Question 1

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.

Accepted Answer

Individual stocks are exposed to differing amounts of market risk, depending on various factors such as the company's industry, financial health, and market conditions. While diversification can help mitigate some market risk, it cannot eliminate it entirely for individual stocks.

Question 2

Which one of the following firms is likely to exhibit the least macro risk exposure?
A) Furniture manufacturer
B) Airline company
C) Dog food processor
D)Auto manufacturer

Accepted Answer

The dog food processor is likely to exhibit the least macro risk exposure as demand for pet food is relatively stable regardless of the economic conditions, in contrast to industries like airlines and auto manufacturers which are highly dependent on consumer discretionary spending and may be negatively impacted during economic downturns. The furniture manufacturer may also face some macro risk exposure as furniture purchases can also be discretionary and tied to overall economic conditions.

Question 3

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.

Accepted Answer

Averaging the deviations from the mean for a portfolio of securities will always equal zero by definition. This is because the sum of positive deviations from the mean equals the sum of negative deviations from the mean. Therefore, averaging the deviations from the mean will result in a value of zero.

Question 4

When viewing the long-term trend of the price volatility of U.S. stocks, it is readily apparent that volatility has:
A) continually increased.
B) continually decreased.
C) increased and decreased but has no specific pattern.
D)remained constant for years.

Accepted Answer

The long-term trend of the price volatility of U.S. stocks shows that volatility has both increased and decreased over the years, but there is no specific pattern indicating a constant increase or decrease.

Question 5

Which one of the following companies is most apt to be exposed to the least amount of macro risk?
A) A large producer of flour
B) A regional airline
C) A major commercial bank
D)A machine tool manufacturer

Accepted Answer

A large producer of flour is least likely to be exposed to macro risk as there is always a constant demand for basic food staples like flour, regardless of macroeconomic conditions. On the other hand, industries like regional airlines, commercial banks, and machine tool manufacturers are more sensitive to the macro environment and can be impacted by factors like interest rates, inflation, and consumer spending.

Question 6

Which one of these is a specific risk?
A) Revision to the corporate tax laws
B) Inflation increase of 2.3%
C) Reduction in the overall economic output
D)Retirement of a company executive

Accepted Answer

Specific risk refers to the risk that affects a very small number of assets. The retirement of a company executive is a specific risk because it directly impacts only the company in question, unlike the other options which are examples of systematic risks affecting a broad range of assets or the entire market.

Question 7

A project's expected return is 15%, which represents a 35% return in a booming economy and a 5% return in a stagnant economy. What is the probability of a booming economy occurring if these are the only two economic states?
A) 18.33%
B) 25.00%
C) 33.33%
D)50.00%

Accepted Answer

15% = 35%(x) + 5%(1 - x); x = 33.33%

Question 8

Which one of the following would you expect to represent the broadest-based index of U.S. stocks?
A) Wilshire 5000
B) Dow Jones Industrial Average
C) Standard and Poor's Composite
D)Financial Times Index

Accepted Answer

The Wilshire 5000 is a market-capitalization-weighted index that includes all actively traded U.S. stocks, making it the broadest-based index of U.S. stocks. The Dow Jones Industrial Average and the Standard and Poor's Composite are both more limited in their scope, and the Financial Times Index is not focused solely on U.S. stocks.

Question 9

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%
B) 0%
C) 5%
D)10%

Accepted Answer

R = ($28.50 + 1.50 - 30)/$30 = 0%

Question 10

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.

Accepted Answer

Stocks with low exposure to business cycles are less affected by macroeconomic changes, thus reducing macro risk in a portfolio.

Question 11

Assume 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 20 tosses?
A) $5.00
B) $7.50
C) $10.00
D)$15.00

Accepted Answer

Expected return = 20 × [($1 × .5) - (.50 × .5)] = $5.00

Question 12

Treasury bonds have provided a higher historical return than Treasury bills, which can be attributed to their:
A) greater default risk.
B) higher level of unique risk.
C) greater exposure to interest rate risk.
D)illiquidity.

Accepted Answer

Treasury bonds have a longer maturity than Treasury bills, which exposes them to a greater risk of changes in interest rates. As interest rates rise, the value of a bond with a fixed interest rate will decrease, and vice versa if interest rates fall. This exposure to interest rate risk is why bonds have historically provided a higher return than bills. The other answer choices do not accurately explain why bonds have historically provided a higher return.

Question 13

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.

Accepted Answer

Standard deviations are stated in the same units as the original data, making them more understandable than variances. Option A is incorrect because standard deviations are typically higher than variances. Option C is incorrect because both variances and standard deviations can handle negative numbers. Option D is incorrect because both variances and standard deviations take probability estimates into consideration.

Question 14

Which one of the following statements is incorrect concerning stock indexes?
A) Indexes have been developed for foreign stocks.
B) Some indexes cover only a specific market sector.
C) Most indexes include all of the publicly-traded common stocks.
D)Some indexes are equally weighted.

Accepted Answer

While most indexes cover a broad range of publicly-traded stocks, some are limited to specific sectors or geographic regions. Additionally, some indexes are equally weighted or include foreign stocks. Therefore, statement C, which asserts that most indexes include all of the publicly-traded common stocks, is incorrect.

Question 15

A common stock was held for 2 years during which time total dividends of $20 were paid. The stock was sold for $100. What was the purchase price of the stock if the total rate of return for the period was 32%?
A) $61.60
B) $64.80
C) $88.00
D)$90.91

Accepted Answer

.32 = ($100 + 20 - P)/P; P = $90.91

Question 16

The fact that historical returns on Treasury bills are less volatile than common stock returns indicates that:
A) the variance of Treasury bill returns is zero.
B) the standard deviation of Treasury bill returns is negative.
C) the real return on Treasury bills has been negative.
D)common stocks should offer a higher return than Treasury bills.

Accepted Answer

Treasury bills are considered safer investments compared to common stocks, which are more volatile. As a result, investors demand higher returns for the increased risk associated with common stocks, leading to the expectation that common stocks should offer higher returns than Treasury bills.

Question 17

Investment risk can best be described as the:
A) dispersion of possible returns.
B) elimination of macro risk through diversification.
C) possibility of changes in the cost of capital.
D)level of systematic risk for an undiversified investor.

Accepted Answer

Investment risk refers to the degree of uncertainty about the returns that an investment will generate over a specific period. The dispersion of possible returns is a measure of the potential variability in those returns, which is a key component of investment risk. Option B is incorrect because diversification can reduce, but not eliminate, macro risk. Option C is incorrect because changes in the cost of capital can impact returns, but they are not the primary measure of investment risk. Option D is incorrect because systematic risk is a component of overall investment risk but is not the only measure of risk for undiversified investors.

Question 18

Historically, periods of market declines:
A) have been limited to losses of 38% or less of market value.
B) have affected all stocks to the same degree.
C) have been limited to periods of one year or less in duration.
D)can be sudden and severe.

Accepted Answer

Historical market declines have shown that they can be sudden and severe, as seen in the stock market crashes of 1929 and 1987.

Question 19

A portfolio is comprised of 60% of Stock A and 40% of Stock B.  What is the expected return of the portfolio?
A) 7.7%
B) 8.3%
C) 9.1%
D) 6.4%

Accepted Answer

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Question 20

If a stock's returns are volatile, then the stock:
A) cannot be considered a negative risk asset.
B) can still be considered a negative risk asset.
C) has macro risk, but no unique risk.
D)does not offer diversification potential.

Accepted Answer

A stock can still be considered a negative risk asset even if its returns are volatile. The term "negative risk" refers to the risk that the stock's returns will be lower than expected or will result in a loss. While high volatility may increase the risk of the stock's returns being lower than expected, it does not necessarily mean that the expected return is negative. Additionally, a high-risk asset can still have diversification potential if it does not move in tandem with other assets in a portfolio. Therefore, choice B is the best answer as it acknowledges that high volatility does not necessarily disqualify a stock from being a negative risk asset.

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

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

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

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

When viewing the long-term trend of the price volatility of U.S. stocks, it is readily apparent that volatility has:

Which one of the following companies is most apt to be exposed to the least amount of macro risk?

Which one of these is a specific risk?

A project's expected return is 15%, which represents a 35% return in a booming economy and a 5% return in a stagnant economy. What is the probability of a booming economy occurring if these are the only two economic states?

Which one of the following would you expect to represent the broadest-based index of U.S. stocks?

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?

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

Assume 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 20 tosses?

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

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

Which one of the following statements is incorrect concerning stock indexes?

A common stock was held for 2 years during which time total dividends of $20 were paid. The stock was sold for $100. What was the purchase price of the stock if the total rate of return for the period was 32%?

The fact that historical returns on Treasury bills are less volatile than common stock returns indicates that:

Investment risk can best be described as the:

Historically, periods of market declines:

A portfolio is comprised of 60% of Stock A and 40% of Stock B. What is the expected return of the portfolio?

If a stock's returns are volatile, then the stock: