc. stock:
Assuming that the expected return on Cheese’s stock is 14.35%, what is the standard deviation of these returns?
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| 33. | An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980. What is the holding-period return on his investment?
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| 34. | An investor purchased a bond 63 days ago for $980. He received $17 in interest and sold the bond for $987. What is the holding-period return on his investment?
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| 35. | Over the past year you earned a nominal rate of interest of 8% on your money. The inflation rate was 3.5% over the same period. The exact actual growth rate of your purchasing power was
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| 36. | Over the past year you earned a nominal rate of interest of 14% on your money. The inflation rate was 2% over the same period. The exact actual growth rate of your purchasing power was
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| 37. | Over the past year you earned a nominal rate of interest of 12.5% on your money. The inflation rate was 2.6% over the same period. The exact actual growth rate of your purchasing power was
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| 38. | A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 6%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year?
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| 39. | A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 3%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year?
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| 40. | A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 5.7%. What is your approximate annual real rate of return if the rate of inflation was 1.6% over the year?
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| 41. | A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 2.5%. What is your approximate annual real rate of return if the rate of inflation was 3.4% over the year?
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| 42. | A year ago, you invested $12,000 in an investment that produced a return of 18%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year?
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| 43. | If the annual real rate of interest is 3.5% and the expected inflation rate is 2.5%, the nominal rate of interest would be approximately
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| 44. | If the annual real rate of interest is 2.5% and the expected inflation rate is 3.4%, the nominal rate of interest would be approximately
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| 45. | If the annual real rate of interest is 4% and the expected inflation rate is 3%, the nominal rate of interest would be approximately
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| 46. | You purchased a share of stock for $12. One year later you received $0.25 as a dividend and sold the share for $12.92. What was your holding-period return?
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| 47. | You purchased a share of stock for $120. One year later you received $1.82 as a dividend and sold the share for $136. What was your holding-period return?
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| 48. | You purchased a share of stock for $65. One year later you received $2.37 as a dividend and sold the share for $63. What was your holding-period return?
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| 49. | You have been given this probability distribution for the holding-period return for a stock:
What is the expected holding-period return for the stock?
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| 50. | You have been given this probability distribution for the holding-period return for a stock:
What is the expected standard deviation for the stock?
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| 51. | You have been given this probability distribution for the holding-period return for a stock:
What is the expected variance for the stock?
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| 52. | Which of the following measures of risk best highlights the potential loss from extreme negative returns?
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| 53. | Over the past year you earned a nominal rate of interest of 3.6% on your money. The inflation rate was 3.1% over the same period. The exact actual growth rate of your purchasing power was
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| 54. | A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 4.3%. What is your approximate annual real rate of return if the rate of inflation was 3% over the year?
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| 55. | If the annual real rate of interest is 3.5% and the expected inflation rate is 3.5%, the nominal rate of interest would be approximately
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| 56. | You purchased a share of CSCO stock for $20. One year later you received $2 as a dividend and sold the share for $31. What was your holding-period return?
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| 57. | You have been given this probability distribution for the holding-period return for GM stock:
What is the expected holding-period return for GM stock?
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| 58. | You have been given this probability distribution for the holding-period return for GM stock:
What is the expected standard deviation for GM stock?
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| 59. | You have been given this probability distribution for the holding-period return for GM stock:
What is the expected variance for GM stock?
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| 60. | You purchase a share of CAT stock for $90. One year later, after receiving a dividend of $4, you sell the stock for $97. What was your holding-period return?
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| 61. | When comparing investments with different horizons, the ____________ provides the more accurate comparison.
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| 62. | Annual percentage rates (APRs) are computed using
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| 63. | An investment provides a 2% return semi-annually, its effective annual rate is
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| 64. | If an investment provides a 1.25% return quarterly, its effective annual rate is
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| 65. | If an investment provides a 0.78% return monthly, its effective annual rate is
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| 66. | If an investment provides a 3% return semi-annually, its effective annual rate is
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| 67. | If an investment provides a 2.1% return quarterly, its effective annual rate is
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| 68. | Skewness is a measure of
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| 69. | Kurtosis is a measure of
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| 70. | When a distribution is positively skewed,
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| 71. | When a distribution is negatively skewed,
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| 72. | If a distribution has “fat tails,” it exhibits
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| 73. | If a portfolio had a return of 8%, the risk-free asset return was 3%, and the standard deviation of the portfolio’s excess returns was 20%, the Sharpe measure would be
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| 74. | If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio’s excess returns was 25%, the Sharpe measure would be
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| 75. | If a portfolio had a return of 15%, the risk-free asset return was 5%, and the standard deviation of the portfolio’s excess returns was 30%, the Sharpe measure would be
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| 76. | If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio’s excess returns was 25%, the risk premium would be
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| 77. | ________ is a risk measure that indicates vulnerability to extreme negative returns.
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| 78. | ________ is a risk measure that indicates vulnerability to extreme negative returns.
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| 79. | The most common measure of loss associated with extremely negative returns is
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| 80. | Practitioners often use a ________% VaR, meaning that ________% of returns will exceed the VaR, and ________% will be worse.
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| 81. | When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the
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| 82. | When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside exposure would be
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Short Answer Questions
| 83. | Discuss the relationships between interest rates (both real and nominal), expected inflation rates, and tax rates on investment returns.
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| 84. | Discuss why common stocks must earn a risk premium.
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| 85. | Discuss the historical distributions of each of the following in terms of their average return and the dispersion of their returns: U.S. small company stocks, U.S. large company stocks, and U.S. long-term government bonds. Would any of these investments cause a loss in purchasing power during a 1926-2009 holding period?
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| 86. | Discuss some reasons why an investor with a longtime horizon might choose to invest in common stocks, even though they have historically been riskier than government bonds or T-bills.
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Chapter 05 Risk, Return, and the Historical Record Answer Key
Multiple Choice Questions
| 1. | Over the past year you earned a nominal rate of interest of 10% on your money. The inflation rate was 5% over the same period. The exact actual growth rate of your purchasing power was
r = (1 + R)/(1 + I) -1; 1.10%/1.05% – 1 = 4.8%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 2. | Over the past year you earned a nominal rate of interest of 8% on your money. The inflation rate was 4% over the same period. The exact actual growth rate of your purchasing power was
r = (1 + R)/(1 + I) – 1; 1.08%/1.04% – 1 = 3.8%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 3. | A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 9%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year?
9% – 4% = 5%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Rates of Return |
| 4. | A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year?
5% – 3.5% = 1.5%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Rates of Return |
| 5. | If the annual real rate of interest is 5% and the expected inflation rate is 4%, the nominal rate of interest would be approximately
5% + 4% = 9%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Rates of Return |
| 6. | If the annual real rate of interest is 2.5% and the expected inflation rate is 3.7%, the nominal rate of interest would be approximately
2.5% + 3.7% = 6.2%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Rates of Return |
| 7. | You purchased a share of stock for $20. One year later you received $1 as a dividend and sold the share for $29. What was your holding-period return?
($1 + $29 – $20)/$20 = 0.5000, or 50%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 8. | You purchased a share of stock for $68. One year later you received $3.00 as a dividend and sold the share for $74.50. What was your holding-period return?
($3.00 + $74.50 – $68.00)/$68.00 = 0.1397, or 14.0%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 9. | Which of the following determine(s) the level of real interest rates?
I) The supply of savings by households and business firms
The value of savings by households is the major supply of funds; the demand for investment funds is a portion of the total demand for funds; the government’s position can be one of either net supplier or net demander of funds. The above factors constitute the total supply and demand for funds, which determine real interest rates. |
| AACSB: Analytic Blooms: Remember Difficulty: Intermediate Topic: Interest Rate Determinants |
| 10. | Which of the following statement(s) is(are) true?
I) The real rate of interest is determined by the supply and demand for funds.
The expected rate of inflation is a determinant of nominal, not real, interest rates. Real rates are determined by the supply and demand for funds, which can be affected by the Fed. |
| AACSB: Analytic Blooms: Understand Difficulty: Intermediate Topic: Interest Rate Determinants |
| 11. | Which of the following statement(s) is(are) true?
Expected inflation rates are a determinant of nominal interest rates. The realized nominal rate of interest would be negative if the difference between actual and anticipated inflation rates exceeded the real rate. The realized nominal rate of interest would be less than the real rate if the unexpected inflation were greater than the real rate of interest. Certificates of deposit contain a real rate based on an estimate of inflation that is not guaranteed. |
| AACSB: Analytic Blooms: Understand Difficulty: Intermediate Topic: Rates of Return |
| 12. | Other things equal, an increase in the government budget deficit
An increase in the government budget deficit, other things equal, causes the government to increase its borrowing, which increases the demand for funds and drives interest rates up. |
| AACSB: Analytic Blooms: Understand Difficulty: Intermediate Topic: Interest Rate Determinants |
| 13. | Ceteris paribus, a decrease in the demand for loanable funds
A decrease in demand, ceteris paribus, always drives interest rates down. An increase in business prospects would increase the demand for funds. The savings level affects the supply of, not the demand for, funds. |
| AACSB: Analytic Blooms: Understand Difficulty: Intermediate Topic: Interest Rate Determinants |
| 14. | The holding-period return (HPR) on a share of stock is equal to
The HPR of any investment is the sum of the capital gain and the cash flow over the period, which for common stock is B. |
| AACSB: Analytic Blooms: Understand Difficulty: Intermediate Topic: Risk |
| 15. | Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2012 show that
The historical data show that, as expected, stocks offer a greater return and greater volatility than the other investment alternatives. Inflation sometimes exceeded the T-bill return. |
| AACSB: Analytic Blooms: Remember Difficulty: Intermediate Topic: Rates of Return |
| 16. | If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of inflation,
If the described interest rate accurately reflects the rate of inflation, both borrowers and lenders are paying and receiving, respectively, the real rate of interest; thus, neither group gains. |
| AACSB: Analytic Blooms: Understand Difficulty: Intermediate Topic: Interest Rate Determinants |
| 17. | You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected holding-period return for KMP stock?
HPR = .30 (18%) + .50 (12%) + .20 (-5%) = 10.4%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 18. | You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected standard deviation for KMP stock?
s = [.30 (18 – 10.4)2 + .50 (12 – 10.4)2 + .20 (-5 – 10.4)2]1/2 = 8.13%. |
| AACSB: Analytic Blooms: Apply Difficulty: Challenge Topic: Return Analysis |
| 19. | You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected variance for KMP stock?
Variance = [.30 (18 – 10.4)2 + .50 (12 – 10.4)2 + .20 (-5 – 10.4)2] = 66.04%. |
| AACSB: Analytic Blooms: Apply Difficulty: Challenge Topic: Return Analysis |
| 20. | If the nominal return is constant, the after-tax real rate of return
Inflation rates have an inverse effect on after-tax real rates of return. |
| AACSB: Analytic Blooms: Understand Difficulty: Intermediate Topic: Taxes and Interest |
| 21. | The risk premium for common stocks
If the risk premium for common stocks were zero or negative, investors would be unwilling to accept the lower returns for the increased risk. |
| AACSB: Analytic Blooms: Understand Difficulty: Intermediate Topic: Risk |
| 22. | If a portfolio had a return of 18%, the risk-free asset return was 5%, and the standard deviation of the portfolio’s excess returns was 34%, the risk premium would be
18 – 5 = 13%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 23. | You purchase a share of Boeing stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding-period return?
HPR = (92 – 90 + 3)/90 = 5.56%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 24. | Toyota stock has the following probability distribution of expected prices one year from now:
If you buy Toyota today for $55 and it will pay a dividend during the year of $4 per share, what is your expected holding-period return on Toyota?
E(P1) = .25 (54/55 – 1) + .40 (64/55 – 1) + .35 (74/55 – 1) = 18.18%. |
| AACSB: Analytic Blooms: Apply Difficulty: Challenge Topic: Risk |
| 25. | Which of the following factors would not be expected to affect the nominal interest rate?
The nominal interest rate is affected by supply, demand, government actions, and inflation. Coupon rates on previously issued government bonds reflect historical interest rates but should not affect the current level of interest rates. |
| AACSB: Analytic Blooms: Remember Difficulty: Basic Topic: Interest Rate Determinants |
| 26. | If a portfolio had a return of 11%, the risk-free asset return was 6%, and the standard deviation of the portfolio’s excess returns was 25%, the risk premium would be
11 – 6 = 5%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 27. | In words, the real rate of interest is approximately equal to
The actual relationship is (1 + real rate) = (1 + nominal rate)/(1 + inflation rate). This can be approximated by the equation: Real rate = nominal rate – inflation rate. |
| AACSB: Analytic Blooms: Remember Difficulty: Basic Topic: Rates of Return |
| 28. | If the Federal Reserve lowers the discount rate, ceteris paribus, the equilibrium levels of funds lent will __________ and the equilibrium level of real interest rates will ___________.
A lower discount rate would encourage banks to make more loans, which would increase the money supply. The supply curve would shift to the right and the equilibrium level of funds would increase while the equilibrium interest rate would fall. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Interest Rate Determinants |
| 29. | What has been the relationship between T-Bill rates and inflation rates since the 1980s?
The T-Bill rate was higher than the inflation rate for over two decades. |
| AACSB: Analytic Blooms: Remember Difficulty: Intermediate Topic: Return Analysis |
| 30. | “Bracket Creep” happens when
A positive inflation rate typically leads to higher nominal income. Higher nominal income means people will have higher tax liabilities and in some cases will put them in higher tax brackets. This can happen even when real income has declined. |
| AACSB: Analytic Blooms: Remember Difficulty: Intermediate Topic: Taxes and Interest |
| 31. | The holding-period return (HPR) for a stock is equal to
HPR consists of an income component and a price change component. The income component on a stock is the dividend yield. The price change component is the capital gains yield. |
| AACSB: Analytic Blooms: Remember Difficulty: Basic Topic: Risk |
| 32. | You have been given this probability distribution for the holding-period return for Cheese, Inc. stock:
Assuming that the expected return on Cheese’s stock is 14.35%, what is the standard deviation of these returns?
Variance = .20 × (24 – 14.35)2 + .45 × (15 – 14.35)2 + .35 × (8 – 14.35)2 = 32.9275. Standard deviation = 32.92751/2 = 5.74. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Return Analysis |
| 33. | An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980. What is the holding-period return on his investment?
HPR = ($15 + 980 – 985)/$985 = .010152284 = approximately 1.02%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Risk |
| 34. | An investor purchased a bond 63 days ago for $980. He received $17 in interest and sold the bond for $987. What is the holding-period return on his investment?
HPR = ($17 + 987 – 980)/$980 = .0244898 = approximately 2.45%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Risk |
| 35. | Over the past year you earned a nominal rate of interest of 8% on your money. The inflation rate was 3.5% over the same period. The exact actual growth rate of your purchasing power was
r = (1 + R)/(1 + I) – 1; 1.08/1.035 – 1 = 4.35%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 36. | Over the past year you earned a nominal rate of interest of 14% on your money. The inflation rate was 2% over the same period. The exact actual growth rate of your purchasing power was
r = (1 + R)/(1 + I) – 1; 1.14/1.02 – 1 = 11.76%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 37. | Over the past year you earned a nominal rate of interest of 12.5% on your money. The inflation rate was 2.6% over the same period. The exact actual growth rate of your purchasing power was
r = (1 + R)/(1 + I) – 1; 1.125/1.026 – 1 = 9.65%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 38. | A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 6%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year?
6% – 2% = 4%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Rates of Return |
| 39. | A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 3%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year?
3% – 4% = -1%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Rates of Return |
| 40. | A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 5.7%. What is your approximate annual real rate of return if the rate of inflation was 1.6% over the year?
5.7% – 1.6% = 4.1%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Rates of Return |
| 41. | A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 2.5%. What is your approximate annual real rate of return if the rate of inflation was 3.4% over the year?
2.5% – 3.4% = -0.9%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Rates of Return |
| 42. | A year ago, you invested $12,000 in an investment that produced a return of 18%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year?
18% – 2% = 16%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Rates of Return |
| 43. | If the annual real rate of interest is 3.5% and the expected inflation rate is 2.5%, the nominal rate of interest would be approximately
3.5% + 2.5% = 6%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Interest Rate Determinants |
| 44. | If the annual real rate of interest is 2.5% and the expected inflation rate is 3.4%, the nominal rate of interest would be approximately
2.5% + 3.4% = 5.9%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Interest Rate Determinants |
| 45. | If the annual real rate of interest is 4% and the expected inflation rate is 3%, the nominal rate of interest would be approximately
4% + 3% = 7%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Interest Rate Determinants |
| 46. | You purchased a share of stock for $12. One year later you received $0.25 as a dividend and sold the share for $12.92. What was your holding-period return?
($0.25 + $12.92 – $12)/$12 = 0.0975, or 9.75%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 47. | You purchased a share of stock for $120. One year later you received $1.82 as a dividend and sold the share for $136. What was your holding-period return?
($1.82 + $136 – $120)/$120 = 0.1485, or 14.85%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 48. | You purchased a share of stock for $65. One year later you received $2.37 as a dividend and sold the share for $63. What was your holding-period return?
($2.37 + $63 – $65)/$65 = 0.00569, or 0.57%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 49. | You have been given this probability distribution for the holding-period return for a stock:
What is the expected holding-period return for the stock?
HPR = .40 (22%) + .35 (11%) + .25 (-9%) = 10.4%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 50. | You have been given this probability distribution for the holding-period return for a stock:
What is the expected standard deviation for the stock?
s = [.40 (22 – 10.4)2 + .35 (11 – 10.4)2 + .25 (-9 – 10.4)2]1/2 = 12.167%. |
| AACSB: Analytic Blooms: Apply Difficulty: Challenge Topic: Return Analysis |
| 51. | You have been given this probability distribution for the holding-period return for a stock:
What is the expected variance for the stock?
Variance = [.40 (22 – 10.4)2 + .35 (11 – 10.4)2 + .25 (-9 – 10.4)2] = 148.04%. |
| AACSB: Analytic Blooms: Apply Difficulty: Challenge Topic: Return Analysis |
| 52. | Which of the following measures of risk best highlights the potential loss from extreme negative returns?
Only VaR measures potential loss from extreme negative returns. |
| AACSB: Analytic Blooms: Understand Difficulty: Intermediate Topic: Risk |
| 53. | Over the past year you earned a nominal rate of interest of 3.6% on your money. The inflation rate was 3.1% over the same period. The exact actual growth rate of your purchasing power was
r = (1 + R)/(1 + I) – 1; 1.036/1.031% – 1 = 0.484%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Return Analysis |
| 54. | A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 4.3%. What is your approximate annual real rate of return if the rate of inflation was 3% over the year?
4.3% – 3% = 1.3%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Return Analysis |
| 55. | If the annual real rate of interest is 3.5% and the expected inflation rate is 3.5%, the nominal rate of interest would be approximately
3.5% + 3.5% = 7%. |
| AACSB: Analytic Blooms: Apply Difficulty: Basic Topic: Return Analysis |
| 56. | You purchased a share of CSCO stock for $20. One year later you received $2 as a dividend and sold the share for $31. What was your holding-period return?
($2 + $31 – $20)/$20 = 0.65, or 65%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 57. | You have been given this probability distribution for the holding-period return for GM stock:
What is the expected holding-period return for GM stock?
HPR = .40 (30%) + .40 (11%) + .20 (-10%) = 14.4%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 58. | You have been given this probability distribution for the holding-period return for GM stock:
What is the expected standard deviation for GM stock?
s = [.40 (30 – 14.4)2 + .40 (11 – 14.4)2 + .20 (-10 – 14.4)2]1/2 = 14.87%. |
| AACSB: Analytic Blooms: Apply Difficulty: Challenge Topic: Return Analysis |
| 59. | You have been given this probability distribution for the holding-period return for GM stock:
What is the expected variance for GM stock?
Variance = [.40 (30 – 14.4)2 + .40 (11 – 14.4)2 + .20 (-10 – 14.4)2] = 221.04%. |
| AACSB: Analytic Blooms: Apply Difficulty: Challenge Topic: Return Analysis |
| 60. | You purchase a share of CAT stock for $90. One year later, after receiving a dividend of $4, you sell the stock for $97. What was your holding-period return?
HPR = ([97 – 90] + 4)/90 = 12.22%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 61. | When comparing investments with different horizons, the ____________ provides the more accurate comparison.
The effective annual rate provides the more accurate comparison of investments with different horizons because it expresses the returns in a common period. |
| AACSB: Analytic Blooms: Remember Difficulty: Basic Topic: Return Analysis |
| 62. | Annual percentage rates (APRs) are computed using
APRs use simple interest. |
| AACSB: Analytic Blooms: Remember Difficulty: Basic Topic: Rates of Return |
| 63. | An investment provides a 2% return semi-annually, its effective annual rate is
(1.02)2 – 1 = 4.04%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 64. | If an investment provides a 1.25% return quarterly, its effective annual rate is
(1.0125)4 – 1 = 5.09%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 65. | If an investment provides a 0.78% return monthly, its effective annual rate is
(1.0078)12 – 1 = 9.77%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 66. | If an investment provides a 3% return semi-annually, its effective annual rate is
(1.03)2 – 1 = 6.09%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 67. | If an investment provides a 2.1% return quarterly, its effective annual rate is
(1.021)4 – 1 = 8.67%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Rates of Return |
| 68. | Skewness is a measure of
Skewness is a measure of the normality of a distribution. |
| AACSB: Analytic Blooms: Remember Difficulty: Intermediate Topic: Normal Distribution |
| 69. | Kurtosis is a measure of
Kurtosis is a measure of the normality of a distribution that specifically measures how fat the tails are. |
| AACSB: Analytic Blooms: Remember Difficulty: Intermediate Topic: Normal Distribution |
| 70. | When a distribution is positively skewed,
When a distribution is positively skewed, standard deviation overestimates risk. |
| AACSB: Analytic Blooms: Remember Difficulty: Intermediate Topic: Normal Distribution |
| 71. | When a distribution is negatively skewed,
When a distribution is negatively skewed, standard deviation underestimates risk. |
| AACSB: Analytic Blooms: Remember Difficulty: Intermediate Topic: Normal Distribution |
| 72. | If a distribution has “fat tails,” it exhibits
Kurtosis is a measure of the tails of a distribution, or “fat tails.” |
| AACSB: Analytic Blooms: Remember Difficulty: Intermediate Topic: Normal Distribution |
| 73. | If a portfolio had a return of 8%, the risk-free asset return was 3%, and the standard deviation of the portfolio’s excess returns was 20%, the Sharpe measure would be
(8 – 3)/20 = 0.25. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Return Analysis |
| 74. | If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio’s excess returns was 25%, the Sharpe measure would be
(12 – 4)/25 = 0.32. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Return Analysis |
| 75. | If a portfolio had a return of 15%, the risk-free asset return was 5%, and the standard deviation of the portfolio’s excess returns was 30%, the Sharpe measure would be
(15 – 5)/30 = 0.33. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Return Analysis |
| 76. | If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio’s excess returns was 25%, the risk premium would be
12 – 4 = 8%. |
| AACSB: Analytic Blooms: Apply Difficulty: Intermediate Topic: Risk |
| 77. | ________ is a risk measure that indicates vulnerability to extreme negative returns.
Value at risk and lower partial standard deviation are risk measures that indicate vulnerability to extreme negative returns. |
| AACSB: Analytic Blooms: Understand Difficulty: Challenge Topic: Risk |
| 78. | ________ is a risk measure that indicates vulnerability to extreme negative returns.
All of the options are risk measures that indicate vulnerability to extreme negative returns. |
| AACSB: Analytic Blooms: Understand Difficulty: Challenge Topic: Risk |
| 79. | The most common measure of loss associated with extremely negative returns is
The most common measure of loss associated with extremely negative returns is value at risk. |
| AACSB: Analytic Blooms: Understand Difficulty: Challenge Topic: Risk |
| 80. | Practitioners often use a ________% VaR, meaning that ________% of returns will exceed the VaR, and ________% will be worse.
Practitioners often use a 5% VaR, meaning that 95% of returns will exceed the VaR, and 5% will be worse. |
| AACSB: Analytic Blooms: Apply Difficulty: Challenge Topic: Risk |
| 81. | When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the
When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the most optimistic as it takes the highest return (smallest loss) of all the cases. |
| AACSB: Analytic Blooms: Understand Difficulty: Challenge Topic: Normal Distribution |
| 82. | When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside exposure would be
When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside exposure would be expected shortfall (or conditional tail expectation). |
| AACSB: Analytic Blooms: Understand Difficulty: Challenge Topic: Normal Distribution |
Short Answer Questions
| 83. | Discuss the relationships between interest rates (both real and nominal), expected inflation rates, and tax rates on investment returns.
The nominal interest rate is the quoted interest rate; however this rate is approximately equal to the real rate of interest plus the expected rate of inflation. Thus, an investor is expecting to earn the real rate in terms of the increased purchasing power resulting from the investment. In addition, the investor should consider the after-tax returns on the investment. The higher the inflation rate, the lower the real after-tax rate of return. Investors suffer an inflation penalty equal to the tax rate times the inflation rate. Feedback: The rationale for this question is to ascertain that the student understands the relationships among these basic determinants of the after-tax real rate of return. |
| AACSB: Reflective Thinking Blooms: Evaluate Difficulty: Intermediate Topic: Interest Rate Determinants |
| 84. | Discuss why common stocks must earn a risk premium.
Most investors are risk averse; that is, in order to accept the risk involved in investing in common stocks, the investors expect a return from the stocks over and above the return the investors could earn from a risk-free investment, such as U.S. Treasury issues. This excess return (the return in excess of the risk-free rate) is the risk premium required by the investors to invest in common stocks. Feedback: The purpose of this question is to ascertain that the students understand the basic risk-return relationship, as the relationship applies to investing in common stocks vs. a risk-free asset (i.e., why would investors be willing to assume the risk of common stock as investment vehicles?). |
| AACSB: Reflective Thinking Blooms: Evaluate Difficulty: Basic Topic: Risk |
| 85. | Discuss the historical distributions of each of the following in terms of their average return and the dispersion of their returns: U.S. small company stocks, U.S. large company stocks, and U.S. long-term government bonds. Would any of these investments cause a loss in purchasing power during a 1926-2009 holding period?
The data is given in Table 5.3. Whether the averages are measured on a geometric basis or an arithmetic basis, the ranking is always the same, with small company average > large company average > government bond average. With regard to risk, the relationships among the standard deviations are small company > large company > government bonds. These ranks indicate that the ex-post data confirm what would be expected—higher returns are earned to compensate for the increased risk. None of these investments would have caused a loss in purchasing power during the 1926-2009 period, because all had average returns higher than the average inflation rate. Feedback: The goal of this question is to see if students have a general idea of the historical relationships among the returns and risk levels of various categories of investments relative to each other and to the level of inflation. |
| AACSB: Reflective Thinking Blooms: Apply Difficulty: Challenge Topic: Return Analysis |
| 86. | Discuss some reasons why an investor with a longtime horizon might choose to invest in common stocks, even though they have historically been riskier than government bonds or T-bills.
Common stocks can be expected to provide for the best growth in purchasing power based on historical data. An investor with a longtime horizon can tolerate fluctuations in stock returns because of the long-term upward trend in stock returns. How much common stock an investor is willing to hold and what types of stocks he chooses for his portfolio will depend on his level of risk aversion. Feedback: The goal of this question is to see if students have a general idea of the historical relationships among the returns and risk levels and why investors may choose stocks for long-term investments. |
| AACSB: Reflective Thinking Blooms: Evaluate Difficulty: Basic Topic: Risk |
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Original price was: $30.00.$20.00Current price is: $20.00.
Original price was: $30.00.$20.00Current price is: $20.00.
Original price was: $30.00.$20.00Current price is: $20.00.
Original price was: $30.00.$20.00Current price is: $20.00.
