Question 1

Given that a stock has generated returns of 6%, 18%, -5% and 20% over the last four years, the variance of stock returns was:
A) 0.013492.
B) 0.017423.
C) 0.024930.
D) 0.028970.

Accepted Answer

The variance of stock returns is 0.013492. This is calculated by taking the average of the squared differences between each return and the mean return. The mean return is 9.25%. The squared differences are 0.00015625, 0.075625, 0.000625, and 0.10208333. The average of these squared differences is 0.013492.

Question 2

Given that a stock has generated returns of 6%, 18%, -5% and 20% over the last four years, the standard deviation of stock returns was:
A) 9.03%.
B) 10.50%.
C) 11.62%.
D) 12.46%.

Accepted Answer

The standard deviation of the stock returns can be calculated using the formula for standard deviation, which involves finding the mean (average) return, subtracting each year's return from the mean, squaring those results, finding the average of those squared differences, and then taking the square root of that average. The returns are 6%, 18%, -5%, and 20%. The mean return is (6 + 18 - 5 + 20) / 4 = 9.75%. The squared differences from the mean are (6 - 9.75)^2, (18 - 9.75)^2, (-5 - 9.75)^2, and (20 - 9.75)^2. The average of these squared differences is calculated, and then the square root of that average gives the standard deviation, which is approximately 11.62%.

Question 3

If returns are normally distributed, the expected return plus or minus one standard deviation will cover what percentage of all possible returns?
A) 68%.
B) 90%.
C) 95%.
D) 99%.

Accepted Answer

If returns are normally distributed, the expected return plus or minus one standard deviation will cover 68% of all possible returns.

Question 4

If returns are normally distributed, the expected return plus or minus 1.96 standard deviations will cover what percentage of all possible returns?
A) 99%.
B) 90%.
C) 68%.
D) 95%.

Accepted Answer

If returns are normally distributed, the expected return plus or minus 1.96 standard deviations will cover 95% of all possible returns.

Question 5

If returns are normally distributed, the expected return plus or minus 1.64 standard deviations will cover what percentage of all possible returns?
A) 99%.
B) 68%.
C) 90%.
D) 95%.

Accepted Answer

If returns are normally distributed, the expected return plus or minus 1.64 standard deviations will cover 90% of all possible returns.

Question 6

Covariance measures:
A) how the returns of two assets move in opposite directions.
B) how the risks of two assets move in opposite directions.
C) how the risks of two assets move together.
D) how the returns of two assets move together.

Accepted Answer

Covariance measures how the returns of two assets move together

Question 7

You hold a portfolio of two assets. When the return on one asset is positive, the return on the other asset is negative. We can conclude that:
A) the correlation between the two assets in the portfolio is negative.
B) there is no correlation between the two assets in the portfolio.
C) the correlation between the two assets in the portfolio is positive.
D) none of the above.

Accepted Answer

When returns on two assets have opposite signs like in this scenario, we deduce that the correlation is negative between the two assets.

Question 8

Domino's shares have an expected return of 9 per cent and a variance of 0.25 per cent. What is the coefficient of variation for Domino's?
A) 0.0278.
B) 0.0556.
C) 2.7778.
D) 5.5556.

Accepted Answer

The coefficient of variation (CV) is calculated as the standard deviation (σ) divided by the mean (μ), expressed as CV = σ/μ. First, find the standard deviation by taking the square root of the variance: √0.25% = 0.5%. Then, divide the standard deviation by the expected return: 0.5% / 9% = 0.0556.

Question 9

Beef Stock returns have exhibited a standard deviation of 0.57, whereas Sheep Stock returns have a standard deviation of 0.63. The correlation coefficient between the returns is 0.078042. What is the covariance of the returns?
A) 0.028025.
B) 0.217327.
C) 0.359100.
D) 0.993094.

Accepted Answer

Covariance is calculated as the product of the standard deviations of the two variables and their correlation coefficient. Thus, Covariance = 0.57 * 0.63 * 0.078042 = 0.028025.

Question 10

Which of the following expressions best describes the concept of reducing risk through diversification?
A) Look before you leap.
B) A stitch in time saves nine.
C) The early bird catches the worm.
D) Don't put all your eggs in one basket.

Accepted Answer

Although the text doesn't specifically refer to this adage, it should be clear that it accurately encapsulates the notion that risk is reduced by not putting all one's eggs in one basket; i.e. by diversifying into different investments.

Question 11

Risk is less effectively reduced through diversifying into different investments when the different investments:
A) are in the same country.
B) are in the same industry.
C) have zero correlation with the market.
D) have negatively correlated returns.

Accepted Answer

Risk is less effectively reduced through diversifying into different investments in the same industry.

Question 12

Correlation is a measure of:
A) dispersion.
B) central tendency.
C) the equity risk premium (ERP).
D) the way two variables move relative to each other.

Accepted Answer

Correlation is a measure of the way two variables move relative to each other.

Question 13

What does a beta of greater than one mean if you hold a bond?
A) The bond has greater systematic risk than the market.
B) The bond has the same systematic risk as the market.
C) The bond has greater non-diversifiable risk than the market.
D) The bond has greater unsystematic risk than the market.

Accepted Answer

Beta is used in finance as a measure of systematic/market risk. A beta >1 means that the asset has a greater systematic risk than the market.

Question 14

Beta is a measure of an asset's:
A) total risk.
B) correlation with market returns.
C) systematic risk.
D) unsystematic risk.

Accepted Answer

Note that although a share's beta value is influenced by its correlation with the market, it is not determined by that factor alone. A share's beta value is also determined by the standard deviation of its returns and the standard deviation of market returns.

Question 15

______________ risk is the risk that is common to all businesses.
A) systematic.
B) unique.
C) firm-specific.
D) unsystematic.

Accepted Answer

Systematic risk is the risk inherent to the entire market or market segment, affecting all businesses, not just a particular company or industry.

Question 16

A beta equal to one means the stock has:
A) less systematic risk than the market.
B) no systematic risk.
C) the same systematic risk as the market.
D) more systematic risk than the market.

Accepted Answer

A beta of one indicates that the stock has the same systematic risk as the market. This means the stock's price is expected to move with the market.

Question 17

A treasury bond has a systematic risk of:
A) 1.5.
B) 0.
C) 1.
D) insufficient information provided.

Accepted Answer

Treasury bonds are considered to have no systematic risk because their returns are not correlated with the returns of the market. Systematic risk, also known as market risk, affects the overall market, not just a particular security or sector. Since the government backs treasury bonds, their returns are generally considered safe and independent of market fluctuations.

Question 18

Which of the following is false?
A) Treasury bonds are viewed as risk-free.
B) Investing in the market will not earn compensation for taking on risk.
C) Assets with a beta of 1.2 have more risk than the market.
D) None of the above.

Accepted Answer

Investing in the market typically earns compensation for taking on risk, as per the principles of risk and return. This statement is false because investors expect to be compensated with higher returns for taking on more risk, which contradicts the assertion in option B.

Question 19

The expected return on Fishermans Inn Ltd shares is 10.8 per cent. If the expected return on the market is 10 per cent and the beta for Fishermans Inn is 1.7, then what is the risk-free rate?
A) 4.5%.
B) 5.0%.
C) 5.5%.
D) 6.0%.

Accepted Answer

The answer of The expected return on Fishermans Inn Ltd...

Question 20

Using the CAPM, calculate the expected rate of return for a share that has a beta of 2.3. The expected return on the market and risk-free rate are 6% and 5% respectively.
A) 2.3%.
B) 2.7%.
C) 7.3%.
D) 6.3%.

Accepted Answer

Using the CAPM equation, the answer is 7.3%. E(R_i) = R_rf + B_i[E(R_m) - R_rf]

Quiz 4: Risk and Return

Given that a stock has generated returns of 6%, 18%, -5% and 20% over the last four years, the variance of stock returns was:

Given that a stock has generated returns of 6%, 18%, -5% and 20% over the last four years, the standard deviation of stock returns was:

If returns are normally distributed, the expected return plus or minus one standard deviation will cover what percentage of all possible returns?

If returns are normally distributed, the expected return plus or minus 1.96 standard deviations will cover what percentage of all possible returns?

If returns are normally distributed, the expected return plus or minus 1.64 standard deviations will cover what percentage of all possible returns?

Covariance measures:

You hold a portfolio of two assets. When the return on one asset is positive, the return on the other asset is negative. We can conclude that:

Domino's shares have an expected return of 9 per cent and a variance of 0.25 per cent. What is the coefficient of variation for Domino's?

Beef Stock returns have exhibited a standard deviation of 0.57, whereas Sheep Stock returns have a standard deviation of 0.63. The correlation coefficient between the returns is 0.078042. What is the covariance of the returns?

Which of the following expressions best describes the concept of reducing risk through diversification?

Risk is less effectively reduced through diversifying into different investments when the different investments:

Correlation is a measure of:

What does a beta of greater than one mean if you hold a bond?

Beta is a measure of an asset's:

______________ risk is the risk that is common to all businesses.

A beta equal to one means the stock has:

A treasury bond has a systematic risk of:

Which of the following is false?

The expected return on Fishermans Inn Ltd shares is 10.8 per cent. If the expected return on the market is 10 per cent and the beta for Fishermans Inn is 1.7, then what is the risk-free rate?

Using the CAPM, calculate the expected rate of return for a share that has a beta of 2.3. The expected return on the market and risk-free rate are 6% and 5% respectively.