Deck 11: Introduction to Risk, Return, and the Opportunity Cost of Capital

Question 1

Average returns on high-risk assets are higher than those on low-risk assets.

Answer 1

True

Question 2

The historical record fails to show that investors have received a risk premium for holding risky assets.

Answer 2

False

Question 3

If one portfolio's variance exceeds that of another portfolio, its standard deviation will also be greater than that of the other portfolio.

Answer 3

True

Question 4

Long-term corporate bonds are the only portfolio of securities found to be riskier than common stocks.

Question 5

The TSX 300 accounts for nearly 50 percent of the total value of stocks traded in Canada.

Question 6

Standard deviation can be calculated as the square of the variance.

Question 7

The covariance of two stocks was calculated at -.01733.If the standard deviation of the first stock is .106 and .164 for the second, determine the correlation.

A)-.997
B)-.887
C)-.687
D)-.587

Question 8

For investment horizons greater than 20 years, long-term corporate bonds traditionally have outperformed common stocks.

Question 9

When inflation is expected to be low, the risk premium on common stocks is expected to be low.

Question 10

Market risk can be eliminated in a stock portfolio through diversification.

Question 11

The risk that remains in a stock portfolio after efforts to diversify is known as unique risk.

Question 12

Cyclical stocks tend to perform well when other stocks are performing well also.

Question 13

A market index is used to measure performance of a broad-based portfolio of stocks.

Question 14

Common stock is held for two years, during which time it receives an annual dividend of $10.The stock was sold for $100 and generated an average annual return of 16 percent.What price was paid for the stock?

A)$61.60
B)$64.80
C)$88.00
D)$90.91

Question 15

Which of the following statements is true for a stock that sells now for $60, pays an annual dividend of $3.00, and experienced a 30 percent return on investment over the past year? Its price one year ago was:

A)$42.00.
B)$46.15.
C)$48.46.
D)$56.10.

Question 16

Stock market indexes are found in several countries outside of Canada.

Question 17

Systematic risk is faced by all common stock investors.

Question 18

If when a coin is tossed the observance of a head rewards you with a dollar and the observance of a tail costs you fifty cents, how much would you expect to gain after twenty tosses?

A)$5.00
B)$7.50
C)$10.00
D)$15.00

Question 19

Which of the following statements is correct for an investor starting with $1,000 in common stocks over a 20-year investment horizon in which stocks averaged 11 percent in nominal terms and 4 percent in real terms? The portfolio value is now approximately:

A)$1,800 in real terms.
B)$3,679 in real terms.
C)$3,870 in nominal terms.
D)$8,062 in nominal terms.

Question 20

An investor receives a 15 percent total return by purchasing a stock for $40 and selling it after one year with a 10 percent capital gain.How much was received in dividend income during the year?

A)$2.00
B)$2.20
C)$4.00
D)$6.00

Question 21

What percentage return is achieved by an investor who purchases a stock for $30, receives a $1.50 dividend, and sells the share one year later for $28.50?

A)-5 percent
B)0 percent
C)5 percent
D)10 percent

Question 22

Calculate the real rate of interest if the nominal rate of interest is 9.3% and the inflation rate is 3.25%.

A)7.86%
B)6.86%
C)5.86%
D)4.86%

Question 23

What is the variance of a three-stock portfolio that produced returns of 20 percent, 25 percent and 30 percent?

A)0.17%
B)0.33%
C)0.50%
D)0.10%

Question 24

If a stock is purchased for $25 per share and held one year, during which time a $3.50 dividend is paid and the price climbs to $28.25, the nominal rate of return is:

A)13.00 percent.
B)14.00 percent.
C)23.01 percent
D)27.00 percent.

Question 25

What is the standard deviation of a portfolio's returns if the mean return is 15 percent, the variance of returns is 184 percent, and there are three stocks in the portfolio?

A)7.83 percent
B)13.56 percent
C)41.00 percent
D)225.00 percent

Question 26

From a historical perspective (1926-2014), what would you expect to be the approximate return on a diversified portfolio of common stocks in a year that Treasury bills offered 7.5 percent?

A)8.5 percent
B)12.5 percent
C)14.5 percent
D)19.5 percent

Question 27

Calculate the inflation rate, given a nominal rate of 10.2% and a real rate of 8.05%.

A)2.99%
B)2.49%
C)1.99%
D)1.06%

Question 28

What nominal return was received by an investor when inflation averaged 8.0 percent and the real rate of return was a negative 2.5 percent?

A)5.30 percent
B)5.36 percent
C)6.50 percent
D)10.77 percent

Question 29

What is the approximate variance of returns if over the past three years an investment returned 8.0 percent, -12.0 percent, and 15.0 percent?

A)1.31%
B)1.96%
C)2.74%
D)3.66%

Question 30

What is the approximate standard deviation of returns for a one-year project that is equally likely to return 100 percent as it is to provide a 100 percent loss?

A)0 percent
B)50 percent
C)71 percent
D)100 percent

Question 31

What is the variance of return of a three-stock portfolio (with unequal weights 25%, 50% and 25%) that produced returns of 20%, 25% and 30%, respectively?

A)10.00
B)12.50
C)15.00
D)20.00

Question 32

If a stock is purchased for $12.50 per share and held one year, during which time a $1.50 dividend is paid and the price drops to $10.75, the percentage return is:

A)-2%.
B)-1%.
C)1%.
D)2%.

Question 33

What real rate of return is earned by a one-year investor in a bond that was purchased for $1,000, has an 8 percent coupon, and was sold for $960 when the inflation rate was 6 percent?

A)-1.89 percent
B)1.92 percent
C)5.66 percent
D)11.47 percent

Question 34

What is the approximate standard deviation of returns if over the past four years an investment returned 8.0%, - 12.0%, - 12% and 15.0%?

A)9.26%
B)10.26%
C)11.26%
D)12.26%

Question 35

What is the expected return on a portfolio that will decline in value by 13 percent in a recession, will increase by 16 percent in normal times, and will increase by 23 percent during boom times if each scenario has equal likelihood?

A)8.67 percent
B)13.00 percent
C)13.43 percent
D)17.33 percent

Question 36

Determine the nominal rate of interest, if the real rate is 6% and the inflation rate is 1.85%.

A)8.84%
B)7.96%
C)6.75%
D)3.24%

Question 37

Most of the beneficial effects of diversification will have been received by the time a portfolio of common stocks contains _____ stocks.

A)2
B)5
C)20
D)50

Question 38

What is the percentage return on a stock that was purchased for $40.00 and paid a $3.00 dividend after one year, then sold for $39.00?

A)(2.50 percent)
B)2.50 percent
C)5.00 percent
D)7.50 percent

Question 39

If a project's expected return is 15 percent, which represents a 35 percent return in a booming economy and a 5 percent return in a stagnant economy, what is the probability of a booming economy?

A)18.33 percent
B)25.00 percent
C)33.33 percent
D)50.00 percent

Question 40

Calculate the real rate of interest if the nominal rate of interest is 8.65% and the inflation rate is 2.24%.

A)9.50%
B)8.49%
C)7.38%
D)6.27%

Question 41

Calculate the nominal rate if the real rate is 4.25% and the inflation rate is 3%.

A)10.18%
B)9.28%
C)8.83%
D)7.38%

Question 42

When the annual rate of return on Canadian Treasury bills is historically high, investors expect the risk premium on the stock market to be:

A)considerably lower than normal.
B)considerably higher than normal.
C)approximately normal.
D)approximately equal to zero.

Question 43

One common reason for reporting standard deviations rather than variances is that standard deviations:

A)are lower.
B)are stated in understandable units.
C)account properly for negative returns.
D)take probability estimates into consideration.

Question 44

Which of the following concerns is likely to be most important to portfolio investors seeking diversification?

A)total volatility of individual securities.
B)standard deviation of individual securities.
C)correlation of returns between securities.
D)achieving the risk-free rate of return.

Question 45

Stock A has 10 million shares issued and Stock B has 5 million shares issued.What is their relative weighting if both stocks are represented in the S&P 500?

A)equal-weightings, like all S&P 500 stocks.
B)B has twice the weighting, to account for having fewer shares.
C)A has twice the weighting, to account for having more shares.
D)they are weighted according to their expected performance.

Question 46

Which of the following statements seems most appropriate when the TSX 300 increases by 2 percent?

A)all stocks on the exchange increased by 2 percent.
B)only 2 percent of the TSX index's stocks increased.
C)a broad-based market indicator was up by 2 percent.
D)The S&P 500 index increased by 2 percent.

Question 47

"TSX up 14.Story at 6:00 p.m." This means that:

A)The TSX was up 14 percent during today's trading.
B)14 of the TSX's 300 stocks increased in price today.
C)a share of TSX stock went up by $14 today.
D)The TSX index increased by 14 points in today's trading.

Question 48

Market interest rates have risen substantially in the five years since an investor purchased Treasury bonds that were offering a 7 percent return.If the investor sells now she is likely to receive:

A)greater than a 7 percent total return.
B)less than a 7 percent total return.
C)a 7 percent total rate of return.
D)a 7 percent nominal return but less than a 7 percent real return.

Question 49

A stock investor owns a diversified portfolio of 15 stocks.What will be the likely effect on portfolio standard deviation from adding one more stock?

A)a slight increase will occur.
B)a large increase will occur.
C)a slight decrease will occur.
D)a large decrease will occur.

Question 50

The benefits of portfolio diversification are highest when the individual securities have returns that:

A)vary directly with the rest of the portfolio.
B)vary indirectly with the rest of the portfolio.
C)are uncorrelated with the rest of the portfolio.
D)are countercyclical.

Question 51

If the standard deviation of a portfolio's returns is known to be 30 percent, then its variance is:

A)5.48 percent.
B)5.48 percent squared.
C)900.00 percent.
D)900.00 percent squared.

Question 52

Which of the following risks would be classified as a unique risk for an auto manufacturer?

A)interest rates
B)steel prices
C)business cycles
D)foreign exchange rates

Question 53

Although the TSX 300 contains a small proportion of Canadian publicly traded stocks, it represents:

A)all stocks that prefer to be equal-weighted.
B)all stocks that prefer to be value-weighted.
C)approximately 50 percent of Canadian stocks traded, in value.
D)approximately 70 percent of Canadian stocks traded, in value.

Question 54

Which of the following companies might you expect to be exposed to less macro risk?

A)a large producer of flour
B)a regional airline
C)a major commercial bank
D)an electric utility

Question 55

Although several stock indexes are available to inform U.S.investors of market changes, the Dow Jones Industrial Average:

A)is the broadest-based of the market indices.
B)is the only reliable market index.
C)accounts for approximately 70 percent of U.S.market value.
D)is the best-known of the U.S.market indexes.

Question 56

The TSX 300 index is:

A)the most representative of stock market indexes.
B)an index of Canada's major corporations.
C)an index of 300 major stocks.
D)an equally weighted index of all stocks traded on the New York Stock Exchange.

Question 57

A firm is said to be countercyclical if its returns:

A)continue to decrease, year after year.
B)continue to increase, year after year.
C)are better when most firms do poorly.
D)are negative in real terms.

Question 58

Which of the following risk types can be diversified by adding stocks to a portfolio?

A)systematic risk
B)unique risk
C)default risk
D)market risk

Question 59

If a share of stock provided a 14.0 percent nominal rate of return over the previous year while the real rate of return was 6.0 percent, then the inflation rate was:

A)1.89 percent.
B)7.55 percent.
C)8.00 percent.
D)9.12 percent.

Question 60

In a year in which common stocks offered an average return of 18 percent, Treasury bonds offered 10 percent and Treasury bills offered 7 percent, the risk premium for common stocks was:

A)1 percent.
B)3 percent.
C)8 percent.
D)11 percent.

Question 61

Which of the following guarantees is offered to common stock investors?

A)guaranteed to receive dividends
B)guaranteed to receive capital gains
C)guaranteed only to receive a refund of principal
D)no guarantees of any form

Question 62

Which of the following firms is likely to exhibit the least macro risk exposure?

A)furniture manufacturer
B)oil driller
C)dog food processor
D)auto manufacturer

Question 63

Which of the following statements is incorrect concerning stock indexes?

A)they have been developed for foreign stocks.
B)they have been developed for smaller companies.
C)indexes include all common stocks.
D)some indexes are equal-weighted.

Question 64

The primary difference between Canadian Treasury bills and Canadian Treasury bonds is that the bills:

A)do not have default risk.
B)have more price volatility.
C)have a shorter maturity at time of issue.
D)offer a higher return.

Question 65

The addition of a negative risk asset to a portfolio of assets will:

A)increase the portfolio's expected return.
B)decrease the portfolio's expected return.
C)increase the portfolio's expected volatility.
D)decrease the portfolio's expected volatility.

Question 66

Which statement is correct concerning macro risk exposure?

A)all firms face equal macro risk exposure
B)only portfolios of stocks face macro risk exposure
C)macro risk exposure affects the cost of capital
D)macro risk exposure is less important to diversified investors than micro risk exposure

Question 67

Common stocks have offered an annual risk premium in nominal terms, but they have:

A)also offered the risk premium in real terms.
B)not offered a risk premium in real terms.
C)not offered more than corporate bonds in real terms.
D)offered only slightly more than Treasury bonds in real terms.

Question 68

Perhaps the best way to reduce macro risk in a stock portfolio is to invest in stocks that:

A)have only unique risks.
B)have diversified away the macro risk.
C)have low exposure to business cycles.
D)pay guaranteed dividends.

Question 69

Although unique risk is present in differing amounts, individual stocks are:

A)exposed to the same amount of market risk.
B)exposed to differing amounts of market risk also.
C)not exposed to market risk; only the general economy is subject to market risk.
D)able to diversify away their market risk.

Question 70

Treasury bonds have provided a higher historical return than Treasury bills, which can be attributed to:

A)greater default risk.
B)a higher level of unique risk.
C)greater price risk due to longer maturities.
D)the fact that they are less frequently traded than bills.

Question 71

The incremental risk to a portfolio from adding another stock:

A)is always greater than the average portfolio risk.
B)is always less than the average portfolio risk.
C)is always positive.
D)is often positive but can be negative.

Question 72

In addition to the number of stocks represented, a difference between the TSX 300 and the Dow is that the TSX 300:

A)dates back to the 19th century while the Dow is a recent innovation.
B)is value-weighted while the Dow is an equal-weighted index.
C)includes foreign stocks while the Dow is domestic.
D)index includes dividends in its return while the Dow does not.

Question 73

The risk premium that is offered on common stock is equal to the:

A)expected return on the stock.
B)real rate of return on the stock.
C)excess of expected return over a risk-free return.
D)expected return on the S&P 500 index.

Question 74

A stock that is considered to be a positive risk asset is added to a portfolio.As a result, the portfolio will:

A)have lower average returns.
B)have a lower variance of returns.
C)have a higher volatility of returns.
D)have a lower correlation of returns with stock market indexes.

Question 75

The standard deviations of individual stocks are generally higher than the standard deviation of the market portfolio because individual stocks:

A)offer higher returns.
B)have more systematic risk.
C)have no diversification of risk.
D)do not have unique risk.

Question 76

The variance of an investment's returns is a measure of the:

A)volatility of the rates of return.
B)probability of a negative return.
C)historic return over long periods.
D)average value of the investment.

Question 77

A stock is held one year, during which time its dividend yield was greater than its capital gains yield.For this stock, the percentage return:

A)is positive.
B)is negative.
C)equals the dividend yield.
D)cannot be determined.

Question 78

Averaging the deviations from the mean for a portfolio of securities will:

A)compute the standard deviation.
B)compute the variance.
C)equal zero.
D)equal the number of securities in the portfolio.

Question 79

How is it possible for real rates of return to increase during times when the rate of inflation increases?

A)inflation increased more than the real return
B)nominal returns actually decreased
C)nominal returns increased more than inflation
D)nominal returns increased less than inflation

Question 80

Real rates of return are typically less than nominal rates of return due to:

A)Inflation.
B)Capital gains.
C)Dividend payments.
D)Depreciation.