Deck 7: An Introduction to Risk and Return-History of Financial Market Returns

Question 1

What is the standard deviation of an investment that has the following expected scenario? 18% probability of a recession, 2.0% return; 65% probability of a moderate economy, 9.5% return; 17% probability of a strong economy, 14.2% return.

A) 3.68%
B) 1.23%
C) 8.47%
D) 6.66%

Answer 1

A

Question 2

If there is a 20% chance we will get a 16% return, a 30% chance of getting a 14% return, a 40% chance of getting a 12% return, and a 10% chance of getting an 8% return, what is the expected rate of return?

A) 12%
B) 13%
C) 14%
D) 15%

Answer 2

B

Question 3

Investments that have earned the highest rates of return over 1995-2015 also have

A) the lowest risk.
B) the highest standard deviation of returns.
C) the largest market capitalization.
D) the least sensitivity to inflation.

Answer 3

B

Question 4

The higher the standard deviation, the less risk the investment has.

Question 5

Over the period 1995-2015, the risk-return relationship appears to be

A) negative.
B) perfectly positive.
C) random.
D) generally positive, but not perfect.

Question 6

The cash return on an investment is calculated as purchase price-selling price.

Question 7

You have invested in a project that has the following payoff schedule: Probability of
Payoff Occurrence
$40 .15
$50 .20
$60 .30
$70 .30
$80 .05
What is the expected value of the investment's payoff? (Round to the nearest $1.)

A) $60
B) $65
C) $58
D) $70

Question 8

Which of the following best measures an asset's risk?

A) Expected return
B) The standard deviation
C) The probability distribution
D) The cash return

Question 9

Spartan Sofas, Inc. is selling for $50.00 per share today. In one year, Spartan will be selling for $48.00 per share, and the dividend for the year will be $3.00. What is the cash return on Spartan stock?

A) $51.00
B) $1.00
C) $2.00
D) $3.00

Question 10

Investment variances may be either positive or negative.

Question 11

Over the period 1995-2015, which pair of investments does not perfectly fit the "higher risk, higher return" pattern?

A) Government bonds, treasury bills
B) U.S. equities, corporate bonds
C) U.S. Equities, international equities
D) Corporate bonds, international equities

Question 12

Even though an investor expects a positive rate of return, it is possible that the actual return will be negative.

Question 13

Which of the following sequences is arranged in the correct order, from highest long-term returns to lowest?

A) International equities, U.S. government bonds, U.S. equities
B) Corporate bonds, treasury bills, international equities
C) International equities, U.S. government bonds, treasury bills
D) Government bonds, emerging market equities, treasury bills

Question 14

You are considering investing in a firm that has the following possible outcomes: Economic boom: probability of 25%; return of 25%
Economic growth: probability of 60%; return of 15%
Economic decline: probability of 15%; return of -5%
What is the expected rate of return on the investment?

A) 15.0%
B) 11.7%
C) 14.5%
D) 25.0%

Question 15

You purchased the stock of Sargent Motors at a price of $75.75 one year ago today. If you sell the stock today for $89.00, what is your rate of return?

A) 35.00%
B) 12.50%
C) 17.50%
D) 25.00%

Question 16

Because returns are more certain for the least risky investments, the required return on these investments should be higher than the required returns on more risky investments.

Question 17

Using the following information for McDonovan, Inc.'s stock, calculate their expected return and standard deviation.
State Probability Return
Boom 20% 40%
Normal 60% 15%
Recession 20% (20%)

Question 18

The expected rate of return is the weighted average of the possible returns for an investment.

Question 19

You are considering investing in a firm that has the following possible outcomes: Economic boom: probability of 25%; return of 25%
Economic growth: probability of 60%; return of 15%
Economic decline: probability of 15%; return of -5%
What is the standard deviation of returns on the investment?

A) 84.75%
B) 15.28%
C) 12.47%
D) 9.21

Question 20

You are considering investing in a project with the following possible outcomes: Probability of Investment
States Occurrence Returns
State 1: Economic boom 15% 16%
State 2: Economic growth 45% 12%
State 3: Economic decline 25% 5%
State 4: Depression 15% -5%
Calculate the expected rate of return for this investment.

A) 9.8%
B) 7.0%
C) 8.3%
D) 6.3%

Question 21

During the period 1995 to 2015, gold has underperformed both REITS and Equities.

Question 22

Treasury Bills have less default risk than do Government Bonds.

Question 23

Risky investments have the potential for higher returns, but also larger losses.

Question 24

What is the arithmetic average return of Roddy Richard's investment?

A) 2.42%
B) 3.96%
C) 5.18%
D) 15.1%

Question 25

The arithmetic average rate of return takes compounding into effect.

Question 26

Michael Lynch invested $10,000 in the Rearguard Fund four years ago. All earnings were reinvested in the fund. If his compound annual rate of return was 7%, what is his investment worth today (round to the nearest dollar)?

A) $13,108
B) $10,700
C) $12,800
D) $763

Question 27

How much money did Roddy Richards receive when he sold his shares of W.M.D.?

A) $12,014.88
B) $12,398.42
C) $13,663.47
D) $14,184.73

Question 28

How much will Susan's stock be worth if she sells it five years from today?

A) $71,423.85
B) $73,419.66
C) $75,628.75
D) $80,333.40

Question 29

Investments in emerging markets have higher volatility than do U.S. Stocks.

Question 30

The risk-return tradeoff tells us that expected returns should be higher on investments that have higher risk.

Question 31

Less risky investments have lower standard deviations than do more risky investments.

Question 32

What is the arithmetic average return on her stock if she sells it five years from today?

A) 1.92%
B) 3.98%
C) 6.47%
D) 7.11%

Question 33

Riskier investments have traditionally had lower returns than less risky investments have had.

Question 34

An emerging market is

A) a market for small, but rapidly growing companies.
B) market for companies coming out from bankruptcy proceedings.
C) market for promising, but untested technologies
D) a market located in an economy with low to middle per capita income.

Question 35

What is the geometric average return on her stock if she sells it five years from today?

A) -2.33%
B) )59%
C) 3.67%
D) 4.88%

Question 36

What is the geometric average return of Roddy's Richard's investment?

A) 3.38%
B) 4.63%
C) 6.96%
D) 8.78%

Question 37

Marcus Berger invested $9842.33 in Hawkeye Hats, Inc. four years ago. He sold the stock today for $11,396.22. What is his geometric average return?

A) 2.98%
B) 3.73%
C) 3.95%
D) There is insufficient information to derive an answer.

Question 38

The difference between returns on stocks and government bonds is known as

A) the equity risk premium.
B) the risk and return tradeoff.
C) the maturity premium.
D) the risk/reward paradox.

Question 39

Historically, in the United States stocks have had higher returns and greater volatility than have government bonds.

Question 40

Investors are always rewarded for taking higher risk with higher realized returns.

Question 41

Why do the arithmetic average return and the geometric return differ?

Question 42

If an investor holds a stock for three years, the value at the end of three years will always be the initial cost of the stock times (1 + arithmetic average return) to the third power.

Question 43

Which of the following is consistent with the semi-strong form efficient market hypothesis?

A) so-called value stocks outperform growth stocks.
B) stocks that have performed well over the past year continue to perform well for several more months.
C) a company announces higher than expected sales and earnings. The stock price immediately increases by 10%.
D) a company announces higher than expected sales and earnings. The stock price remains unchanged.

Question 44

An investor who wishes to hold a stock for five years will be most interested in the geometric average rather than in the arithmetic average return.

Question 45

If an investor earns 10% on her investment in the first year and loses 10% the next year, she will have neither a gain nor a loss.

Question 46

Under the efficient market hypothesis, would securities be properly priced.

Question 47

Jayden spends a lot of time studying charts of stocks past performance, but his investment return are only average. This outcome supports

A) the weak-form efficient market hypothesis.
B) the semi-strong form efficient market hypothesis.
C) the strong form efficient market hypothesis.
D) all of the above.

Question 48

Strategies that exploit market inefficiencies tend to lose their effectiveness when they become widely known.

Question 49

Work by the behavioral economists Robert Shiller and Daniel Kahnemann strongly supports the weak and semi-strong forms of the Efficient Market Hypothesis.

Question 50

If a market is weak form efficient, an investor can make higher than expected profits by studying the past price patterns of a stock.

Question 51

Each of the following would tend to weaken the semi-strong form Efficient Market Hypothesis EXCEPT:

A) There is publicly available information that Boeing Aircraft has procured a contract to build 25 planes for the U.S. Government and the price of Boeing quickly goes up.
B) ACG, Inc. performed well for the past six months, but they just lost a major distribution contract, but the price of ACG stock continues to go up.
C) Louisville Slugger, Inc., gets a contract to supply bats for Little League play, a contract it never had before, and stock price remains stable.
D) Muguet Company consistently underperforms the market in October, but outperforms the market in May.

Question 52

If an individual with inside information can make higher than expected profits, the market is no more than semi-strong form efficient.

Question 53

Madison was hired to design and decorate the offices of a large pharmaceutical company. She accidentally read a report indicating that a new drug had just been approved by the Food and Drug administration. She immediately bought the company's stock which doubled in price over the following week. This outcome is inconsistent with

A) the weak-form efficient market hypothesis.
B) the semi-strong form efficient market hypothesis.
C) the strong form efficient market hypothesis. Her action was probably illegal.
D) all of the above.

Question 54

Are markets moving toward being more efficient or toward being less efficient?

Question 55

If markets are efficient, stock prices go up when there is positive information about a company, and go down when there is negative information about the company.

Question 56

Once market inefficiencies become known, they will be exploited by traders until they disappear.