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

Question 1

The S&P 500 accounts for most of the total market value of stocks traded in the United States.

Answer 1

True

Question 2

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

Answer 2

True

Question 3

When using historical data to estimate the market risk premium,it is important to focus on recent experience.

Answer 3

False

Question 4

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

Question 5

The risk that remains in a well-diversified stock portfolio is known as specific risk.

Question 6

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

Question 7

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

Question 8

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

Question 9

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

Question 10

A share of stock currently sells for $60,pays an annual dividend of $4.00,and earned a rate of return of 20% over the past year.What did this stock sell for one year ago?

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

Question 11

Many investors who bought shares of dot.com stocks in March 2000 saw the value of their investment decline over the next two-and-a-half years.

Question 12

The market risk premium is the difference between the return on common stocks and the risk-free interest rate.

Question 13

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

Question 14

Macro risks are faced by all common stock investors.

Question 15

Every additional stock added to a portfolio reduces the portfolio's level of risk by an equal amount.

Question 16

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

Question 17

The expected return on an investment includes compensation for both the time value of money and the risks assumed.

Question 18

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

Question 19

One estimate of the market risk premium is provided by the difference between the average historical return on common stocks and the risk-free interest rate.

Question 20

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

Question 21

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 22

"Dow up 14.Story at 6:00." 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 23

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 90% of U.S. market value.
D) is one of the best-known of the U.S. market indexes.

Question 24

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 specific risk.
D) the uncertainty of their maturity date.

Question 25

What was the percentage return on a non-dividend-paying stock that was purchased for $40.00 and then sold after one year for $39.00?

A) −2.50%
B) −0.39%
C) −0.04%
D) −2.56%

Question 26

Assume market interest rates have risen substantially in the 5 years since an investor purchased Treasury bonds that were offering a 6% return over their 15-year life.If the investor sells now,he or she is likely to realize a total return that is:

A) greater than 6%.
B) less than 6%.
C) equal to 2%.
D) equal to 6%.

Question 27

What is the percentage return on a stock that was purchased for $48.40,paid a $1.67 dividend,and was then sold after one year for $46.20?

A) −2.50%
B) −1.10%
C) 0.23%
D) −0.33%

Question 28

Sue purchased a stock for $25 a share,held it for one year,received a $1.34 dividend,and sold the stock for $26.45.What nominal rate of return did she earn?

A) 11.16%
B) 14.23%
C) 12.09%
D) 10.55%

Question 29

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) $4.40

Question 30

If a share of stock provided a 14.84% nominal rate of return over the previous year while the real rate of return was 6.65%,then the inflation rate was:

A) 8.89%.
B) 7.68%.
C) 8.03%.
D) 9.12%.

Question 31

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 32

What nominal return was received by an investor when inflation averaged 3.46% and the real rate of return was 2.5%?

A) 0.96%
B) 5.96%
C) 6.05%
D) 5.47%

Question 33

Stock A has 10 million shares outstanding and stock B has 5 million shares outstanding.Both stocks sell for $10 a share.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 34

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

A) all stocks in the industrial sector.
B) all stocks priced at $50 a share or more.
C) approximately 40% of U.S. stocks traded, in market value.
D) approximately 75% of U.S. stocks traded, in market value.

Question 35

Risks that are peculiar to a single firm:

A) are called market risks
B) cannot be diversified away
C) are called specific risks
D) tend to cause stocks to move together

Question 36

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 37

The Dow Jones Industrial Average is:

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

Question 38

The actual real rate of return on an investment will be positive as long as the:

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

Question 39

Which one of these is the safest investment?

A) Corporate bonds
B) Common stock
C) U.S. Treasury bills
D) Preferred stock

Question 40

If inflation is 6%,what real rate of return is earned by an investor in a bond that was purchased for $1,000,has an annual coupon of 8%,and was sold at the end of the year for $960?

A) −1.89%
B) 1.92%
C) −2.66%
D) 2.47%

Question 41

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

A) possess the same level of risk.
B) earn the risk-free rate of return.
C) are included in the S&P 500 index.
D) earn the average market rate of return.

Question 42

The wider the dispersion of returns on a stock,the:

A) lower the expected rate of return.
B) higher the standard deviation.
C) lower the real rate of return.
D) lower the variance.

Question 43

Which one of the following security classes has the highest standard deviation of returns?

A) Common stocks
B) Long-term Treasury bonds
C) Treasury bills
D) Corporate bonds

Question 44

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 the average value of deviations from the mean.
D) sum of the deviations from the mean.

Question 45

A stock is expected to return 11% in a normal economy,19% if the economy booms,and lose 8% if the economy moves into a recessionary period.Economists predict a 65% chance of a normal economy,a 25% chance of a boom,and a 10% chance of a recession.What is the expected return on the stock?

A) 11.10%
B) 12.06%
C) 11.98%
D) 11.23%

Question 46

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

A) considerably lower than normal.
B) about average.
C) also to be high.
D) approximately equal to zero.

Question 47

What is the standard deviation of returns of a portfolio that produced returns of 10%,15%,25%,and 30%?

A) 7.9%
B) 31.1%
C) 62.5%
D) 5.2%

Question 48

Calculate the variance of returns for Alpha stock with the following historical rates of return: 2013 20%
2014 25%
2015 30%

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

Question 49

Over a 20-year period an investment of $1,000 in common stocks returned an average of 11% in nominal terms and 4% in real terms.At the end of the 20 years,the portfolio value was:

A) $1,800 in real terms.
B) $3,679.19 in real terms.
C) $7,870.59 in nominal terms.
D) $8,062.31 in nominal terms.

Question 50

Historical returns (1900-2015)suggest that in a year when Treasury bills offered 7.5 the approximate return on portfolio of common stocks should be in the region of:

A) 7.5%
B) 9.3%
C) 15%
D) 18.5%

Question 51

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 time periods.
D) average value of the investment.

Question 52

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 squared.
D) 900.00

Question 53

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

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

Question 54

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

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

Question 55

In a year in which common stocks offered an average return of 18% and Treasury bills offered 7%.The risk premium for common stocks was:

A) 1%.
B) 3%.
C) 18%.
D) 11%.

Question 56

Over the past 4 years an investment returned 18%,−9%,−12%,and 15%.What is the standard deviation of returns?

A) 9.2%
B) 10.36%
C) 11.2%
D) 13.6%

Question 57

What is the variance of returns of a portfolio that produced returns of 20%,25%,and 30%,respectively?

A) 10.00
B) 16.7
C) 15.00
D) 20.00

Question 58

The idea that investors on average have earned a higher return from common stocks than from Treasury bills supports the view that:

A) investors are irrational.
B) there is a relationship between risk and return.
C) real rates of return will be lower during periods of price stability.
D) stocks should be avoided when inflation is low.

Question 59

Over the past 3 years an investment returned 18%,−12%,and 15%.What is the variance of returns?

A) 231
B) 182
C) 546
D) 961

Question 60

An estimation of the opportunity cost of capital for projects that have an "average" level of risk is the expected rate of return on:

A) Treasury bills.
B) the market portfolio.
C) the market portfolio minus the rate of return on Treasury bills.
D) Treasury bonds plus a maturity premium.

Question 61

As you add more stocks to a portfolio:

A) specific risk at first falls, then rises.
B) market risk is increasingly diversified away.
C) specific risk is increasingly diversified away.
D) market risk declines but specific risk rises.

Question 62

Risks that affect only a single firm are called:

A) market risks.
B) specific risks.
C) systematic risks.
D) risk premiums.

Question 63

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) outperform when most stocks do poorly.
D) are negative in real terms.

Question 64

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) may be either positive or negative.

Question 65

The higher the standard deviation of a stock's returns,the:

A) lower the level of specific risk.
B) lower the expected rate of return.
C) higher the accuracy of predictions of the stock's return for any given year.
D) wider the dispersion of those returns over time.

Question 66

In general,which stocks should be combined into a portfolio if the goal is the greatest reduction possible in overall portfolio risk?

A) Stocks with returns that are positively correlated
B) Stocks with returns that are not correlated
C) Stocks with returns that have the highest specific risk
D) Stocks that have the highest expected returns

Question 67

A stock investor owns a diversified portfolio of 15 stocks.What will be the most likely effect on the portfolio's standard deviation if one more stock is added?

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 68

Which one of the following risks can be progressively eliminated by adding stocks to a portfolio?

A) Systematic risk
B) Specific risk
C) Market risk
D) Inflation rate risk

Question 69

Companies that are exposed to the business cycle:

A) tend to have high market risk.
B) tend to have low market risk.
C) have negligible specific risk.
D) are safe investments.

Question 70

The major benefit of diversification is the:

A) increased expected return.
B) removal of all negative risk assets from the portfolio.
C) reduction in the portfolio's market risk.
D) reduction in the portfolio's total risk.

Question 71

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

A) vary directly with the rest of the portfolio.
B) vary proportionally with the rest of the portfolio.
C) are largely uncorrelated with the rest of the portfolio.
D) are perfectly correlated with the market portfolio.

Question 72

Which one 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 73

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

A) Market risk
B) Specific risk
C) Unsystematic risk
D) Diversifiable risk

Question 74

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 relationship.

Question 75

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

A) offers lower returns.
B) has less systematic risk.
C) diversifies risk.
D) has specific risk.

Question 76

Industries that generally perform very well when the entire economy performs well and perform very badly when the economy performs badly are called:

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

Question 77

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

A) Interest rates
B) Delays in launching a new model
C) Business cycles
D) Foreign exchange rates

Question 78

What is the standard deviation of returns for an investment that is equally likely to return 100% as it is to provide a 100% loss?

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

Question 79

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? Each scenario has an equal likelihood of occurrence.

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

Question 80

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.