Deck 4: Return and Risk

Question 1

Historically, what is the correct ranking of the following securities from lowest rate of return to the highest?

A) Short-term government bills, long-term government bonds, stocks.
B) Long-term government bonds, short-term government bills, stocks.
C) Stocks, short-term government bills,long-term government bonds.
D) Historical returns do not exhibit a consistent pattern.

Answer 1

A

Question 2

Krishna bought a stock at a price of $33.75. She received a $1.25 dividend and sold the stock for $36.10. What is Kelly's capital gain on this investment?

A) $(2.35)
B) $3.65
C) $2.35
D) $1.25

Answer 2

C

Question 3

Rational investor's are motivated to purchase an asset because of its

A) expected returns.
B) past returns.
C) emotional benefits.
D) all of the above.

Answer 3

A

Question 4

An investor who requires a 7% rate of return should be willing to pay $934.58 now to receive $1,000 at the end of one year.

Question 5

Which of the following investments may be impacted by government actions?

A) stocks
B) corporate bonds
C) government bonds
D) all of the above

Question 6

The greatest risk inherent in highly rated bonds is

A) the difficulty of selling them before their maturity date.
B) a potential reduction in the expected interest rate.
C) potential failure of the issue to repay the principal.
D) loss of purchasing power due to inflation.

Question 7

If the discount rate is appropriate for the level of risk, a satisfactory investment will have a present value of benefits equal to or greater than than the present value of costs.

Question 8

An investment that has earned a high rate of return over the last 5 years will necessarily continue to perform well in the future.

Question 9

A capital loss is computed by

A) subtracting the original cost of an investment from the proceeds received from the sale of that investment minus any income from the investment.
B) subtracting the original cost of an investment from the proceeds received from the sale of that investment plus any income from the investment.
C) subtracting the proceeds received from the sale of an investment from the original cost of the investment.
D) subtracting the original cost of an investment from the proceeds received from the sale of that investment.

Question 10

The financial concept of time value of money is dependent upon the opportunity to earn interest over time.

Question 11

Over the long term, which one of the following has historically had the lowest risk and lowest average annual rate of return?

A) U.S. common stock
B) long-term government bonds
C) short-term government bills
D) German common stock

Question 12

In response to the same external force, the return on one investment may increase while the return on another investment may decrease.

Question 13

To determine the total return on an investment, one needs to know the purchase price, the current value and any income the investment produced.

Question 14

Ashley purchased a stock at $54 per share. She received quarterly dividends of $0.80 per share. After one year, Ashley sold the stock at a price of $53.25 a share. What is her percentage holding period return on this investment?

A) 4.5%
B) 7.3%
C) 5.9%
D) -1.4%

Question 15

The internal rate of return takes into account all of an investment's cash flows over a period of time.

Question 16

In general, when investors expect inflation they will demand higher returns.

Question 17

The holding period return includes the time value of money.

Question 18

The most predictable component of stock returns is

A) capital gains.
B) capital losses.
C) inflation adjusted return.
D) dividend income.

Question 19

Meaningful measures of an investment's return must consider both income and capital gains.

Question 20

When investors expect higher inflation, they will generally require higher rates of return.

Question 21

Which one of the following statements is correct concerning the time value of money?

A) The future value of $1 at the end of two years is equal to $1.00(1+r)(1+r)
B) As the interest rate increases for any given year, the future value interest factor will decrease.
C) The future value of $1 decreases with the passage of time.
D) The future value of $1.00 at the end of 2 years is $1.00+2($1.00 × r).

Question 22

One reason that the holding period return should not be used to compare long-term investments is that it does not consider the time value of money.

Question 23

Mathew has purchased an investment for $6,805.83. . He will receive $10,000 5 years from today. What is the internal rate of return on his investment?

A) 9.40%
B) 8.00%
C) 10.36%
D) 47%

Question 24

Bob's house has doubled in value since he bought it 30 years ago. The house's value has increased by an annual rate of

A) 2.34%.
B) 3.33%.
C) 6.67%.
D) 100%.

Question 25

The return that fully compensates for the risk of an investment is called the risk-free rate of return.

Question 26

Short-term U. S. Treasury bills are yielding 1.5%. The expected inflation rate is 3%. Therefore, the real rate of interest must be 1.5%.

Question 27

Christopher invests $400 today at a 4% rate of return which is compounded annually. What is the future value of this investment after four years?

A) $342
B) $416
C) $464
D) $468

Question 28

Mila purchased an investment for $1,000. It generated the following stream of cash flows. $$\begin{array} { | l | l | } \hline \text { End of year 1 } & \$ 500 \\\hline \text { End of year } 2 & \$ 400 \\\hline \text { End of year 3 } & \$ 300 \\\hline\end{array}$$ Her internal rate of return was

A) 10.65%.
B) 6.67%
C) 9.70%
D) 8.90%.

Question 29

Roy is going to receive a payment of $5,000 one year from today. He earns an average of 6% on his investments. What is the present value of this payment?

A) $4,717
B) $4,821
C) $5,000
D) $5,300

Question 30

When all the cash flows from an investment, including its initial cost, are discounted at the internal rate of return, their present value will be zero.

Question 31

When the rate of return is equal to the discount rate

A) the present value of an investment's benefits must be greater than its cost.
B) the cost of an investment equals the sum of its benefits.
C) the cost of an investment equals the future value of its benefits.
D) the cost of an investment equals the present value of its benefits.

Question 32

If the risk-free rate of return is less than the inflation rate, the real rate of return is negative.

Question 33

The present value of $10,000 discounted at 5% per year and received at the end of 5 years is

A) $10,000/1.25.
B) $10,000(1.05)5.
C) $10,000/(1.05)5.
D) $10,000 (1.05)1/5.

Question 34

The required return on a risky investment includes a real rate of return, an inflation premium and a risk premium.

Question 35

It is not possible for the nominal risk-free rate of return to be lower than the rate of inflation.

Question 36

Zachary has purchased an investment that he expects to produce income of $3,000 at the end of the first year and $4,000 at the end of the second year. If he requires an 8% rate of return compounded annually, what is the maximum amount that he can pay and still earn the required rate of return?

Question 37

The holding period return is not useful for comparing investments with unequal holding periods.

Question 38

The present value of $1,000 discounted at the rate of 5% per year, to be received at the end of 3 years is equal to

A) $1,000/(1.03)5.
B) $1,000/(1.05)3.
C) $1,000 × (1.05)3.
D) $1,000 - ($1,000) × .03 × 5.

Question 39

If the present value of an investment's benefits equals the present value of the investment's costs, then the investor would earn a

A) return equal to the discount rate.
B) negative rate of return.
C) 0% rate of return.
D) return greater than the discount rate.

Question 40

Zachary has purchased an investment that he expects to produce income of $3,000 at the end of the first year and $4,000 at the end of the second year. If he pays $5,800 for this investment, what is the internal rate of return?

Question 41

Jason purchased ABC stock at $40 per share and DEF stock at $35 per share on the same day in 2020. Exactly 6 months later, the ABC stock is worth $42.00 per share and has not paid a dividend while the DEF stock is worth $36 per share and has paid 2 quarterly dividends of $0.50 each. The holding period returns are

A) ABC, $2.00 and DEF $2.00.
B) ABC 5% and DEF 2.9%.
C) ABC 5% and DEF 5.7%.
D) The holding period return cannot be determined because we do not know the discount rate.

Question 42

The holding period return (HPR) can appropriately be used to

A) compare the yield on investments held for any time period.
B) compare returns among investments that are held for the same period of time.
C) isolate realized capital gains.
D) determine the required reinvestment rate for long-term investments.

Question 43

In which of the following circumstances would it be most appropriate to use the holding period return?

A) to compare the capital gains on a house held for 8 years and a mutual fund held for 6 years
B) to compare the calendar year performance of stocks purchased in March to stocks purchased in September
C) to compare the dividend yield of stocks to the interest rate on bonds
D) to compare the performance of several stocks, each of which was held throughout an entire year

Question 44

The closest approximation to the real, risk-free rate of interest is

A) the short-term Treasury bill rate plus the inflation rate.
B) the short-term Treasury bill rate minus the inflation rate.
C) the 10 year Treasury bond rate minus the inflation rate.
D) the 10 year Treasury bond rate minus the 1 year Treasury bill rate.

Question 45

Which of the following is(are) issue characteristics of an investment?
I) type of investment such as stocks or bonds
II) financial condition of the issuer
III) coupon or dividend payments
IV) time to maturity

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

Question 46

Which one following will lower required rates of return?

A) higher rates of inflation
B) higher risk premiums
C) lower rates of inflation
D) lower dividend yields

Question 47

The risk-free rate is equal to the real rate of return plus

A) an expected inflation premium.
B) a risk premium.
C) both an inflation and a risk premium.
D) the prevailing prime rate.

Question 48

The internal rate of return is the rate of return that causes a project to have a zero net present value.

Question 49

The internal rate of return is the correct method to use when an investor wants to determine an investment's average annual yield.

Question 50

The markets in general are paying a 1% real rate of return. Inflation is expected to be 3%. RJH stock commands an 8% risk premium. What is the expected rate of return on RJH stock?

A) 1%
B) 4%
C) 9%
D) 12%

Question 51

Kayla purchased a stock for $56 a share and sold it six months later for $62. While she owned the stock, Kayla received two quarterly dividends of $0.70 per share. Kayla's annualized holding period return on this stock is

A) 13.2%.
B) 10.7%.
C) 11.9%.
D) 26.4%.

Question 52

The required return on Beta stock is 14%. The risk-free rate of return is 4% and the real rate of return is 2%. How much are investors requiring as compensation for risk?

A) 8%
B) 10%
C) 12%
D) 14%

Question 53

The present value of an investment must be computed by discounting cash flows at the internal rate of return.

Question 54

The internal rate of return on an investment is the discount rate that produces a present value of benefits greater than the cost of the investment.

Question 55

Josh purchased 200 shares of HAR stock at $25.30 per share and sold it 9 months later for $27.20. HAR does not pay a dividend. At the same time, he bought 500 shares of WIG for
$9)15 a share. He sold WIG for $9.65 one year later. During the year, WIG paid 4 quarterly dividends of $0.07 each. The most useful way to compare the holding period returns on these stocks is to

A) Multiply the 9 month return on HAR by 12/9.
B) Divide the 9 month return on HAR by 9/12.
C) Divide the 1 year return on WIG by 9/12.
D) The two holding period returns cannot be compared.

Question 56

Briefly explain the holding period return (HPR) and give several characteristics of this measure.

Question 57

A holding period return is calculated by adding the current income to the capital gains and dividing this sum by the

A) average investment value.
B) beginning investment value.
C) total income received.
D) selling price of the investment.

Question 58

The required rate of return on the Cosmos Corporation's common stock is 10%, the current real rate of return in the market is 1%, and the inflation rate is 3%. In this case, the risk premium associated with Cosmos stock is

A) 5%.
B) 6%.
C) 7%.
D) 8%.

Question 59

The internal rate of return takes into account the purchase price, the selling price and the timing of any income received from the investment.

Question 60

The internal rate of return is a less meaningful measure of an investment's performance than holding period return if the holding period is other than 1 year.

Question 61

Taylor bought a stock for $68 a share three years ago. The stock does not pay any dividends. Today she sold the stock for $57 a share. What was her internal rate of return on this investment?

A) 6.43%
B) -5.71%
C) 19.30%
D) -6.43%

Question 62

-Given a spreadsheet similar to the one shown in Table 1, the command to compute the internal rate of return would be

A) =RATE(3,B3,B4,B2).
B) =IRR(B2:B4).
C) =IRR(B3:B4)-B2.
D) =TVM(A2:B4).

Question 63

The potential for Congress to alter tax rates and deductions increases tax risk for U.S. businesses.

Question 64

Josh purchased 100 shares of XOM at the beginning of 2016. He received dividends per share of $1.37 (2016), $1.55 (2017), $1.66 (2018), $1.74 (2019), $1.85 (2020). At the end of 2020, just after receiving the last dividend, he sold the stock for $84.76. At what rate did the dividends grow from the end of 2016 to the end of 2020? Assume that all dividends were received at the end of the year.

A) 7.8%
B) 6.2%
C) 13.1%
D) 35%

Question 65

When computing an investment's internal rate of return using a financial calculator or spreadsheet such as Excel, which of the following should be entered as a negative number?

A) the number of time periods
B) dividend or interest payments
C) the price at which the investment is sold
D) the initial cost of the investment

Question 66

If a stock is purchased at the beginning of a year, a single dividend is paid at the end of the year and the stock is sold immediately after the dividend has been received. In this case

A) the internal rate of return is lower than the holding period return.
B) the holding period return. is lower than the internal rate of return.
C) it is not possible to calculate the internal rate of return.
D) the internal rate of return equals the holding period return.

Question 67

A suitable investment should have an internal rate of return equal to or greater than its required rate of return.

Question 68

The following investment cash flows have been entered into cells B5 through B9 of an EXCEL spreadsheet. B5 $(5,200 ), B6 $2,100, B7 $1,300, B8 $1,800, B9 $1,200, where $(5,200) is the cost of the investment and the following amounts are cash flows at the end of years one through four. The correct function for computing the yield on this investment is

A) =irr(B6:B9)+B5.
B) =irr(B5:B9).
C) =rate(4,0,-5200, 1200).
D) =ytm(B5, B6:B9).

Question 69

Eli purchased an investment for $1,000. It generated the following stream of cash flows. $$\begin{array} { | l | l | } \hline \text { End of year 1 } & \$ 300 \\\hline \text { End of year } 2 & \$ 400 \\\hline \text { End of year 3 } & \$ 500 \\\hline\end{array}$$ His internal rate of return was

A) 10.65%.
B) 6.67%.
C) 9.70%.
D) 8.90%.

Question 70

Business risk is the risk associated with the amount of debt financing used by a firm.

Question 71

Josh purchased 100 shares of XOM for $76.63 per share at the beginning of 2016. He received dividends per share of $1.37 (2016), $1.55 (2017), $1.66 (2018), $1.74 (2019), $1.85 (2020). At the end of 2020, just after receiving the last dividend, he sold the stock for $84.76. What was his average annual rate of return form both dividends and capital gains? (Hint: compute the IRR, assume that all dividends were received at the end of the year.)

Question 72

Lower risk investments are associated with lower expected rates of return.

Question 73

Ryan purchased a bond for $980 at the beginning of 2016. He received annual interest payments of $55 at the end of each year through 2020 when the bond was redeemed at its face value of $1,000. Compute the yield (internal rate of return) Ryan earned on his bond purchase.

A) 5.50%
B) 5.61%
C) 5.97%
D) 0.34%

Question 74

The Sorka Corp. has paid annual dividends of $0.60, $0.63, $0.65, $0.68 and $0.72, respectively, over the past five years. What is the dividend growth rate?

A) 4.7%
B) 5.2%
C) 5.4%
D) 5.9%

Question 75

7 years ago, Nick invested $7,000. Today his investment is worth $11,500. The internal rate of return on this investment is

A) 7.35%.
B) 9.18%.
C) 64.23%.
D) error 5.

Question 76

Risk can be defined as uncertainty concerning the actual return that an investment will generate.

Question 77

Business risk resulting from uncertainty over a firm's earnings is a concern for stockholders, but not for debt holders.

Question 78

Explain the similarities and differences between the holding period return and the internal rate of return.

Question 79

Josh purchased 100 shares of XOM for $76.63 per share at the beginning of 2016. He received dividends per share of $1.37 (2016), $1.55 (2017), $1.66 (2018), $1.74 (2019), $1.85 (2020). At the end of 2020 just after receiving the last dividend, he sold the stock for $84.76. What was his average annual rate of return form both dividends and capital gains? (Hint: compute the IRR, assume that all dividends were received at the end of the year.)

A) 9.831%
B) 3.774%
C) 3.423%
D) 4.076%

Question 80

An investment costs $3,500 today. This investment is expected to produce annual cash flows of $1,200, $1,400, $1,300 and $1,100, respectively, over the next four years. What is the internal rate of return on this investment?

A) 8.1%
B) 9.33%
C) 14.6%
D) 16.2%