Deck 7: Introduction to Risk and Return

Question 1

What has been the average annual real rate of interest on Treasury bills over the past 107 years (from 1900 to 2006)?

A) Less than 1%
B) Between 1% and 2%
C) Between 2% and 3%
D) Greater than 3%

Answer 1

Between 1% and 2%

Question 2

Which of the following countries had the lowest risk premium?

A) U.S.A
B) Denmark
C) Italy
D) none of the above

Answer 2

Denmark

Question 3

Which portfolio had the highest average annual return in real terms between 1900 and
2006?

A) Portfolio of U.S. Common stocks
B) Portfolio of U.S. government bonds
C) Portfolio of Treasury bills
D) None of the given answers

Answer 3

Portfolio of U.S. Common stocks

Question 4

Which portfolio has had the highest average risk premium during the period 1900-2006?

A) Common stocks
B) Government bonds
C) Treasury bills
D) None of the given answers

Question 5

Which of the following provides a correct measure of the opportunity cost of capital regardless of the timing of the cash flows?

A) Arithmetic average
B) Geometric average
C) Hyperbolic mean
D) None of the above

Question 6

What has been the average annual nominal rate of return on a portfolio of U.S. common stocks over the past 107 years (from 1900 to 2006)?

A) Less than 2%
B) Between 2% and 5%
C) Between 5% and 11%
D) Greater than 11%

Question 7

What has been the average annual nominal rate of interest on Treasury bills over the past
107 years (1900 - 2006)?

A) Less than 1%
B) Between 1% and 2%
C) Between 2% and 3%
D) Greater than 3%

Question 8

Given the following data: risk-free rate = 4%, average risk premium = 7.7%. Calculate the required rate of return:

A) 5.6%
B) 7.6%
C) 11.7%
D) None of the given answers

Question 9

Which of the following portfolios have the least risk?

A) A portfolio of Treasury bills
B) A portfolio of long-term United States Government bonds
C) Portfolio of U.S. common stocks of small firms
D) None of the above

Question 10

Spill Oil Company's stocks had -8%, 11% and 24% rates of return during the last three years respectively; calculate the average rate of return for the stock.

A) 8% per year
B) 9% per year
C) 11% per year
D) None of the above

Question 11

For log-normally distributed returns the annul compound returns is equal to:

A) the arithmetic average returns minus half the variance
B) the arithmetic average returns plus half the variance
C) the arithmetic average returns minus half the standard deviation
D) the arithmetic average returns plus half the standard deviation

Question 12

Standard error is estimated as:

A) Average annual rate of return divided by the square root of the number of observations
B) Variance divided by the number of observations
C) Standard deviation of returns divided by the square root of the number of observations
D) None of the above

Question 13

Which portfolio has had the lowest average annual nominal rate of return during the 1900-
2006 periods?

A) Portfolio of U.S. Common stocks
B) Portfolio of U.S. government bonds
C) Portfolio of Treasury bills
D) None of the given answers

Question 14

One dollar invested in a portfolio of U.S. common stocks in 1900 would have grown in nominal value by the end of year 2006 to:

A) $21,536
B) $176
C) $719
D) $6.81

Question 15

If the standard deviation is 19.8% and the number of observations is 107, what is the standard error?

A) 4.23 %
B) 1.9%
C) 0.47%
D) None of the above

Question 16

Long-term U.S. government bonds have:

A) Interest rate risk
B) Default risk
C) Market risk
D) None of the above

Question 17

If the average annual rate of return for common stocks is 11.7%, and for treasury bills it is
4)0%, what is the market risk premium?

A) 15.8%
B) 4.1%
C) 7.7%
D) None of the above

Question 18

What has been the average annual rate of return in real terms for a portfolio of U.S. common stocks between 1900 and 2006?

A) Less than 2%
B) Between 2% and 5%
C) Between 5% and 8%
D) Greater than 8%

Question 19

One dollar invested in a portfolio of U.S. government bonds in 1900 would have grown in nominal value by the end of year 2006 to:

A) $719
B) $66
C) $176
D) $2.80

Question 20

Standard error measures:

A) Nominal annual rate of return on a portfolio
B) Risk of a portfolio Reliability of an estimate
C) Reliability of an estimate
D) Real annual rate of return on a portfolio

Question 21

Stock A has an expected return of 10% per year and stock B has an expected return of
20%) If 40% of the funds are invested in stock A, and the rest in stock B, what is the expected return on the portfolio of stock A and stock B?

A) 10%
B) 20%
C) 16%
D) None of the above

Question 22

As the number of stocks in a portfolio is increased:

A) Unique risk decreases and approaches to zero
B) Market risk decreases
C) Unique risk decreases and becomes equal to market risk
D) Total risk approaches to zero

Question 23

For a two-stock portfolio, the maximum reduction in risk occurs when the correlation coefficient between the two stocks is:

A) +1
B) -0.5
C) -1
D) 0

Question 24

A statistical measure of the degree to which securities' returns move together is called:

A) Variance
B) Correlation Coefficient
C) Standard Deviation
D) None of the above

Question 25

Market risk is also called:
I. systematic risk, II) undiversifiable risk,
III. firm specific risk.

A) I only
B) II only
C) III only
D) I and II only

Question 26

The type of the risk that can be eliminated by diversification is called:

A) Market risk
B) Unique risk
C) Interest rate risk
D) Default risk

Question 27

Sun Corporation has had returns of -6%, 16%, 18%, and 28% for the past four years. Calculate the standard deviation of the returns.

A) 11.6%
B) 14.3%
C) 13.4 %
D) None of the above

Question 28

In the case of a portfolio of N-stocks, the formula for portfolio variance contains:

A) N variance terms
B) N(N - 1)/2 variance terms
C) N2 variance terms
D) None of the above

Question 29

Which of the following countries had the highest risk premium?

A) Germany
B) Denmark
C) Italy
D) None of the above

Question 30

Stock M and Stock N have had the following returns for the past three years of -12%,
10%, 32%; and 15%, 6%, 24% respectively. Calculate the covariance between the two securities.

A) -99
B) +99
C) +250
D) None of the above

Question 31

What has been the standard deviation of returns of common stocks during the period between 1900 and 2006?

A) 19.8%
B) 33.4%
C) 8.1%
D) 7.8%

Question 32

Stock X has a standard deviation of return of 10%. Stock Y has a standard deviation of return of 20%. The correlation coefficient between stocks is 0.5. If you invest 60% of the funds in stock X and 40% in stock Y, what is the standard deviation of a portfolio?

A) 10%
B) 20%
C) 12.2%
D) None of the above

Question 33

The range of values that correlation coefficients can take can be:

A) zero to +1
B) -1 to +1
C) - infinity to +infinity
D) zero to + infinity

Question 34

Which portfolio had the highest standard deviation during the period between 1900 and
2006?

A) Common stocks
B) Government bonds
C) Treasury bills
D) None of the given answers

Question 35

Mega Corporation has the following returns for the past three years: 8%, 12% and 10%. Calculate the variance of the return and the standard deviation of the returns.

A) 64 and 8%
B) 124 and 11.1%
C) 4 and 2%
D) None of the above

Question 36

The standard deviation of the UK market during the period from 2001 through 2006 was: (Approximately)

A) 12.3%
B) 14.1%
C) 9.8%
D) None of the above

Question 37

Stock P and stock Q have had annual returns of -10%, 12%, 28% and 8%, 13%, 24%
Respectively. Calculate the covariance of return between the securities.

A) -149
B) +149
C) 100
D) None of the above

Question 38

The unique risk is also called the:

A) Unsystematic risk
B) Diversifiable risk
C) Firm specific risk
D) All of the above

Question 39

Macro Corporation has had the following returns for the past three years, -10%, 10%, and
30%) Calculate the standard deviation of the returns.

A) 10%
B) 20%
C) 30%
D) None of the above

Question 40

If the covariance between stock A and stock B is 100, the standard deviation of stock A is
10% and that of stock B is 20%, calculate the correlation coefficient between the two securities.

A) -0.5
B) +1.0
C) +0.5
D) None of the above

Question 41

The "beta" is a measure of:

A) Unique risk
B) Total risk
C) Market risk
D) None of the above

Question 42

For log-normally distributed returns the annual geometric average return is greater than the arithmetic average return.

Question 43

The beta of Nestle measured relative to its home market is:

A) 0.17
B) 1.54
C) 1.01
D) none of the above

Question 44

The beta of market portfolio is:

A) + 1.0
B) +0.5
C) 0
D) -1.0

Question 45

What is the beta of a security where the expected return is double that of the stock market, there is no correlation coefficient relative to the US stock market and the standard deviation of the stock market is .18?

A) 0.00
B) 1.00
C) 1.25
D) 2.00

Question 46

The correlation coefficient between stock B and the market portfolio is 0.8. The standard deviation of the stock B is 35% and that of the market is 20%. Calculate the beta of the stock.

A) 1.0
B) 1.4
C) 0.8
D) 0.7

Question 47

The risk that cannot be eliminated by diversification is called market risk.

Question 48

The annual return for three years for stock B comes out to be 0%, 10% and 26%. Annual returns for three years for the market portfolios are +6%, 18%, 24%. Calculate the beta for the stock.

A) 0.74
B) 1.36
C) 1.0
D) None of the above

Question 49

The correlation coefficient between stock A and the market portfolio is +0.6. The standard deviation of return of the stock is 30% and that of the market portfolio is 20%. Calculate the beta of the stock.

A) 1.1
B) 1.0
C) 0.9
D) 0.6

Question 50

Treasury bills have provided the highest average return, both in nominal terms and in real terms, between 1900-2006.

Question 51

Risk premium is the difference between the security return and the Treasury bill return.

Question 52

For each additional 1% change in the market return, Amazon stock return on the average changes by:

A) 1.26%
B) 1.59%
C) 2.2%
D) None of the above

Question 53

The covariance between YOHO stock and the S&P 500 is .05. The standard deviation of the stock market is 20%. What is the beta of YOHO?

A) 0.00
B) 1.00
C) 1.25
D) 1.42

Question 54

The risk that cannot be eliminated by diversification is called unique risk.

Question 55

If the standard deviation of returns of the market is 20% and the beta of a well-diversified portfolio is 1.5, calculate the standard deviation of the portfolio:

A) 30%
B) 20%
C) 10%
D) none of the above

Question 56

Diversification reduces risk because prices of different securities do not move exactly together.

Question 57

The standard statistical measures of spread are beta and covariance.

Question 58

According to the authors, a reasonable range for the risk premium in the United States is
5% to 8%.

Question 59

In the case of a portfolio of N-stocks, the formula for portfolio variance contains:

A) N covariance terms
B) N(N - 1)/2 covariance terms
C) N2 covariance terms
D) None of the above

Question 60

Beta of a well-diversified portfolio is equal to the value weighted average beta of the securities
included in the portfolio.

Question 61

A stock with a covariance with the market higher than the variance of the market will always high a beta above 1.0.

Question 62

The average beta of all stocks in the market is zero.

Question 63

Briefly explain how individual securities affect portfolio risk.

Question 64

Briefly explain the concept of value additivity.

Question 65

Discuss the importance of "beta" as a measure of risk.

Question 66

Define the term risk premium.

Question 67

Briefly explain how "beta" of a stock is estimated.

Question 68

What is the beta of a portfolio with a large number of randomly selected stocks?

Question 69

Briefly explain the difference between beta as a measure of risk and variance as a measure of risk.

Question 70

Briefly explain the term "variance" of the returns.

Question 71

In the formula for calculating the variance of N-stock portfolio, how many covariance and variance terms are there?

Question 72

How can individual investors diversify?

Question 73

Briefly explain how diversification reduces risk.

Question 74

Higher the standard deviation of a stock higher is its beta.

Question 75

Briefly explain what "beta" of a stock means.

Question 76

A portfolio with a beta of one offers an expected return equal to the market risk premium.

Question 77

High standard deviation always translates into high beta.

Question 78

Explain why international stock may have high standard deviation but low betas.