Question 1

If the probability of a 20% return is 70% and the probability of a 3% loss is 30%, what is the expected return?
A)13%
B)10%
C)12%
D)17%
E)15%

Accepted Answer

Expected return = E(k) = Pr₁k₁ + Pr₂k₂ + ... + Pr_nk_n Expected return = (.70 × .20) + (.30 × -.03) = .13 or 13%

Question 2

A year ago, you purchased IBM stock for $94 a share. Today, IBM stock is selling for $93 a share. Additionally, you just received a check for $1.20 per share. Your holding period return is
A)0.21%
B)2.34%
C)-2.34%
D)2.13%
E)1.06%

Accepted Answer

11ea7fdb_fc10_dbc9_a768_f5fae1dfe307_TB2902_11 = 11ea7fdb_fc10_dbca_a768_e108823d3c1b_TB2902_11 11ea7fdb_fc10_dbcb_a768_ddd74ae17999_TB2902_11 = 11ea7fdb_fc10_dbcc_a768_d9e083cc226f_TB2902_11 = .21%

Question 3

Suppose you paid $18.50 per share for Commerce Group Inc. common stock and sold it one year later for $24 per share. What was your holding period return if the stock paid no dividends during the year?
A)27%
B)13%
C)23%
D)32%
E)30%

Accepted Answer

11ea7fdb_fc10_b4b5_a768_5904c0682499_TB2902_11 = 11ea7fdb_fc10_b4b6_a768_33ff45017db8_TB2902_11 11ea7fdb_fc10_b4b7_a768_adbff5bcad87_TB2902_11 = 11ea7fdb_fc10_b4b8_a768_c7e55e7f750a_TB2902_11 = .297 or 30%

Question 4

If General Motors expects profits of $50 million in a booming economy, what is the expected profit during a recession if this is the only other possibility and the overall expected profit is $35 million? The probability of a recession is 70%.
A)$35.00 million
B)$25.00 million
C)$23.45 million
D)$39.50 million
E)$28.57 million

Accepted Answer

To solve the problem, we can use the formula:

Expected profit = (Probability of Scenario 1 x Profit in Scenario 1) + (Probability of Scenario 2 x Profit in Scenario 2)

Let x be the profit in a recession.

Then we can write the equation:

$35 million = (0.3 x $50 million) + (0.7 x x)

Simplifying this equation, we get:

$35 million = $15 million + 0.7x

0.7x = $20 million

x = $28.57 million

Therefore, the expected profit during a recession is $28.57 million.

The best choice is E.

Question 5

Which of the following would be the most useful to an investor who is evaluating securities to add to her portfolio?
A)The previous opportunity cost of holding the asset
B)The simple interest return
C)The historical return
D)The expected return
E)The Lynch risk-adjusted historical return

Accepted Answer

The expected return is the most useful to an investor who is evaluating securities to add to their portfolio as it represents the estimated return on investment based on the investor's subjective analysis and market conditions. It helps an investor to assess the risk-reward trade-off of a particular security and compare it with other investment options. Option A, B, and C are not as relevant as they do not provide a forward-looking estimate of the potential return. Option E, the Lynch risk-adjusted historical return, represents a complicated method of calculating an adjusted return that is not commonly used in investment analysis.

Question 6

Consider the following bet: heads I pay you a dollar, tails you pay me a dollar. What is the expected payoff (return)of this bet? (Assume a fair coin.)
A)-$0.50
B)$1.00
C)$0
D)$0.50
E)-$1.00

Accepted Answer

The expected value of the bet is calculated by taking the probability of each outcome multiplied by its payoff and summing them up. In this case, both heads and tails have a probability of 0.5 (assuming a fair coin) and the payoff is a dollar in either case. Therefore, the expected payoff is:

(0.5 x $1) + (0.5 x -$1) = $0

This means that on average, you can expect to break even on this bet, with no profit or loss. Choice C is the best answer as it correctly identifies the expected payoff.

Question 7

A home insurance company anticipates the following pattern of claims, based on historical data. What is the expected claim on the next policy sold by the company? $\begin{array}{c}
\begin{array}{|c|}
\hline\
\
\
\text { Type of Claim }\
\hline1 \
\hline 2 \
\hline 3 \
\hline 4\
\hline
\end{array}
\begin{array}{c}
\hline\
\
\
\text { Size of Claim }\
\hline \$ 200,000 \
\hline \$ 50,000 \
\hline \$ 2,000 \
\hline \$ 0\
\hline
\end{array}
\begin{array}{|c|}
 \hline \text {Number of}\
\text { Claims out of}\
\text {10,000 Policy }\
\text {Holders}\
\hline 1 \
\hline 10 \
\hline 200 \
\hline 9,789\
\hline 
\end{array}
\begin{array}{c|}
\hline\
\
\
\text { Probability } \
\hline 0.0001 \
\hline 0.001 \
\hline 0.02 \
\hline 0.9789\
\hline
\end{array}
\end{array}$

A)$100
B)$110
C)$120
D)$130
E)$140

Accepted Answer

The answer of A home insurance company anticipates the following...

Question 8

If the required return from an asset is 10%, and the asset has a 60% probability of yielding a 20% return and a 40% probability of earning a 5% return, you should:
A)Not acquire the asset since the expected return of 32% exceeds the required return.
B)Purchase the asset since the expected return of 14% exceeds the required return.
C)Buy the asset because the expected return of 32% exceeds the required return.
D)Forgo the investment opportunity since the expected return of 14% is too low.
E)Buy the asset because the expected return of 12.5% exceeds the required return.

Accepted Answer

Expected return = E(k) = Pr₁k₁ + Pr₂k₂ + ... + Pr_nk_n Expected return = (.60 × .20) + (.40 × .05) = .14 or 14%

Question 9

The stock for L-Corp expects a 12% return in a down economy, 15% in a normal economy, and 20% in a booming economy. What is the expected return if there is a 20% chance for a down economy and a 65% chance for a normal economy?
A)13.05%
B)15.00%
C)15.15%
D)15.55%
E)14.25%

Accepted Answer

Expected return = (probability of down economy x return in down economy) + (probability of normal economy x return in normal economy)
+ (probability of booming economy x return in booming economy)
= (0.20 x 12%) + (0.65 x 15%) + (0.15 x 20%)
= 2.4% + 9.75% + 3%
= 15.15% 
Therefore, the expected return is 15.15%, which is closest to option C (15.15%).

Question 10

Which of the following is a false statement?
A)Expected returns are not always predicted accurately.
B)Expected returns may differ from actual returns because of an unforeseen recession.
C)Historical returns can be calculated with more confidence than expected returns.
D)Accurate predictions of expected returns depend on the analyst's ability to estimate probabilities.
E)Although expected returns may differ from actual returns, they seldom do.

Accepted Answer

This statement is false because expected returns may differ significantly from actual returns, as they can be affected by various unpredictable factors such as market volatility, unexpected events, and changes in economic conditions.

Question 11

Compaq recently adjusted the probabilities for its expected cash flows in light of the Asian currency crisis. It revised the probability of favorable conditions from 32% to 18% and the probability of poor earnings from 7% to 17%. Which of the following is the most likely result from this revision?
A)It would raise expected returns.
B)It would lower expected returns.
C)The probabilities cannot be revised once they have been estimated.
D)It would lower its historical return.
E)It would have no effect on expected returns.

Accepted Answer

Compaq's revision shows a lower probability of favorable conditions and a higher probability of poor earnings, indicating a decrease in expected returns.

Question 12

Which of the following is a true statement?
A)It is easy to predict the probability and length of a foreign country's recession.
B)Although economists understand the relationship between risk and return, they have been unable to develop a way to quantify it.
C)There is a direct relationship between risk and expected return.
D)Risk and the likelihood of realizing future cash flows from an investment are unrelated.
E)Riskless investments do not usually earn a positive return.

Accepted Answer

According to the principle of risk-return tradeoff, there is a direct relationship between risk and expected return. Generally, investors require a higher return for taking on higher risk. Therefore, investors who are willing to take on more risk expect to receive a higher return on their investment.

Question 13

Which of the following most closely defines the term risk in finance?
A)Knowing that you will lose money on an investment
B)A decision in which the potential outcomes are known with certainty
C)A measure of the variability of cash flows
D)A situation in which the required return on an asset equals its expected return
E)A measure of the magnitude of cash flows

Accepted Answer

Risk in finance is a measure of the variability of cash flows or returns. It represents the uncertainty and potential for loss in an investment or financial decision. Options A and B describe a scenario where risk is certain, which is not the case in finance. Option D describes a situation where risk is minimized, as the required return equals the expected return. Option E refers to the size of the cash flows, but not necessarily the level of risk involved.

Question 14

You bought a stock for $80.00 and sold it after three years for $95.00. While you held the stock it paid $3.00 in dividends. What is the annualized return?
A)18.75%
B)11.25%
C)7.50%
D)22.50%
E)9.38%

Accepted Answer

11ea7fdb_fc11_02dd_a768_cda6c460a7d1_TB2902_11 = 11ea7fdb_fc11_02de_a768_576ec1e71aa9_TB2902_11 11ea7fdb_fc11_02df_a768_296ede81aa50_TB2902_11 = 11ea7fdb_fc11_02e0_a768_7f79963dcadc_TB2902_11 = 22.5%
Since this return is over three years, we must divide by 3 to get the annualized return. 11ea7fdb_fc11_02e1_a768_cd6a591007f3_TB2902_11 = 7.5%

Question 15

To earn a ________ return, you must incur ________ risk.
A)lower; higher
B)higher; higher
C)decent; very high
D)higher; lower
E)None of the above.

Accepted Answer

We expect return to increase as risk increases.

Question 16

XYZ Corp expects to have $350,000 in sales in a poor economy, $500,000 in a moderate economy, and $900,000 in a booming economy. If the chances of a booming economy and poor economy are 10% each, what is the expected return?
A)525,000
B)512,500
C)500,000
D)805,000
E)621,000

Accepted Answer

Expected return = E(k) = Pr₁k₁+ Pr₂k₂ + ... + Pr_nk_n Expected return = 350,000 × 10% + 500,000 × 80% + 900,000 × 10% = 525,000

Question 17

Frank's Franks went public and opened at $15.00 per share. One year later the stock was selling for $17.50 per share. What was the holding period return if during the year Frank sent out $1.25 per share in dividends?
A)17%
B)21%
C)25%
D)14%
E)23%

Accepted Answer

The holding period return can be calculated using the formula:

Holding Period Return = [(Ending Price + Dividends) - Beginning Price] / Beginning Price

Plugging in the numbers, we get:

Holding Period Return = [(17.50 + 1.25) - 15.00] / 15.00
Holding Period Return = 3.75 / 15.00
Holding Period Return = 0.25 or 25%

Therefore, the answer is C) 25%.

Question 18

If the probability of a 20% return is 70% and the probability of a 4% loss is 30%, what is the expected return to the nearest whole percentage?
A)17%
B)3%
C)13%
D)15%
E)11%

Accepted Answer

Expected return = E(k) = Pr₁k₁ + Pr₂k₂ + ... + Pr_nk_n E(k) = (.70 × .20) + (.30 × -.04) = .128 or 13%

Question 19

The expected return on an asset is 13% and the required return is 12%. You should probably
A)wait and see what happens to actual returns before making a decision.
B)buy the asset now.
C)sell the asset now.
D)hold the asset.
E)None of the above.

Accepted Answer

If the expected return exceeds the required return, you should buy.

Question 20

Given the following probability distributions, what are the expected returns for the Market and for Security J? State 1 P1 = 0.2 Km = -10% Kj = 40% : State 2 P1 = 0.5 Km = 10% Kj = -20% : State 3 P1 = 0.3 Km = 30% Kj = 30%
A)10.0%; 13.0%
B)9.5%; 13.0%
C)10.0%; 11.3%
D)12.0%; 7.0%
E)10.0%; 9.5%

Accepted Answer

Expected return = E(k) = Pr₁k₁ + Pr₂k₂ + ... + Pr_nk_n Market E(k) = (.20 × -.10) + (.50 × .10) + (.30 × .30) = .12 or 12% Security J E(k) = (.20 × .40) + (.50 × -.20) + (.30 × .30) = .07 or 7%

Quiz 5: Risk and Return - Introduction

If the probability of a 20% return is 70% and the probability of a 3% loss is 30%, what is the expected return?

A year ago, you purchased IBM stock for $94 a share. Today, IBM stock is selling for $93 a share. Additionally, you just received a check for $1.20 per share. Your holding period return is

Suppose you paid $18.50 per share for Commerce Group Inc. common stock and sold it one year later for $24 per share. What was your holding period return if the stock paid no dividends during the year?

If General Motors expects profits of $50 million in a booming economy, what is the expected profit during a recession if this is the only other possibility and the overall expected profit is $35 million? The probability of a recession is 70%.

Which of the following would be the most useful to an investor who is evaluating securities to add to her portfolio?

Consider the following bet: heads I pay you a dollar, tails you pay me a dollar. What is the expected payoff (return) of this bet? (Assume a fair coin.)

If the required return from an asset is 10%, and the asset has a 60% probability of yielding a 20% return and a 40% probability of earning a 5% return, you should:

The stock for L-Corp expects a 12% return in a down economy, 15% in a normal economy, and 20% in a booming economy. What is the expected return if there is a 20% chance for a down economy and a 65% chance for a normal economy?

Which of the following is a false statement?

Compaq recently adjusted the probabilities for its expected cash flows in light of the Asian currency crisis. It revised the probability of favorable conditions from 32% to 18% and the probability of poor earnings from 7% to 17%. Which of the following is the most likely result from this revision?

Which of the following is a true statement?

Which of the following most closely defines the term risk in finance?

You bought a stock for $80.00 and sold it after three years for $95.00. While you held the stock it paid $3.00 in dividends. What is the annualized return?

To earn a return, you must incur risk.

XYZ Corp expects to have $350,000 in sales in a poor economy, $500,000 in a moderate economy, and $900,000 in a booming economy. If the chances of a booming economy and poor economy are 10% each, what is the expected return?

Frank's Franks went public and opened at $15.00 per share. One year later the stock was selling for $17.50 per share. What was the holding period return if during the year Frank sent out $1.25 per share in dividends?

If the probability of a 20% return is 70% and the probability of a 4% loss is 30%, what is the expected return to the nearest whole percentage?

The expected return on an asset is 13% and the required return is 12%. You should probably

Given the following probability distributions, what are the expected returns for the Market and for Security J? State 1 P1 = 0.2 Km = -10% Kj = 40% : State 2 P1 = 0.5 Km = 10% Kj = -20% : State 3 P1 = 0.3 Km = 30% Kj = 30%