Deck 4: Risk and Return

Question 1

Which of the following statements is false?

A) The greater the risk, the larger the return investors require for bearing that risk.
B) The risk and return relationship is one of the most fundamental relationships in finance.
C) The rate of return investors require for an investment depends on the risk associated with that investment.
D) None of the above.

Answer 1

None of the above.

Question 2

Which of the following statements is true?

A) Higher risk means you are more certain about your expected return.
B) Risk is a measure of how certain you are about your expected return.
C) The rate of return is what you earn on an investment, stated in dollar terms.
D) None of the above.

Answer 2

Risk is a measure of how certain you are about your expected return.

Question 3

If two investments have the same expected return, investors will prefer the __________ risky alternative.

A) risk is not important.
B) more.
C) less.
D) none of the above.

Answer 3

less.

Question 4

When choosing between two investments that have the same level of risk, investors prefer the investment with the ____________ return.

A) more predictable return.
B) lower.
C) higher.
D) none of the above.

Question 5

Share A has an expected return of 8% and a risk level of 10%. Share B has an expected return of 8% and a risk level of 14%. Which would you choose?

A) A.
B) B.
C) Indifferent as expected return is the same.
D) Neither as risk is too high.

Question 6

Share A has an expected return of 12% and risk level of 10%. Share B has an expected return of 12% and risk level of 14%. Share C has an expected return of 10% and risk level of 14%. Rank them in order of your preference.

A) A, B, C.
B) B, C, A.
C) C, B, A.
D) B, A, C.

Question 7

A risk averse person will:

A) have to be compensated to participate in a fair game.
B) participate in fair game.
C) pay to participate in a fair game.
D) none of the above.

Question 8

A risk neutral investor will assess investment alternatives based on their:

A) expected returns.
B) relative expected risks.
C) relative expected risks and returns.
D) none of the above.

Question 9

If a person chooses to take $100 in cash instead of betting it to win $210 on the toss of a coin, that person is:

A) risk averse.
B) risk neutral.
C) a risk seeker.
D) indifferent to risk.

Question 10

1 year ago, you bought a share from Bechtel Ltd for $110. Today it's worth $115. Over the year, the company did not pay any dividend. What total return did you earn on this share over the past year?

A) -4.35%.
B) 4.35%.
C) 4.45%.
D) 4.54%.

Question 11

Let's suppose you recently bought a share of BHP Billiton for $110.00. You plan to sell the share next year. You estimate that there is a 25% chance that the shares will sell for $115 at the end of 1 year, 50% chance it will sell for $120 and 25% chance it will sell for $112. Moreover, you estimate that the company will pay a $3 dividend per share under any circumstances. What is your total expected return?

A) 8.27%.
B) 8.86%.
C) 22.25%.
D) 23.64%.

Question 12

A share bought for $20 at the start of the period and sold for $15 at the end of the period which paid dividends of $2 and $3 in the interim generated a holding period return of:

A) -50%.
B) 0%.
C) 50%.
D) 100%.

Question 13

What is the expected return from an asset having the following possible returns and associated probabilities?
$\begin{array}{cc} \text {Possible return} & \text {Probability} \\ 25 \% & 20 \% \\ 15 \% & 50 \% \\ 5 \% & 30 \% \end{array}$

A) 13.5%.
B) 14%.
C) 15%.
D) 16.5%.

Question 14

A stock which has possible returns of 40% and -5% each with equal likelihood has an expected return of:

A) 10%.
B) 15.5%.
C) 17.5%.
D) 20%.

Question 15

Given that a stock has generated returns of 6%, 18%, -5% and 20% over the last four years, the average annual return on this stock over the period was:

A) 9.75%.
B) 10.50%.
C) 12.25%.
D) 39%.

Question 16

Given the following series of annual returns for a managed fund: 5%, 6%, 23%, -15%, 20%, -29%, 40%, -40%, 23%, the average annual return over the period was:

A) 3.67%.
B) 6.37%.
C) 10.11%.
D) 13.44%.

Question 17

There are two probabilities of returns for Stock A. If the probability of a 10% return is 60%, what is the probability of a 12% return?

A) 40%.
B) 60%.
C) 100%.
D) insufficient information provided.

Question 18

The sum of the probabilities of returns must be:

A) more than 100 per cent.
B) less than 100 per cent.
C) equal to 100 per cent.
D) none of the above.

Question 19

You are considering investing in a share of ASX Ltd and you know that the share returns tend to be normally distributed, and you have calculated the expected return on the share to be 10% and the standard deviation to be around 15%. Based on those statistics, within what range would you expect the return on this share to fall during next year (calculate the range at 99% level of confidence).

A) - 28.625% and 10%.
B) - 28.625% and 48.625%.
C) 10% and 38.625%.
D) 10% and 48.625%.

Question 20

Suppose a particular stock's return is perfectly characterised by the normal distribution. This stock has a mean return of 10% and standard deviation of 3%. Within what range will approximately 95% of all possible returns on this stock lie:

A) -2% to 22%.
B) 2% to 18%.
C) 4% to 16%.
D) 4% to 10%.

Question 21

Given that a stock has generated returns of 6%, 18%, -5% and 20% over the last four years, the variance of stock returns was:

A) 0.013492.
B) 0.017423.
C) 0.024930.
D) 0.028970.

Question 22

Given that a stock has generated returns of 6%, 18%, -5% and 20% over the last four years, the standard deviation of stock returns was:

A) 9.03%.
B) 10.50%.
C) 11.62%.
D) 12.46%.

Question 23

If returns are normally distributed, the expected return plus or minus one standard deviation will cover what percentage of all possible returns?

A) 68%.
B) 90%.
C) 95%.
D) 99%.

Question 24

If returns are normally distributed, the expected return plus or minus 1.96 standard deviations will cover what percentage of all possible returns?

A) 99%.
B) 90%.
C) 68%.
D) 95%.

Question 25

If returns are normally distributed, the expected return plus or minus 1.64 standard deviations will cover what percentage of all possible returns?

A) 99%.
B) 68%.
C) 90%.
D) 95%.

Question 26

Covariance measures:

A) how the returns of two assets move in opposite directions.
B) how the risks of two assets move in opposite directions.
C) how the risks of two assets move together.
D) how the returns of two assets move together.

Question 27

You hold a portfolio of two assets. When the return on one asset is positive, the return on the other asset is negative. We can conclude that:

A) the correlation between the two assets in the portfolio is negative.
B) there is no correlation between the two assets in the portfolio.
C) the correlation between the two assets in the portfolio is positive.
D) none of the above.

Question 28

Domino's shares have an expected return of 9 per cent and a variance of 0.25 per cent. What is the coefficient of variation for Domino's?

A) 0.0278.
B) 0.0556.
C) 2.7778.
D) 5.5556.

Question 29

Beef Stock returns have exhibited a standard deviation of 0.57, whereas Sheep Stock returns have a standard deviation of 0.63. The correlation coefficient between the returns is 0.078042. What is the covariance of the returns?

A) 0.028025.
B) 0.217327.
C) 0.359100.
D) 0.993094.

Question 30

Which of the following expressions best describes the concept of reducing risk through diversification?

A) Look before you leap.
B) A stitch in time saves nine.
C) The early bird catches the worm.
D) Don't put all your eggs in one basket.

Question 31

Risk is less effectively reduced through diversifying into different investments when the different investments:

A) are in the same country.
B) are in the same industry.
C) have zero correlation with the market.
D) have negatively correlated returns.

Question 32

Correlation is a measure of:

A) dispersion.
B) central tendency.
C) the equity risk premium (ERP).
D) the way two variables move relative to each other.

Question 33

What does a beta of greater than one mean if you hold a bond?

A) The bond has greater systematic risk than the market.
B) The bond has the same systematic risk as the market.
C) The bond has greater non-diversifiable risk than the market.
D) The bond has greater unsystematic risk than the market.

Question 34

Beta is a measure of an asset's:

A) total risk.
B) correlation with market returns.
C) systematic risk.
D) unsystematic risk.

Question 35

______________ risk is the risk that is common to all businesses.

A) systematic.
B) unique.
C) firm-specific.
D) unsystematic.

Question 36

A beta equal to one means the stock has:

A) less systematic risk than the market.
B) no systematic risk.
C) the same systematic risk as the market.
D) more systematic risk than the market.

Question 37

A treasury bond has a systematic risk of:

A) 1.5.
B) 0.
C) 1.
D) insufficient information provided.

Question 38

Which of the following is false?

A) Treasury bonds are viewed as risk-free.
B) Investing in the market will not earn compensation for taking on risk.
C) Assets with a beta of 1.2 have more risk than the market.
D) None of the above.

Question 39

The expected return on Fishermans Inn Ltd shares is 10.8 per cent. If the expected return on the market is 10 per cent and the beta for Fishermans Inn is 1.7, then what is the risk-free rate?

A) 4.5%.
B) 5.0%.
C) 5.5%.
D) 6.0%.

Question 40

Using the CAPM, calculate the expected rate of return for a share that has a beta of 2.3. The expected return on the market and risk-free rate are 6% and 5% respectively.

A) 2.3%.
B) 2.7%.
C) 7.3%.
D) 6.3%.

Question 41

A share is priced to return 10% but according to the CAPM its expected return is 7%. According to CAPM theory, we can expect the price of this share to:

A) fall.
B) rise.
C) uncertain.
D) stay the same.

Question 42

A risk-free rate of 5% and an expected market return of 12%, the CAPM predicts an expected return of which of the following, given a beta of 1.6:

A) 17%.
B) 21%.
C) 15%.
D) 16.2%.

Question 43

Given only information on beta, which of the following stocks is considered the least risky:

A) stock A beta = 1.37.
B) stock B beta = 2.16.
C) stock C beta = 0.56.
D) stock D beta = 0.85.

Question 44

If you expect a market return of 10% and a risk-free rate of 5%, the required rate of return on an investment with a beta value of 0.5 is:

A) 5%.
B) 7.5%.
C) 10%.
D) 12.5%.

Question 45

If the expected returns on an investment are uncorrelated with the market, its beta value is:

A) -1.
B) 0.
C) 1.
D) equal to that of the market.