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

Question 1

Cyclical stocks tend to perform well when other stocks are performing well also.

Answer 1

True

Question 2

For investment horizons greater than 20 years,long-term corporate bonds traditionally have outperformed common stocks.

Answer 2

False

Question 3

Macro risks are faced by all common stock investors.

Answer 3

True

Question 4

For the period between 1900 and 2000,the risk premium of Italy is higher than that of the United States.

Question 5

The historical record fails to show that investors have received a risk premium for holding risky assets.

Question 6

Sector funds invest in the broad market index.

Question 7

All financial managers and economists believe that long-run historical returns are the best measure available.

Question 8

The S&P 500 accounts for nearly 75% of the total value of stocks traded in the United States.

Question 9

Market risk can be eliminated in a stock portfolio through diversification.

Question 10

The risk that remains in a stock portfolio after efforts to diversify is known as unique risk.

Question 11

Average returns on high-risk assets are higher than those on low-risk assets.

Question 12

Which of the following statements is true for a stock that sells now for $60,pays an annual dividend of $4.00,and experienced a 20% return on investment over the past year? Its price one year ago was:

A) $42.00.
B) $46.15.
C) $48.46.
D) $53.33.

Question 13

A market index is used to measure performance of a broad-based portfolio of stocks.

Question 14

The expected return on an investment provides compensation to investors both for waiting and for worrying.

Question 15

Long-term corporate bonds are the only portfolio of securities found to be riskier than common stocks.

Question 16

If one portfolio's variance exceeds that of another portfolio,its standard deviation will also be greater than that of the other portfolio.

Question 17

Investors who had bought at the stock market peak in March 2000 would have seen little but falling stock prices over the next two-and-a-half years.

Question 18

When inflation is expected to be low,the risk premium on common stocks is expected to be low.

Question 19

Stock market indexes are found in several countries outside the United States.

Question 20

Recent surveys of financial economists and chief financial officers have suggested an average risk premium of 5.4 to 6.4%.

Question 21

An investor receives a 15% total return by purchasing a stock for $40 and selling it after one year with a 5% capital gain.How much was received in dividend income during the year?

A) $2.00
B) $2.20
C) $4.00
D) $6.00

Question 22

The appropriate opportunity cost of capital is the return that investors give up on alternative investments with:

A) the same risk.
B) the risk-free return.
C) the expected return on the S&P 500 index.
D) the normal, common stock risk premium.

Question 23

Which of the following statements is correct for an investor starting with $1,000 in common stocks over a 20-year investment horizon in which stocks averaged 11% in nominal terms and 4% in real terms? The portfolio value is now approximately:

A) $1,800 in real terms.
B) $3,679 in real terms.
C) $3,870 in nominal terms.
D) $8,062 in nominal terms.

Question 24

How is it possible for real rates of return to increase during times when the rate of inflation increases?

A) Inflation increased more than the real return.
B) Nominal returns actually decreased.
C) Nominal returns increased more than inflation.
D) Nominal returns increased less than inflation.

Question 25

Market interest rates have risen substantially in the 5 years since an investor purchased Treasury bonds that were offering a 7% return.If the investor sells now he or she is likely to receive:

A) greater than a 7% total return.
B) less than a 7% total return.
C) a 7% total rate of return.
D) a 7% nominal return but less than a 7% real return.

Question 26

Stock A has 10 million shares issued and stock B has 5 million shares issued.What is their relative weighting if both stocks are represented in the S&P 500?

A) They have equal weighting, like all S&P 500 stocks.
B) B has twice the weighting, to account for having fewer shares.
C) A has twice the weighting, to account for having more shares.
D) They are weighted according to their expected performance.

Question 27

Which of the following guarantees is offered to common stock investors?

A) Guaranteed to receive dividends
B) Guaranteed to receive capital gains
C) Guaranteed only to receive a refund of principal
D) No guarantees of any form

Question 28

"Dow up 14.Story at 6:00 p.m." This means that:

A) the Dow was up 14% during today's trading.
B) 14 of the Dow's 30 stocks increased in price today.
C) a share of Dow stock went up by $14 today.
D) the Dow index increased by 14 points in today's trading.

Question 29

The idea that investors in common stock may expect a lower total return when prices are relatively stable suggests that:

A) investors are irrational.
B) risk premiums may have a normal magnitude.
C) real rates of return will be lower during periods of price stability.
D) stocks should be avoided when inflation is low.

Question 30

What is the percentage return on a stock that was purchased for $50.00,paid a $3.00 dividend after one year,and was then sold for $49.00?

A) -2.50%
B) 2.50%
C) 4.00%
D) 7.50%

Question 31

The variance of an investment's returns is a measure of the:

A) volatility of the rates of return.
B) probability of a negative return.
C) historic return over long periods.
D) average value of the investment.

Question 32

In a year in which common stocks offered an average return of 18%,Treasury bonds offered 10% and Treasury bills offered 7%,the risk premium for common stocks was:

A) 1%.
B) 3%.
C) 8%.
D) 11%.

Question 33

If a stock is purchased for $25 per share and held one year,during which time a $1.75 dividend is paid and the price climbs to $29.5,the nominal rate of return is:

A) 13.00%.
B) 14.00%.
C) 20.00%.
D) 25.00%.

Question 34

Which of the following statements seems most appropriate when the Dow Jones Industrial Average increases by 2%?

A) All stocks on the exchange increased by 2%.
B) Only the 30 DJIA stocks increased by 2%.
C) A broad-based market indicator was up by 2%.
D) The S&P 500 index increased by 2%.

Question 35

What is the percentage return on a stock that was purchased for $40.00,paid no dividend after one year,and was then sold for $39.00?

A) -2.50%
B) 2.50%
C) 5.00%
D) 7.50%

Question 36

Although Standard and Poor's Composite Index contains a small number of U.S.publicly traded stocks,the Index represents:

A) all stocks that prefer to be equally weighted.
B) all stocks that prefer to be value-weighted.
C) approximately 50% of U.S. stocks traded, in value.
D) approximately 75% of U.S. stocks traded, in value.

Question 37

Although several stock indexes are available to inform investors of market changes,the Dow Jones Industrial Average:

A) is the broadest-based of the market indexes.
B) is the only reliable market index.
C) accounts for approximately 70% of U.S. market value.
D) is the best-known of the market indexes.

Question 38

In addition to the number of stocks represented,a difference between the S&P 500 and the Dow is that the S&P 500:

A) dates back to the nineteenth century while the Dow is a recent innovation.
B) is value-weighted while the Dow is an equally-weighted index.
C) includes foreign stocks while the Dow is domestic.
D) index includes dividends in its return while the Dow does not.

Question 39

The Dow Jones Industrial Average is:

A) the most representative of stock market indexes.
B) an index of America's 500 major corporations.
C) an index of 30 major industrial stocks.
D) an equally weighted index of all stocks traded on the New York Stock Exchange.

Question 40

From a historical perspective (1900-2007),what would you expect to be the approximate return on a diversified portfolio of common stocks in a year that Treasury bills offered 7.5%?

A) 8.3%
B) 12.3%
C) 14.9%
D) 19.3%

Question 41

What is the standard deviation of a portfolio's returns if the mean return is 15%,the variance of returns is 184,and there are three stocks in the portfolio?

A) 7.83%
B) 13.56%
C) 41.00%
D) 225.00%

Question 42

The standard deviations of individual stocks are generally higher than the standard deviation of the market portfolio because individual stocks:

A) offer higher returns.
B) have more systematic risk.
C) have no diversification of risk.
D) do not have unique risk.

Question 43

If the standard deviation of a portfolio's returns is known to be 30%,then its variance is:

A) 5.48%
B) 5.48% squared
C) 900.00%
D) 900.00% squared

Question 44

Which of the following concerns is likely to be most important to portfolio investors seeking diversification?

A) Total volatility of individual securities
B) Standard deviation of individual securities
C) Correlation of returns between securities
D) Achieving the risk-free rate of return

Question 45

What is the approximate variance of returns if over the past 3 years an investment returned 8.0%,-12.0%,and 15.0%?

A) 31
B) 131
C) 182
D) 961

Question 46

Most of the beneficial effects of diversification will have been received by the time a portfolio of common stocks contains _____ stocks.

A) 2
B) 5
C) 20
D) 50

Question 47

Industries that generally perform well when other industries are performing well are referred to as:

A) diversified industries.
B) cyclical industries.
C) risk-free industries.
D) systematic risk industries.

Question 48

A firm is said to be countercyclical if its returns:

A) continue to decrease, year after year.
B) continue to increase, year after year.
C) are better when most firms do poorly.
D) are negative in real terms.

Question 49

What is the standard deviation of return of a four-stock portfolio (each stock being equally weighted)that produced returns of 20%,20%,25%,and 30%?

A) 2.15%
B) 3.15%
C) 4.15%
D) 5.15%

Question 50

What is the approximate standard deviation of returns if over the past 4 years an investment returned 8.0%,-12.0%,-12.0%,and 15.0%?

A) 9.26%
B) 10.26%
C) 11.26%
D) 12.01%

Question 51

When high growth is expected in the economy,an investor should receive higher returns from:

A) cyclical investments.
B) countercyclical investments.
C) stocks with negative correlations.
D) stocks with low standard deviations.

Question 52

A stock that is considered to be a positive risk asset is added to a portfolio.As a result,the portfolio will:

A) have lower average returns.
B) have a lower variance of returns.
C) have a higher volatility of returns.
D) have a lower correlation of returns with stock market indexes.

Question 53

What is the typical relationship between the standard deviation of an individual common stock and the standard deviation of a diversified portfolio of common stocks?

A) The individual stock's standard deviation will be lower.
B) The individual stock's standard deviation will be higher.
C) The standard deviations should be equal.
D) There is no way to predict this relationship.

Question 54

What is the approximate standard deviation of returns for a one-year project that is equally likely to return 100% as it is to provide a 100% loss?

A) 0%
B) 50%
C) 71%
D) 100%

Question 55

The benefits of portfolio diversification are highest when the individual securities have returns that:

A) vary directly with the rest of the portfolio.
B) vary proportionally with the rest of the portfolio.
C) are less than perfectly correlated with the rest of the portfolio.
D) are countercyclical.

Question 56

A stock investor owns a diversified portfolio of 15 stocks.What will be the likely effect on portfolio standard deviation from adding one more stock?

A) A slight increase will occur.
B) A large increase will occur.
C) A slight decrease will occur.
D) A large decrease will occur.

Question 57

The incremental risk to a portfolio from adding another stock:

A) is always greater than the average portfolio risk.
B) is always less than the average portfolio risk.
C) is always positive.
D) is often positive but can be negative.

Question 58

What is the variance of return of a three-stock portfolio (each stock being equally weighted)that produced returns of 20%,25%,and 30%?

A) 16.67
B) 33.33
C) 50.00
D) 100.00

Question 59

The variance of a stock's returns can be calculated as the:

A) average value of deviations from the mean.
B) average value of squared deviations from the mean.
C) square root of average value of deviations from the mean.
D) sum of the deviations from the mean.

Question 60

What is the expected return on a portfolio that will decline in value by 13% in a recession,will increase by 16% in normal times,and will increase by 23% during boom times if each scenario has equal likelihood?

A) 8.67%
B) 13.00%
C) 13.43%
D) 17.33%

Question 61

What nominal return was received by an investor when inflation averaged 8.0% and the real rate of return was a negative 2.5%?

A) 5.30%
B) 5.75%
C) 6.50%
D) 10.77%

Question 62

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.

Question 63

If 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

Question 64

Real rates of return are typically less than nominal rates of return due to:

A) inflation.
B) capital gains.
C) dividend payments.
D) depreciation.

Question 65

When the annual rate of return on U.S.Treasury bills is historically high,investors expect the risk premium on the stock market to be:

A) considerably lower than normal.
B) considerably higher than normal.
C) approximately normal.
D) approximately equal to zero.

Question 66

Which of the following statements is incorrect concerning stock indexes?

A) They have been developed for foreign stocks.
B) They have been developed for smaller companies.
C) Indexes include all common stocks.
D) Some indexes are equally weighted.

Question 67

A stock is held one year,during which time its dividend yield was greater than its capital gains yield.For this stock,the percentage return:

A) is zero.
B) is negative.
C) equals the dividend yield.
D) cannot be determined.

Question 68

Real rates of return will be positive as long as:

A) the nominal return is positive.
B) the inflation rate is positive.
C) the nominal return exceeds the inflation rate.
D) the inflation rate exceeds the real return.

Question 69

Common stocks have offered an annual risk premium in nominal terms,but they have:

A) also offered the risk premium in real terms.
B) not offered a risk premium in real terms.
C) not offered more than corporate bonds in real terms.
D) offered only slightly more than Treasury bonds in real terms.

Question 70

The primary difference between U.S.Treasury bills and U.S.Treasury bonds is that the bills:

A) do not have default risk.
B) have more price volatility.
C) have a shorter maturity at time of issue.
D) offer a higher return.

Question 71

Which of the following risks would be classified as a unique risk for an auto manufacturer?

A) Interest rates
B) Steel prices
C) Business cycles
D) Foreign exchange rates

Question 72

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.

Question 73

Which of the following security portfolios should offer the highest maturity premium?

A) Common stocks, because they never mature.
B) Long-term Treasury bonds, because of potential fluctuations in interest rates.
C) Treasury bills, because of fluctuations in inflation rates.
D) The Dow, because it is the oldest and most stable index.

Question 74

The risk premium that is offered on common stock is equal to the:

A) expected return on the stock.
B) real rate of return on the stock.
C) excess of expected return over a risk-free return.
D) expected return on the S&P 500 index.

Question 75

A maturity premium is offered on long-term Treasury bonds due to:

A) the risk of changing interest rates.
B) the risk of default.
C) their unique risk.
D) their systematic risk.

Question 76

What real rate of return is earned by a one-year investor in a bond that was purchased for $1,000,has an 8% coupon,and was sold for $960 when the inflation rate was 6%?

A) -1.89%
B) 1.92%
C) 5.66%
D) 11.47%

Question 77

If a share of stock provided a 14.0% nominal rate of return over the previous year while the real rate of return was 6.0%,then the inflation rate was:

A) 1.89%.
B) 7.55%.
C) 8.00%.
D) 9.12%.

Question 78

Which statement is correct concerning macro risk exposure?

A) All firms face equal macro risk exposure.
B) Only portfolios of stocks face macro risk exposure.
C) Macro risk exposure affects the cost of capital.
D) Macro risk exposure is less important to diversified investors than micro risk exposure.

Question 79

Which of the following risks is most important to a well-diversified investor in common stocks?

A) Market risk
B) Unique risk
C) Idiosyncratic risk
D) Diversifiable risk

Question 80

The market experienced a volatility spike:

A) during the Great Crash of 1929.
B) during the dot-com crash.
C) during the banking crisis of 2007-2009.
D) all of these.