Deck 4: Return and Risk

Question 1

The holding period return includes the time value of money.

Answer 1

False

Question 2

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%

Answer 2

D

Question 3

Which of the following investments may be impacted by government actions?

A)stocks
B)corporate bonds
C)government bonds
D)all of the above

Answer 3

D

Question 4

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 5

When investors expect higher inflation, they will generally require higher rates of return.

Question 6

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

Question 7

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 8

The most predictable component of stock returns is

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

Question 9

Compound interest is interest paid not only on the initial investment but also on any interest earned after the initial investment.

Question 10

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 11

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

Question 12

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

Question 13

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 14

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

Question 15

Historically, what is the correct ranking of the following securities from lowest rate of return to the
Highest?

A)Short-term government bills, long-term government bonds, stocks.
B)Long-term government bonds, short-term government bills, stocks.
C)Stocks, short-term government bills,long-term government bonds.
D)Historical returns do not exhibit a consistent pattern.

Question 16

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

Question 17

Rational 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.

Question 18

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 19

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

A)common stock
B)long-term government bonds
C)real-estate
D)corporate bonds

Question 20

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

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

Question 21

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 22

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

Question 23

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 24

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 pays $5,800 for this investment, what is the internal rate of return?

Question 25

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 26

An investment's internal rate of return does not depend on the rate at which income from the investment is reinvested.

Question 27

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 28

The time value of money concept best supports the idea of

A)the sooner the better.
B)better late than never.
C)a bird in hand is worth two in the bush.
D)good things come to those who wait.

Question 29

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 30

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

Question 31

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

Question 32

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 33

Camille purchased a bond 5 years ago for $1,050.The bond paid $50 in annual interest and returned the $1,000 principal at the end of the fifth year.Camille used the interest payment to pay for college textbooks.

A)Her internal rate of return was exactly than 5%.
B)Her internal rate of return was greater than 5%.
C)Her internal rate of return was less than 5%.
D)Her internal rate of return cannot be determined.

Question 34

Which of the following statements are correct concerning the present value of $1.00 five years from today discounted at 5%?
I.The present value is equal to $1.00 divided by 1.05 to the 5th power.
II.If the discount rate were less than 5%, the present value would be smaller.
III.If the discount rate were more than 5%, the present value would be smaller.
IV.If the $1.00 were to be received 6 years from today, the present value would be larger.

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

Question 35

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 36

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

Question 37

Bob's house has doubled in value since he bought it 30 years ago.The house's value has increased by an annual rate of

A)2.34%.
B)3.33%.
C)6.67%.
D)100%.

Question 38

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 39

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 40

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

Question 41

Short-term U.S.Treasury bills are yielding 0.5%.The expected inflation rate is 2%.Therefore, the real rate of interest must be negative 1.5%.

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

Which of the following is(are)issue characteristics of an investment?
I.type of investment such as stocks or bonds
II.financial condition of the issuer
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 44

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 45

Jason purchased ABC stock at $40 per share and DEF stock at $35 per share on the same day in 2015.Exactly 6 months later, the ABC stock is worth $42.00 per share and has not paid a dividend while the DEF stock is worth $36 per share and has paid 2 quarterly dividends of $0.50 each.The holding period returns are

A)ABC, $2.00 and DEF $2.00.
B)ABC 5% and DEF 2.9%.
C)ABC 5% and DEF 5.7%.
D)The holding period return cannot be determined because we do not know the discount rate.

Question 46

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.Christopher 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 47

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 48

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

Question 49

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

Question 50

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

Question 51

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 52

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 53

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 54

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 55

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 56

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

Question 57

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 58

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 59

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

Question 60

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 61

Josh purchased 100 shares of XOM for $76.63 per share at the beginning of 2011.He received dividends per share of $1.37 (2011), $1.55 (2012), $1.66 (2013), $1.74 (2014), $1.85 (2015).At the end of 2015 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)4.94%

Question 62

Six years ago, Miguel invested $3,500.Today his investment is worth $5659.The internal rate of return on this investment is

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

Question 63

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

Question 64

When computing an investment's internal rate of return 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 65

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 66

A suitable investment should have an internal rate of return equal to or greater than its required rate of return.

Question 67

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 68

Ryan purchased a bond for $980 at the beginning of 2011.He received annual interest payments of $55 at the end of each year through 2016 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 69

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

Question 70

Table 1

Given a spreadsheet similar to the one shown in Table 1, the command to compute the internal rate of return would be

A)=RATE(3,B3,B4,B2).
B)=IRR(B2:B4).
C)=IRR(B3:B4)-B2.
D)=TVM(A2:B4).

Question 71

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 72

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 73

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 74

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

Question 75

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 76

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 77

Josh purchased 100 shares of XOM at the beginning of 2011.He received dividends per share of $1.37 (2011), $1.55 (2012), $1.66 (2013), $1.74 (2014), $1.85 (2015).At the end of 2015, just after receiving the last dividend, he sold the stock for $84.76.At what rate did the dividends grow from the end of 2011 to the end of 2015? Assume that all dividends were received at the end of the year.

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

Question 78

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

Question 79

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

Question 80

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