Deck 6: The Risk and Return From Investing

Question 1

To calculate the return on a stock that pays a year-end dividend, an investor should:

A) divide the stock's sale price by its purchase price and subtract 1.
B) add the dividend and sale price, divide by the purchase price and subtract 1.
C) divide the sale price by the purchase price and add the dividend yield.
D) divide all cash flows received by the selling price and subtract 1.

Answer 1

B

Question 2

Liquidity risk:

A) is the risk that investment bankers normally face.
B) is lower for small OTC stocks than for large NYSE stocks.
C) is a risk associated with secondary market transactions.
D) increases whenever interest rates increase.

Answer 2

C

Question 3

If the Dow Jones Industrials had a price appreciation of 6 percent one year and yet total return for the year was 9 percent, the difference would be due to:

A) the tax treatment of capital gains.
B) the cumulative wealth effect.
C) dividends.
D) inflation.

Answer 3

C

Question 4

Total return is equal to:

A) capital gain + price change.
B) yield + income.
C) capital gain - loss.
D) yield + price change.

Question 5

The housing bubble and resulting credit crisis of 2008 is an example of:

A) nonsystematic risk.
B) systematic risk.
C) inflation risk.
D) political risk

Question 6

Which of the following is true regarding the cumulative wealth index? It:

A) is measured by adding up the total returns over the holding period and dividing by the investment.
B) uses a beginning index value (often set to $1, but it can be set to any amount).
C) is the present value of the future cash flows expected from the investment.
D) uses the arithmetic mean as the rate of growth of one's wealth.

Question 7

In deriving changes in wealth over time, the return relative solves the problem of:

A) inflation. b negative returns.
C) interest rates.
D) tax differences.

Question 8

Financial risk is most closely associated with:

A) the use of equity financing by corporations.
B) the use of debt financing by corporations.
C) equity investments held by corporations.
D) debt investments held by corporations.

Question 9

Based on prior empirical evidence, which of the following investment strategies has benefitted most from adding a dividend exposure? A strategy targeting:

A) small-cap stocks with limited growth opportunities.
B) small-cap stocks with strong growth opportunities.
C) large-cap stocks with limited growth opportunities.
D) large-cap stocks with strong growth opportunities.

Question 10

Political stability is the major factor concerning:

A) exchange-rate risk.
B) systematic risk.
C) nonsystematic risk.
D) country risk.

Question 11

If a U.S. investor buys foreign stock, his dollar-denominated return will increase if the dollar:

A) appreciates relative to the foreign currency.
B) depreciates relative to the foreign currency.
C) remains unchanged relative to the foreign currency.
D) moves to a net gain position relative to all foreign currencies.

Question 12

Investors should be willing to invest in riskier investments only:

A) if the expected holding period is short term.
B) if there are no safe alternatives except for holding cash.
C) if the expected return is adequate for the risk level.
D) if they are speculators.

Question 13

An impending recession is an example of:

A) interest rate risk.
B) inflation risk.
C) market risk.
D) financial risk.

Question 14

Which of the following corresponds most closely with an increase in interest rates?

A) Business risk
B) Financial risk
C) Liquidity risk
D) Inflation risk

Question 15

If interest rates are expected to rise, you would expect:

A) bond prices to fall more than stock prices.
B) bond prices to rise more than stock prices.
C) stock prices to fall more than bond prices.
D) stock prices to rise and bond prices to fall.

Question 16

Adding 1 to return produces the:

A) arithmetic mean.
B) return relative.
C) cumulative wealth index.
D) geometric mean.

Question 17

Empirical evidence indicates that adding a dividend exposure to a portfolio of non-dividend paying stocks has resulted in:

A) increased returns and decreased risk for the portfolio.
B) increased returns and increased risk for the portfolio.
C) decreased returns and increased risk for the portfolio.
D) decreased returns and decreased risk for the portfolio.

Question 18

New financial disclosure regulations affecting the brokerage industry are a type of:

A) market risk.
B) financial risk.
C) business risk.
D) liquidity risk.

Question 19

Which of the following is not part of the yield component of total return?

A) Dividend payment on common stock
B) Coupon interest payment on bonds
C) Capital gain upon sale of stock
D) Dividend payment on preferred stock

Question 20

Assume an investor purchases a Euro-denominated bond when the Euro is quoted at $0.96 per Euro and sells the bond when the Euro is quoted at $1.12 per Euro. Relative to the dollar, the Euro has:

A) appreciated, and the investor has gained from the currency move.
B) appreciated, and the investor has lost from the currency move.
C) depreciated, and the investor has gained from the currency move.
D) depreciated, and the investor has lost from the currency move.

Question 21

Bond prices and interest rates are inversely related.

Question 22

Which of the following statements regarding the arithmetic mean and the geometric mean is true?

A) The arithmetic mean is always a better measure of average performance.
B) The geometric mean is always a better measure of average performance.
C) The arithmetic mean is a better measure of performance over single periods.
D) The geometric mean is the best estimate of the expected return for the next period.

Question 23

Over the past 90 years, which of the following financial assets showed the greatest amount of price volatility, as measured by standard deviation?

A) Small-cap stocks
B) Large-cap stocks
C) Treasury bonds
D) Treasury bills

Question 24

Return and risk are inversely related.

Question 25

The less the variability of return, the greater the risk.

Question 26

A major difference between real and nominal returns is that:

A) real returns adjust for inflation, and nominal returns do not.
B) real returns use actual cash flows, and nominal returns use expected cash flows.
C) real returns adjust for commissions, and nominal returns do not.
D) real returns show after-tax returns, and nominal returns show before-tax returns.

Question 27

If you invest in German bonds and the Euro becomes stronger during your holding period, then:

A) you will be able to buy back fewer dollars when you redeem your bonds.
B) your dollar-denominated return will increase.
C) your-dollar denominated return will decrease.
D) your return will be the interest you receive.

Question 28

Over a long period of time, common stocks have returned approximately twice as much as bonds; therefore, the amount accumulated in a stock fund relative to a bond fund over time would be:

A) twice as much.
B) less than twice as much.
C) more than twice as much.
D) less (more) than twice as much if volatility is lower (higher) than average.

Question 29

The standard deviation of a security measures the:

A) systematic risk of the security.
B) unsystematic risk of the security.
C) total risk of the security.
D) risk per unit of return for the security.

Question 30

Which of the following statements about the expected equity risk premium is true?

A) It is occasionally negative.
B) There is no direct way to measure it.
C) It decreases as investor uncertainty increases.
D) It increases as the risk-free rate increases.

Question 31

Over the past 10 years, a small-cap fund and a large-cap fund each reported an arithmetic mean return of 7%. Based on this information, the geometric mean return for the small-cap fund was most likely:

A) less than 7% and exceeded the geometric mean return of the large-cap fund.
B) less than 7% and was less than the geometric mean return of the large-cap fund.
C) more than 7% and exceeded the geometric mean return of the large-cap fund.
D) more than 7% and was less than the geometric mean return of the large-cap fund.

Question 32

Another name for a capital gain is yield.

Question 33

The equity risk premium is the difference between the expected return:

A) on stocks and bonds.
B) on high-grade stocks and low-grade stocks.
C) on stocks and the risk-free rate.
D) on a stock market index and the inflation rate.

Question 34

In order to determine the compound growth rate of an investment over some period, an investor would calculate the:

A) arithmetic mean.
B) geometric mean.
C) calculus mean.
D) arithmetic median.

Question 35

Present value is based on the concept of:

A) compounding.
B) systematic risk.
C) duration.
D) discounting.

Question 36

When most people refer to mean return, they are referring to the:

A) holding period return.
B) arithmetic average return.
C) geometric average return.
D) cumulative average return.

Question 37

As the dollar falls,

A) foreign investors owning U.S. stocks suffer.
B) U.S. investors owning U.S. stocks suffer.
C) U.S. investors owning foreign stocks suffer.
D) foreign investors owning foreign stocks suffer.

Question 38

Over the past 90 years, which financial asset class has produced the greatest number of superior 5-year return periods?

A) Large-cap stocks
B) Small-cap stocks
C) Long-term corporate bonds
D) Short-term corporate bonds

Question 39

A number of prominent observers expect the future equity risk premium to be:

A) considerably lower than that of the past.
B) considerably higher than that of the past.
C) very similar to the historical average.
D) very similar to the recent value.

Question 40

Relative to long-term corporate bonds, long-term government bonds (T-bonds) report a higher standard deviation and a lower return. What best explains this observation?

A) The observation reflects a market inefficiency.
B) T-bonds are less liquid than corporate bonds.
C) T-bonds are more commonly callable than corporate bonds.
D) T-bonds pay interest that is exempt from state and local income taxes.

Question 41

Since 1926, there has never been a 20-year period where bonds have outperformed stocks in the U.S. security markets?

Question 42

Assuming stock returns are approximately normally distributed with a 10% mean return. Based on the past 90 years, there is a 2.5% chance an investor could experience an annual loss of at least what amount?

Question 43

The largest 1-year U.S. stock return in history occurred during the 1930s.

Question 44

What does the empirical evidence indicate about the investment performance of small stocks with strong growth opportunities that pay no dividends? Why might such stocks be characterized as lottery tickets?

Question 45

What was the effect on foreign investors owning U.S. stocks when the dollar fell in 2008?

Question 46

The standard deviation of returns, calculated as the square root of the variance of returns, is a measure of total risk of an asset or portfolio.

Question 47

Both present value and future value are based upon the concept of the time value of money.

Question 48

It is generally easier to predict interest rate risk than market risk.

Question 49

What is the major drawback of a return measure? Why is it the most common return calculation used by investors?

Question 50

A stock is purchased for $50 on January 1 and sold on December 31 for $72. A $5.00 per share dividend is paid at the end of the year.
(a) Calculate return (R).

Question 51

The returns and risk measures in this chapter are calculated from historical data. Are such measures good predictors of the future? What are some circumstances that could change to impact future return and risk? How can an investor use these return and risk measures to help construct a portfolio?

Question 52

New regulations concerning auto emissions would be a type of market risk for the auto industry.

Question 53

When should an investor use the arithmetic mean return? The geometric mean return?

Question 54

A Chinese stock denominated in Chinese yuan will have an increase in its dollar-denominated return if the Chinese yuan strengthens against the dollar.

Question 55

What common variable is used in the calculation of both the cumulative wealth index and the geometric mean return? How is the common variable calculated? How is it used in each?

Question 56

Holding interest rates constant, a narrowing of the equity risk premium implies a decline in the return on stocks because the amount earned beyond the risk-free rate is reduced.

Question 57

International mutual funds offer investors global diversification without exchange rate risk.

Question 58

Assume you are a U. S. citizen who purchases $20,000 worth of bonds of the Deep Shaft Mining Company in Kenya. What sources of risk can you identify with this investment?

Question 59

What is the best measure of risk for a sole proprietorship?

Question 60

The most common measure of inflation is the Producer Price Index.

Question 61

What is the present value of $20,000 to be received in 40 years if the interest rate is 9 percent?

Question 62

Korea's consumer price index is expected to increase from its current level of 797 to 859 by next year. The current rate on one-year Korean government bonds is 9.5%. What is the expected real risk-free rate for Korea?

Question 63

If you deposit $1,000 today at 12 percent, how much will you have in 10 years?

Question 64

Calculate FV of $100,000 at the end of 64 years given an interest rate of 10.38%.

Question 65

At the beginning of 2015, Clark's trust fund had a value of $400,000. Between the beginning of 2015 and the end of 2019, Clark's portfolio earned an arithmetic mean annual return of 7.6% and a geometric mean annual return of 6.3%. What approximate value did Clark's portfolio have at the end of 2019? Assume there were no inflow into or outflows from Clark's portfolio.

Question 66

A U.S. investor purchased Sony bonds that were denominated in yen, had a 6.9% yield to maturity, and had one year to maturity. At the time of purchase, the exchange rate was 139 yen/$. At maturity, the exchange rate was 122 yen/$. What was the investor's annual return on the bonds?

Question 67

John Crossborder buys 1 share of Telmex at 140 pesos when the value of the peso is stated in dollars at $0.35. One year later, Telmex is selling for 155 pesos and paid a dividend of 5 pesos at yearend. If after one year the value of pesos is $0.29, what is John's return in U.S. dollars?

Question 68

The S&P 500 showed the following Rs for a 6-year period: 11.1 percent, -5.2 percent, 20.3 percent, 26.7 percent, -12.4 percent, and 2.2 percent.
(a) Calculate the arithmetic mean return for the 6-year period.
(b) Calculate the geometric mean return for the 6-year period.