Question 1

Which of the following statements is false?
A) The greater the risk, the larger the return investors require for bearing that risk.
B) The risk and return relationship is one of the most fundamental relationships in finance.
C) The rate of return investors require for an investment depends on the risk associated with that investment.
D) None of the above.

Accepted Answer

All the statements provided are true and accurately reflect fundamental principles in finance, making D (None of the above) the false statement since it implies one of the previous statements is false.

Question 2

Which of the following statements is true?
A) Higher risk means you are more certain about your expected return.
B) Risk is a measure of how certain you are about your expected return.
C) The rate of return is what you earn on an investment, stated in dollar terms.
D) None of the above.

Accepted Answer

B

Question 3

If two investments have the same expected return, investors will prefer the __________ risky alternative.
A) risk is not important.
B) more.
C) less.
D) none of the above.

Accepted Answer

Investors typically prefer the less risky alternative when two investments offer the same expected return, as it provides a similar return with lower risk.

Question 4

When choosing between two investments that have the same level of risk, investors prefer the investment with the ____________ return.
A) more predictable return.
B) lower.
C) higher.
D) none of the above.

Accepted Answer

Investors typically prefer the investment with the higher return when the level of risk is the same, as it means more potential profit for the same amount of risk.

Question 5

Share A has an expected return of 8% and a risk level of 10%. Share B has an expected return of 8% and a risk level of 14%. Which would you choose?
A) A.
B) B.
C) Indifferent as expected return is the same.
D) Neither as risk is too high.

Accepted Answer

Given the same expected return of 8% for both shares, the rational choice would be to select the share with the lower risk level, which is Share A with a risk level of 10%. This aligns with the principle of risk aversion, where, all else being equal, investors prefer lower risk for a given level of expected return.

Question 6

Share A has an expected return of 12% and risk level of 10%. Share B has an expected return of 12% and risk level of 14%. Share C has an expected return of 10% and risk level of 14%. Rank them in order of your preference.
A) A, B, C.
B) B, C, A.
C) C, B, A.
D) B, A, C.

Accepted Answer

Preference is typically given to shares with higher returns for a given level of risk or lower risk for a given level of return. Share A offers the same return as Share B but at a lower risk, making it more attractive. Share C offers a lower return at the same risk as Share B, making it the least attractive. Therefore, the order of preference is A, B, C.

Question 7

A risk averse person will:
A) have to be compensated to participate in a fair game.
B) participate in fair game.
C) pay to participate in a fair game.
D) none of the above.

Accepted Answer

A risk-averse person dislikes taking risks and would require compensation to participate in a game with uncertain outcomes, even if it's fair, to account for the risk they're taking on.

Question 8

A risk neutral investor will assess investment alternatives based on their:
A) expected returns.
B) relative expected risks.
C) relative expected risks and returns.
D) none of the above.

Accepted Answer

Risk neutral investors do not care about risk and therefore ignore it when comparing or ranking investments.

Question 9

If a person chooses to take $100 in cash instead of betting it to win $210 on the toss of a coin, that person is:
A) risk averse.
B) risk neutral.
C) a risk seeker.
D) indifferent to risk.

Accepted Answer

The expected outcome of betting $100 to win $110 on the toss of a coin is 0.5 * $210 * 0.5 * $100 = $5, which is better than a fair game. In the long run a person would gain from playing such a game, but on a single toss of a coin there is a 50% chance of losing $100 and a 50% chance of gaining $110. A person who decides not to play the game for fear of losing is described as risk averse.

Question 10

1 year ago, you bought a share from Bechtel Ltd for $110. Today it's worth $115. Over the year, the company did not pay any dividend. What total return did you earn on this share over the past year?
A) -4.35%.
B) 4.35%.
C) 4.45%.
D) 4.54%.

Accepted Answer

Using the total holding period return formula, the answer is 4.54%

Question 11

Let's suppose you recently bought a share of BHP Billiton for $110.00. You plan to sell the share next year. You estimate that there is a 25% chance that the shares will sell for $115 at the end of 1 year, 50% chance it will sell for $120 and 25% chance it will sell for $112. Moreover, you estimate that the company will pay a $3 dividend per share under any circumstances. What is your total expected return?
A) 8.27%.
B) 8.86%.
C) 22.25%.
D) 23.64%.

Accepted Answer

Using the estimated return formula, the answer is 8.86% (you need to cater for the dividend per share of $3 in the calculation).

Question 12

A share bought for $20 at the start of the period and sold for $15 at the end of the period which paid dividends of $2 and $3 in the interim generated a holding period return of:
A) -50%.
B) 0%.
C) 50%.
D) 100%.

Accepted Answer

The holding period return (HPR) is calculated as (Ending Value + Dividends - Initial Value) / Initial Value. Here, it's ($15 + $2 + $3 - $20) / $20 = 0%, indicating no gain or loss over the period.

Question 13

What is the expected return from an asset having the following possible returns and associated probabilities?
$\begin{array}{cc} 
\text {Possible return} & \text {Probability} \
 25 \%  & 20 \%  \
 15 \% &  50 \% \
 5 \%  & 30 \% 
\end{array}$
A) 13.5%.
B) 14%.
C) 15%.
D) 16.5%.

Accepted Answer

The calculation is: 25% *0.2 + 15% * 0.5 + 5% * 0.3 = 14%.

Question 14

A stock which has possible returns of 40% and -5% each with equal likelihood has an expected return of:
A) 10%.
B) 15.5%.
C) 17.5%.
D) 20%.

Accepted Answer

The expected return is calculated as the average of possible returns weighted by their probabilities: (0.5 * 40%) + (0.5 * -5%) = 17.5%.

Question 15

Given that a stock has generated returns of 6%, 18%, -5% and 20% over the last four years, the average annual return on this stock over the period was:
A) 9.75%.
B) 10.50%.
C) 12.25%.
D) 39%.

Accepted Answer

The average annual return is calculated by summing the individual yearly returns and then dividing by the number of years. So, (6% + 18% - 5% + 20%) / 4 = 39% / 4 = 9.75%.

Question 16

Given the following series of annual returns for a managed fund: 5%, 6%, 23%, -15%, 20%, -29%, 40%, -40%, 23%, the average annual return over the period was:
A) 3.67%.
B) 6.37%.
C) 10.11%.
D) 13.44%.

Accepted Answer

To calculate the average annual return, sum up all the given returns and divide by the number of years. The sum of the returns is 33%, and there are 9 years. 33% / 9 = 3.67%.

Question 17

There are two probabilities of returns for Stock A. If the probability of a 10% return is 60%, what is the probability of a 12% return?
A) 40%.
B) 60%.
C) 100%.
D) insufficient information provided.

Accepted Answer

total probabilities must equal 100%. Thus 100 - 60 = 40% probability.

Question 18

The sum of the probabilities of returns must be:
A) more than 100 per cent.
B) less than 100 per cent.
C) equal to 100 per cent.
D) none of the above.

Accepted Answer

The sum of the probabilities of all possible outcomes (returns) in a probability distribution must equal 100 per cent (or 1 when using a decimal representation), as this represents the certainty that one of the possible outcomes will occur.

Question 19

You are considering investing in a share of ASX Ltd and you know that the share returns tend to be normally distributed, and you have calculated the expected return on the share to be 10% and the standard deviation to be around 15%. Based on those statistics, within what range would you expect the return on this share to fall during next year (calculate the range at 99% level of confidence).
A) - 28.625% and 10%.
B) - 28.625% and 48.625%.
C) 10% and 38.625%.
D) 10% and 48.625%.

Accepted Answer

At 99% level of confidence, number of deviations from the mean is 2.575. Multiplying the value by the standard deviation of 15% gives you 38.625%. So the range of return will be in between -28.625% (10%- 38.625%) and 48.625% (10%+38.625%) at 99 per cent level of confidence.

Question 20

Suppose a particular stock's return is perfectly characterised by the normal distribution. This stock has a mean return of 10% and standard deviation of 3%. Within what range will approximately 95% of all possible returns on this stock lie:
A) -2% to 22%.
B) 2% to 18%.
C) 4% to 16%.
D) 4% to 10%.

Accepted Answer

The answer of Suppose a particular stock's return is perfectly...

Quiz 4: Risk and Return

Which of the following statements is false?

Which of the following statements is true?

If two investments have the same expected return, investors will prefer the __________ risky alternative.

When choosing between two investments that have the same level of risk, investors prefer the investment with the ____________ return.

Share A has an expected return of 8% and a risk level of 10%. Share B has an expected return of 8% and a risk level of 14%. Which would you choose?

Share A has an expected return of 12% and risk level of 10%. Share B has an expected return of 12% and risk level of 14%. Share C has an expected return of 10% and risk level of 14%. Rank them in order of your preference.

A risk averse person will:

A risk neutral investor will assess investment alternatives based on their:

If a person chooses to take $100 in cash instead of betting it to win $210 on the toss of a coin, that person is:

1 year ago, you bought a share from Bechtel Ltd for $110. Today it's worth $115. Over the year, the company did not pay any dividend. What total return did you earn on this share over the past year?

A share bought for $20 at the start of the period and sold for $15 at the end of the period which paid dividends of $2 and $3 in the interim generated a holding period return of:

What is the expected return from an asset having the following possible returns and associated probabilities? $\begin{array}{cc} \text {Possible return} & \text {Probability} \\ 25 \% & 20 \% \\ 15 \% & 50 \% \\ 5 \% & 30 \% \end{array}$

A stock which has possible returns of 40% and -5% each with equal likelihood has an expected return of:

Given that a stock has generated returns of 6%, 18%, -5% and 20% over the last four years, the average annual return on this stock over the period was:

Given the following series of annual returns for a managed fund: 5%, 6%, 23%, -15%, 20%, -29%, 40%, -40%, 23%, the average annual return over the period was:

There are two probabilities of returns for Stock A. If the probability of a 10% return is 60%, what is the probability of a 12% return?

The sum of the probabilities of returns must be:

Suppose a particular stock's return is perfectly characterised by the normal distribution. This stock has a mean return of 10% and standard deviation of 3%. Within what range will approximately 95% of all possible returns on this stock lie: