Deck 5: Risk and Return - Introduction

Question 1

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

Answer 1

$28.57 million

Question 2

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

Answer 2

$0

Question 3

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%

Answer 3

7.50%

Question 4

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.

Question 5

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.

Question 6

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.

Question 7

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.

Question 8

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%

Question 9

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.

Question 10

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%

Question 11

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

Question 12

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%

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

Question 14

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?

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

Question 15

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%

Question 16

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.

Question 17

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

Question 18

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%

Question 19

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%

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%

Question 21

It costs $1,000 to enter the following game of chance,which is based on the outcome of a coin toss (fair coin).If the coin comes up 'heads' then you win and walk away with $1,100,which is a 10% rate of return.If the coin comes up 'tails',then you lose and walk away with $900,which is a -10% rate of return.What is the variance of the returns?

A) 0.05
B) 0.1
C) 0.09
D) 0.01
E) 0.5

Question 22

XYZ Corp has a 30% chance to earn 12% returns,a 40% chance for 18% returns,and a 30% chance to earn 15% returns.What is the standard deviation?

A) 2.49%
B) 15.3%
C) 4.24%
D) 15%
E) 5.62%

Question 23

You have a portfolio of two stocks: you invested $12,000 in a small biotech company and $6,000 in a fiber optic cable manufacturer.What is the portfolio weight on the biotech stock?

A) 0.25
B) 0.33
C) 0.50
D) 0.67
E) 0.75

Question 24

A home insurance company anticipates the following pattern of claims,based on historical data.What is the standard deviation of claims?

A) $2,562.79
B) $6,567,900
C) $2,000
D) $110
E) $3,753.52

Question 25

It costs $1,000 to enter the following game of chance,which is based on the outcome of a coin toss (fair coin).If the coin comes up 'heads' then you win and walk away with $1,100,which is a 10% rate of return.If the coin comes up 'tails',then you lose and walk away with $900,which is a -10% rate of return.What is the standard deviation of the returns?

A) 9%
B) 15%
C) 30%
D) 10%
E) 5%

Question 26

You are watching the Inter Milan vs.Barcelona Champions League game with your best friend Joe.You make a deal with Joe:
If Barcelona wins,you walk away with $110.
If Inter Milan wins,you walk away with $50.
If you paid $100,what is your expected return assuming that each team has an equal probability of winning?

A) -0.21
B) -0.22
C) -0.20
D) -0.23
E) -0.24

Question 27

You pay $1,000 to flip a two-sided,fair coin at the local fair.If you flip heads,you walk away with $3,000,a return of 200%.However,if you flip tails,you walk away with $250,a return of -75%.What is the standard deviation of the returns?

A) 0.1375%
B) 1.375%
C) 13.75%
D) 137.5%
E) 1,375%

Question 28

The Table below presents returns across three states of nature for two assets: Risky and Safe.The standard deviation of Safe is 3.2%.What is the difference between the standard deviation of Risky and Safe? (Risky - Safe)

A) 3.6%
B) 4.6%
C) 5.6%
D) 6.6%
E) 7.6%

Question 29

If an asset has a 35% probability of earning a 20% return and a 65% probability of earning a 5% return,what is its standard deviation?

A) 1.2%
B) 18.0%
C) 7.2%
D) 11.0%
E) 12.2%

Question 30

If Microsoft stockholders expect either a 25% return or a 2% return,each with a 50% probability,and Apple Computer shareholders expect a 10% return with certainty,what is the expected return from a portfolio comprised of equal amounts of stock from both firms?

A) 37.00%
B) 23.50%
C) 11.75%
D) 10.75%
E) 12.33%

Question 31

A company has a 40% probability of earning 20%,a 40% probability of earning 10%,and a 20% probability of earning 5%.The standard deviation is:

A) 13.0%
B) 36.0%
C) 37.0%
D) 6.0%
E) 15.0%

Question 32

The Table below presents returns across three states of nature for two assets: Risky and Safe.The expected return on Safe is 8.4%.Which asset has a higher expected return?

A) Risky
B) Safe
C) Both have the same expected return

Question 33

Suppose that you hold a two-asset portfolio consisting of 100 shares of Clooney Brothers at $33 per share and 100 shares of Marx Brothers at $42 per share.Assume that you have computed the expected return on Clooney Brothers and Marx Brothers to be 20% and 12%,respectively.What is the expected return from the portfolio?

A) 20.0%
B) 16.0%
C) 15.5%
D) 12.0%
E) 13.5%

Question 34

Which of the following statements is true?

A) Calculus of variations (CV) adjusts standard deviations to compare the risk of securities with different expected returns.
B) Risk-averse investors prefer securities with high standard deviations.
C) An increase in risk will result in an increase in the standard deviation.
D) Standard deviations can be computed for stock returns, but not for bond yields.
E) If the returns from a security are normally distributed, 86% of the observations fall within one standard deviation of the expected value.

Question 35

You bought 200 shares of Microsoft at $50 per share,100 shares of IBM for $100 a share and 300 shares of Amazon.com for $25 per share.What is the portfolio weight on the Amazon.com holding?

A) 0.25
B) 0.26
C) 0.27
D) 0.28
E) 0.29

Question 36

It costs $1,000 to enter the following game of chance,which is based on the outcome of a coin toss (fair coin).If the coin comes up 'heads',you win and walk away with $2,000,which is a 100% rate of return.However,if the coin comes up 'tails',you lose and walk away with nothing,which is a - 100% rate of return.What is the expected return on this gamble?

A) 0%
B) 1,000%
C) 100%
D) 10%
E) -10%

Question 37

Consider the following bet: heads I pay you a dollar,tails you pay me a dollar.What is the standard deviations of the payoffs (returns)of this bet? (Assume a fair coin.)

A) -$1.00
B) $0
C) $0.50
D) $1.00
E) $10.00

Question 38

An expected return from a portfolio

A) can be calculated more accurately than the expected return from any of the securities in the portfolio.
B) will lie somewhere between the highest and lowest expected returns from securities in the portfolio.
C) cannot be computed if there are fewer than three securities in the portfolio.
D) will exceed the highest expected return from any of the securities in the portfolio.
E) will be lower than the expected return from the security in the portfolio with the lowest yield because portfolios have less risk than individual securities.

Question 39

The table below shows market data for two stocks on two days.The two stocks are the components of a value weighted index like the S&P 500.Calculate the percentage change in the index over the two days.

A) 10%
B) 20%
C) 30%
D) 40%
E) 50%

Question 40

A company will earn 10% returns in a poor economy,15% returns in a normal economy,and 25% returns in a booming economy.What is the standard deviation if there is a 25% chance of a poor economy and a 25% chance of a booming economy?

A) 10.83%
B) 5.45%
C) 6.12%
D) 11.18%
E) 4.91%

Question 41

Correlation

A) is a measure similar to the standard deviation, but more precise.
B) may only be positive.
C) is usually negative for a portfolio with two securities.
D) measures the degree to which a change in the riskiness of one security causes the risk of another to change.
E) ranges between −1 and +1.

Question 42

Assume you currently hold one type of security and decide to construct a portfolio.Which of the following would provide the greatest degree of risk reduction?

A) Adding a security that has perfect negative correlation with the one you are holding
B) Doubling the quantity of the security you already hold
C) Adding a positively, but not perfectly, correlated security
D) Adding a security that is uncorrelated with your current one
E) Adding a security that has perfect positive correlation with the one you are holding

Question 43

By incrementally adding securities to a portfolio

A) you can reduce portfolio risk only if the new security is uncorrelated with the others in the portfolio.
B) you raise portfolio risk since having more securities in a portfolio increases the likelihood that one of them will become worthless.
C) you may reduce portfolio risk, even if new securities are not negatively correlated with others in the portfolio.
D) you may eliminate all risk with about 15 different stocks in a portfolio.
E) you reduce risk at an increasing rate.

Question 44

All of the following statements are true EXCEPT:

A) The standard deviation of a portfolio of assets is the weighted average of the standard deviations of the assets in the portfolio.
B) The expected return on a portfolio of assets is the weighted average of the expected returns of the assets in the portfolio.
C) The expected return on an asset held by itself is the weighted average of the possible outcomes, where the weights reflect the probability of each outcome.
D) The risk of an asset held by itself can be measured by the standard deviation of the expected returns.

Question 45

After taking a reading-week trip to the Dominican Republic,you are now hooked on Cuban cigars.You decide to build a stock portfolio with two different cigar companies:
Altadis'Behike(Altadis)
Gurkha'sHis Majesty's Reserve (Gurkhas)
You purchase 1,000 Altadis' shares,each at a price of $45.You also purchase 1,200 Gurkha's shares,each at a price of $65.Calculate Altadis' portfolio weight.

A) 0.316
B) 0.366
C) 0.386
D) 0.416
E) 0.426

Question 46

Bond prices rise when interest rates fall.These two variables (bond prices and interest rates)are:

A) Not correlated
B) Positively correlated
C) Negatively correlated
D) Positively skewed