Deck 6: Return and Risk: the Foundation of Investing Worldwide

Question 1

Political stability is the major factor concerning:

A) exchange-rate risk
B) systematic risk
C) nonsystematic risk
D) country risk

Answer 1

D

Question 2

Total return as defined in the text is:

A) the difference between the sale price and the purchase price of an investment.
B) measured by dividing the sum of all cash flows received by the amount invested.
C) the reciprocal of a return relative.
D) measured by dividing all cash flows received by its selling price.

Answer 2

B

Question 3

Liquidity risk:

A) is the risk that investment bankers normally face
B) is lower for small OTC stocks than for large NYSE stocks
C) is a risk associated with secondary market transactions
D) increases whenever interest rates increase

Answer 3

C

Question 4

In order to determine the compound growth rate of an investment over some period, an investor would calculate the:

A) arithmetic mean
B) geometric mean
C) calculus mean
D) arithmetic median

Question 5

Total return is equal to:

A) capital gain + price change.
B) yield + income.
C) capital gain - loss.
D) yield + price change.

Question 6

Financial risk is most associated with:

A) the use of equity financing by corporations
B) the use of debt financing by corporations
C) equity investments held by corporations
D) debt investments held by corporations

Question 7

The recent housing bubble and resulting credit crisis of 2008 is a perfect example of:

A) nonsystematic risk
B) systematic risk
C) inflation risk
D) political risk

Question 8

If a U.S. investor buys foreign stock, his dollar-denominated return will increase if the dollar:

A) appreciates in value.
B) depreciates in value.
C) remains unchanged.
D) moves to a net gain position.

Question 9

If interest rates rose, you would expect ------------ to also rise.

A) business risk
B) financial risk
C) liquidity risk
D) inflation risk

Question 10

If the Dow Jones Industrials had a price appreciation of 6 percent one year and yet total return for the year was 9 percent, the difference would be due to:

A) the tax treatment of capital gains.
B) the cumulative wealth effect.
C) dividends.
D) profits.

Question 11

The best return measure to use if you are trying to measure the total effect of returns over time given some stated beginning amount is the:

A) total return
B) return relative
C) cumulative wealth index
D) total yield

Question 12

If interest rates are expected to rise, you would expect:

A) bond prices to fall more than stock prices
B) bond prices to rise more than stock prices
C) stock prices to fall more than bond prices
D) stock prices to rise and bond prices to fall

Question 13

An impending recession is an example of:

A) interest rate risk
B) inflation risk
C) market risk
D) financial risk

Question 14

Which of the following is true regarding the cumulative wealth index? It:

A) is measured by adding up the total returns over the holding period and dividing by the investment
B) uses a beginning index value (often set to $1 but it can be set to any amount)
C) is the present value of the future cash flows expected from the investment
D) uses the arithmetic mean as the rate of growth of one's wealth

Question 15

The return relative solves the problem of:

A) inflation b negative returns
C) interest rates
D) tax differences

Question 16

New financial disclosure regulations affecting the brokerage industry are a type of:

A) market risk
B) financial risk
C) business risk
D) liquidity risk

Question 17

The ----------- is 1 plus the total return.

A) arithmetic mean
B) return relative
C) cumulative wealth index
D) geometric mean

Question 18

Investors should be willing to invest in riskier investments only:

A) if the term is short
B) if there are no safe alternatives except for holding cash
C) if the expected return is adequate for the risk level
D) if they are true speculators

Question 19

All of the following represent the yield component of total return EXCEPT:

A) Dividend payment on common stock
B) Coupon interest payment on bonds
C) Capital gain upon sale of stock
D) Dividend payment on preferred stock

Question 20

A major difference between real and nominal returns is that:

A) real returns adjust for inflation and nominal returns do not
B) real returns use actual cashflows and nominal returns use expected cashflows
C) real returns adjust for commissions and nominal returns do not
D) real returns show the highest possible return and nominal returns show the lowest possible return

Question 21

Present value is based on the concept of:

A) compounding
B) systematic risk
C) duration
D) discounting

Question 22

When most people refer to mean rate of return, they are referring to the:

A) holding period rate of return
B) arithmetic average rate of return
C) geometric average rate of return
D) cumulative average rate of return

Question 23

If you invest in German bonds and the Euro becomes stronger during your holding period, then:

A) you will be able to buy back fewer dollars when you redeem your bond or it matures
B) your dollar-denominated return will increase
C) your-dollar denominated return will decrease
D) your return will be the interest you receive

Question 24

Which of the following statements concerning the equity risk premium is true?

A) Some scholars think it is too low
B) There is no direct way to measure it
C) It predicts high future returns on stocks
D) It is expected to increase in the future

Question 25

New regulations concerning auto emissions would be a type of market risk for the auto industry.

Question 26

Return and risk are inversely related.

Question 27

The less the variability of return, the greater the risk.

Question 28

International mutual funds offer investors global diversification without exchange rate risk.

Question 29

Holding interest rates constant, a narrowing of the equity risk premium implies a decline in the rate of return on stocks because the amount earned beyond the risk-free rate is reduced.

Question 30

A Chinese stock denominated in Chinese yuan will have an increase in its dollar-denominated return if the Chinese yuan strengthens against the dollar.

Question 31

A number of prominent observers expect the equity risk premium in the future to be:

A) Considerably lower than that of the past
B) Considerably higher than that of the past
C) Very similar to the historical average
D) No change is expected from recent years

Question 32

Over the period 1926-2007, which of the following financial assets showed the greatest amount of price volatility, as measured by standard deviation?

A) Small-cap stocks
B) Large-cap stocks
C) Treasury bonds
D) Treasury bills

Question 33

The most common measure of inflation is the Producer Price Index.

Question 34

Another name for a capital gain is yield.

Question 35

It is generally easier to predict interest rate risk than market risk.

Question 36

The standard deviation measures:

A) systematic risk of a security.
B) unsystematic risk of a security.
C) total risk of a security.
D) the equity risk premium.

Question 37

The equity risk premium is:

A) the difference between the expected return on stocks and bonds
B) the difference between the expected return on high-grade stocks and low-grade stocks
C) the difference between the expected return on stocks and the risk-free rate
D) the difference between the expected return on a stock market index and the inflation rate

Question 38

Bond prices and interest rates are inversely related.

Question 39

Which of the following statements regarding the arithmetic mean and the geometric mean is true?

A) The arithmetic mean is always a better measure of average performance
B) The geometric mean is always a better measure of average performance
C) The arithmetic mean is a better measure of performance over single periods
D) The geometric mean is the best estimate of the expected return for the next period

Question 40

As the dollar falls,

A) foreign investors owning U.S. stocks suffer.
B) U.S. investors owning U.S. stocks suffer.
C) U.S. investors owning foreign stocks suffer.
D) foreign investors owning foreign stocks suffer.

Question 41

When should an investor use the arithmetic mean return? The geometric mean return?

Question 42

Calculate the future value of $100,000 at the end of 64 years given an interest rate of 10.38 percent.

Question 43

A stock is purchased for $50 on January 1 and sold on December 31 for $72. A $5.00 per share dividend is paid during the year.
(a) Calculate the TR.
(b) Calculate the RR.

Question 44

Assume you are a U. S. citizen who purchases $20,000 worth of bonds of the Deep Shaft Mining Company in Kenya. What sources of risk can you identify with this investment?

Question 45

The standard deviation of returns, calculated as the square root of the variance of returns, is a measure of total risk of an asset or portfolio.

Question 46

What is the present value of $20,000 to be received in 40 years if the interest rate is 9 percent?

Question 47

John Crossborder buys 1 share of Telmex at 140 pesos when the value of the peso is stated in dollars at $0.35. One year later, Telmex is selling for 155 pesos and paid a dividend of 5 pesos during the year. If after 1 year the value of the pesos is $0.29, what will John's rate of return be in U. S. dollars?

Question 48

If you deposit $1,000 today at 12 percent, how much will you have in 10 years?

Question 49

Both present value and future value are based upon the concept of the time value of money.

Question 50

What was the effect on foreign investors owning U.S. stocks when the dollar fell in 2002?

Question 51

The S&P 500 showed the following TRs for a 6 year period: 11.1 percent, -5.2 percent, 20.3 percent, 26.7 percent, -12.4 percent, and 2.2 percent.
(a) Calculate the arithmetic mean return for the 6 year period.
(b) Calculate the geometric mean return for the 6 year period.

Question 52

What common variable is used in the calculation of both the cumulative wealth index and the geometric mean return? How is the common variable calculated? How is it used in each?

Question 53

The returns and risk measures on this chapter are calculated from historical data. Are such measures good predictors of the future? What are some circumstances that could change to change future return and risk? How can an investor use these return and risk measures to help construct a portfolio?

Question 54

What is the major drawback of the total return measure? Why is it the most common return calculation used by investors?

Question 55

What is the best measure of risk for returns of a sole proprietorship?

Question 56

CF_t + (P_E - P_B) CF_t + PC
TR = -------------- = ---------
P_B P_B
where
CF_t = ______________________________________________
P_E = ______________________________________________
P_B = ______________________________________________
PC = ______________________________________________