Deck 4: Return and Risk

Question 1

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

Answer 1

True

Question 2

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 2

A

Question 3

In the short term, stock prices tend to rise as inflation rises.

Answer 3

False

Question 4

The most predictable component of stock returns is

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

Question 5

The present value is equal to the future value multiplied by the 1 plus the interest rate.

Question 6

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

Question 7

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 8

Stocks in which of the following industries may be impacted by government actions?

A) health care
B) housing
C) defense
D) all of the above

Question 9

Inflation tends to have a favorable impact on

A) real estate.
B) common stock.
C) preferred stock.
D) bonds.

Question 10

Kelly bought a stock at a price of $22.50. She received a $1.75 dividend and sold the stock for $24.75. What is Kelly's capital gain on this investment?

A) $4.00
B) $3.75
C) $2.25
D) $1.75

Question 11

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 12

Compound interest is interest paid not only on the initial investment but also on any interest accumulated in prior periods.

Question 13

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

Question 14

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 15

Inflation tends to have a particularly negative impact on the price of

A) real estate.
B) bonds.
C) gold.
D) crude oil.

Question 16

An investment that has earned a high rate of return over the last 5 years will not necessarily continue to perform well in the future.

Question 17

Ashley purchased a stock at a price of $27 a share. She received quarterly dividends of $0.75 per share. After one year, Ashley sold the stock at a price of $29.25 a share. What is her percentage holding period return on this investment?

A) 10.3%
B) 11.1%
C) 17.9%
D) 19.4%

Question 18

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

A) small-company stocks
B) long-term government bonds
C) large-company stocks
D) long-term corporate bonds

Question 19

Which of the following internal characteristics should cause investors to expect the highest rate of return?

A) a steady record of past dividends
B) interest and principal guaranteed by the U.S. government
C) a record of excellent management and consistent dividend payments
D) poor management and excessive use of debt financing

Question 20

Investors can be confidently predict future returns on an investment by studying its past performance.

Question 21

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 22

When calculating the present value of either a future single sum or a future annuity, the applicable interest rate is usually called the

A) yield to maturity.
B) compound interest rate.
C) internal rate of return.
D) discount rate.

Question 23

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 24

An ordinary annuity has cash flows that occur at the ________ of each time period and are ________ in amount.

A) beginning; constant
B) beginning; variable
C) end; constant
D) end; variable

Question 25

The holding period return is an excellent method for comparing a short-term investment to a long-term investment.

Question 26

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 27

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

Question 28

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 29

The stated rate of interest is equal to the true rate of interest when

A) interest is compounded annually and the period in questions is exactly 1 year.
B) interest is compounded continuously over one or more years.
C) interest is compounded annually over a period of several years.
D) interest is discounted rather than compounded.

Question 30

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

Question 31

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 32

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 plus the first year's interest times 1 plus the annual interest rate.
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 interest factor is equal to zero if the interest rate is zero.

Question 33

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

Question 34

The adage "the sooner one receives a return on a given investment, the better," reflects the financial concept known as the

A) time value of money.
B) total return concept.
C) historical dividend theory.
D) expected yield factor.

Question 35

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 36

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

Question 37

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 x (1.05)3.
D) $1,000-($1,000) x .03 x 5.

Question 38

Which of the following statements are correct concerning present value?
I) The present value interest factor for a single sum is always equal to or less than 1.
II) The lower the discount rate for a given year, the smaller the present value interest factor.
III) The further in time, the smaller the present value interest factor.
IV) The present value is equal to the future value only when the stated interest rate is 1%.

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

Question 39

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 40

The holding period return is especially useful comparing investments with unequal holding periods.

Question 41

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

Question 42

The markets in general are paying a 2% real rate of return. Inflation is expected to be 3%. ABC stock commands a 6% risk premium. What is the expected rate of return on ABC stock?

A) 2%
B) 5%
C) 8%
D) 11%

Question 43

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

Question 44

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

Question 45

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 46

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 47

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 48

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

Question 49

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

Question 50

Which of the following is(are) issue characteristics of an investment?
I) type of investment such as stocks or bonds
II) state of the economy
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 51

The holding period is a useful way to compare investments because it considers

A) the time value of money.
B) only capital gains, but not income.
C) both income and capital gains or losses.
D) the relative size of investments being compared.

Question 52

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 53

Lauren purchased a stock for $28 a share and sold it six months later for $31. While she owned the stock, Lauren received two quarterly dividends of $0.35 per share. Brittany's holding period return on this stock is

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

Question 54

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 55

Christopher purchased 200 shares of ABC stock at $21.25 per share. After nine months, he sold all of his shares at a price of $19.88 a share. Jake received a total of $0.55 per share in dividends during the time he owned the shares. Jake's holding period return is

A) -6.4%.
B) -3.9%.
C) 2.6%.
D) 9.7%.

Question 56

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 57

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 58

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

Question 59

When using a financial calculator or electronic spreadsheet to calculate an investment's yield, the amount invested is expressed as a negative number.

Question 60

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 61

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

Question 62

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%

Question 63

When computing an investment's yield 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 64

To determine the compounded annual rate of return on investments held for more than a year, investors typically use the present-value-based measure known as yield or

A) holding period return.
B) internal rate of return.
C) inflation-adjusted return.
D) simple return.

Question 65

The reluctance of Congress to tinker with tax rates and deductions has virtually eliminated tax risk for U.S. businesses.

Question 66

Josh purchased 100 shares of XOM for $76.63 per share at the beginning of 2007. He received dividends per share of $1.37 (2007), $1.55 (2008), $1.66 (2009), $1.74 (2010), $1.85 (2011). At the end of 2011, 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 67

Six years ago, Miguel invested $3,500. Today his investment is worth $5659. The yield on this investment is

A) -7.69%.
B) error 5.
C) 8.34%.
D) 10.28%.

Question 68

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 69

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

Question 70

If you own an investment providing periodic returns, your actual yield on the investment will depend on the reinvestment rate you are able to obtain.

Question 71

The yield on an investment is equal to its internal rate of return.

Question 72

Ryan purchased a bond for $980 at the beginning of 2007. He received annual interest payments of $$55 at the end of each year through 2012 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) 5.91%
D) )34%

Question 73

Alexis bought a stock for $34 a share two years ago. The stock does not pay any dividends. Today she sold the stock for $28.50 a share. What was her internal rate of return on this investment?

A) 9.22%
B) -9.22%
C) 19.30%
D) -8.44%

Question 74

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

Question 75

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 76

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

Question 77

Samantha bought a stock one year ago for $66 a share. She received a total of $2.00 in dividends. Today she sold the stock for $70 a share. Which one of the following statements is correct concerning this investment?

A) Samantha has current income of $6.00.
B) Samantha has a capital gain of $2.00.
C) Samantha has a total return of 9.1%.
D) Samantha has unrealized income of $4 a share.

Question 78

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

Question 79

Josh purchased 100 shares of XOM for $76.63 per share at the beginning of 2007. He received dividends per share of $1.37 (2007), $1.55 (2008), $1.66 (2009), $1.74 (2010), $1.85 (2011). At the end of 2011, 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 80

Josh purchased 100 shares of XOM at the beginning of 2007. He received dividends per share of $1.37 (2007), $1.55 (2008), $1.66 (2009), $1.74 (2010), $1.85 (2011). At the end of 2011, just after receiving the last dividend, he sold the stock for $84.76. At what rate did the dividends from the end of 2007 to the end of 2011? Assume that all dividends were received at the end of the year.

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