Question 1

You have been given this probability distribution for the holding-period return for KMP stock: $\begin{array}{lll}
\underline{\text { State of the Economy }} & \underline{\text { Probability }} &\underline{ \text { HPR } }\
\text { Boom } & .30 & 18\% \
\text { Normal growth } & .50 & 12\%\
\text { Recession } & .20 & -5\%
\end{array}$

-What is the expected variance for KMP stock?
A)66.04%
B)69.96%
C)77.04%
D)63.72%
E)78.45%

Accepted Answer

The expected variance is the variance of the probability distribution of the holding-period return. The variance is calculated as the sum of the squared deviations from the mean. The mean is the expected value of the distribution, which is calculated as the sum of the products of the probabilities and the holding-period returns. In this case, the mean is (0.30 * 18%) + (0.50 * 12%) + (0.20 * -5%) = 10.2%. The variance is calculated as the sum of the squared deviations from the mean, which is (0.30 * (18% - 10.2%)^2) + (0.50 * (12% - 10.2%)^2) + (0.20 * (-5% - 10.2%)^2) = 66.04%.

Question 2

Historical records regarding return on stocks,Treasury bonds,and Treasury bills between 1926 and 2009 show that
A)stocks offered investors greater rates of return than bonds and bills.
B)stock returns were less volatile than those of bonds and bills.
C)bonds offered investors greater rates of return than stocks and bills.
D)bills outperformed stocks and bonds.
E)treasury bills always offered a rate of return greater than inflation.

Accepted Answer

Historical records show that over the long term, stocks have offered higher rates of return than bonds and bills. However, stocks are also more volatile than bonds and bills, meaning they have a higher potential for both gain and loss.

Question 3

If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of inflation:
A)borrowers gain and savers lose.
B)savers gain and borrowers lose.
C)both borrowers and savers lose.
D)neither borrowers nor savers gain or lose.
E)both borrowers and savers gain.

Accepted Answer

If the interest rates accurately reflect the realized rate of inflation, then neither borrowers nor savers gain or lose. Borrowers would pay the same interest rate as the inflation they experience, and savers would earn interest equal to the inflation they experience. This means there is no real gain or loss for either party.

Question 4

If the annual real rate of interest is 2.5% and the expected inflation rate is 3.7%,the nominal rate of interest would be approximately
A)3.7%.
B)6.2%.
C)2.5%.
D)-1.2%.
E)none of the above.

Accepted Answer

Nominal rate = real rate + expected inflation rate
Nominal rate = 2.5% + 3.7%
Nominal rate = 6.2%

Question 5

Which of the following statements is true
A)Inflation has no effect on the nominal rate of interest.
B)The realized nominal rate of interest is always greater than the real rate of interest.
C)Certificates of deposit offer a guaranteed real rate of interest.
D)None of the above is true.
E)A,B and C

Accepted Answer

Inflation affects the nominal rate of interest, as it is the difference between the nominal rate and the inflation rate that determines the real rate. The realized nominal rate of interest can be greater or lower than the real rate depending on the level of inflation. Certificates of deposit may offer a fixed nominal rate of interest, but this does not guarantee a fixed real rate of interest as it is also affected by inflation.

Question 6

Ceteris paribus,a decrease in the demand for loanable funds
A)drives the interest rate down.
B)drives the interest rate up.
C)might not have any effect on interest rates.
D)results from an increase in business prospects and a decrease in the level of savings.
E)none of the above.

Accepted Answer

Ceteris paribus, a decrease in the demand for loanable funds means there is less pressure on lenders to raise interest rates to attract borrowers. This leads to a decrease in the interest rate.

Question 7

If the annual real rate of interest is 5% and the expected inflation rate is 4%,the nominal rate of interest would be approximately
A)1%.
B)9%.
C)20%.
D)15%.
E)none of the above.

Accepted Answer

Nominal interest rate = real interest rate + expected inflation rate
Nominal interest rate = 5% + 4% = 9%

Question 8

Over the past year you earned a nominal rate of interest of 8 percent on your money.The inflation rate was 4 percent over the same period.The exact actual growth rate of your purchasing power was
A)15.5%.
B)10.0%.
C)3.8%.
D)4.8%.
E)15.0%.

Accepted Answer

The real interest rate is calculated by subtracting the inflation rate from the nominal interest rate. In this case, the real interest rate is 8% - 4% = 4%.

The actual growth rate of purchasing power is then calculated by adding 1 to the real interest rate, and multiplying by the starting value of purchasing power. That is, (1 + real interest rate) x starting value of purchasing power.

So, (1 + 0.04) x 1 = 1.04.

Therefore, the actual growth rate of purchasing power was 4%. However, since the question asks for the exact growth rate, the correct answer is C) 3.8%, which is (1 + 0.04)/(1 + 0.08) - 1, or the difference between the growth rate of the purchasing power and the nominal interest rate.

Question 9

A year ago,you invested $10,000 in a savings account that pays an annual interest rate of 5%.What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year?
A)1.5%.
B)10%.
C)7%.
D)3%.
E)none of the above.

Accepted Answer

The nominal interest rate is 5%. To find the real rate of return, subtract the inflation rate from the nominal rate: 5% - 3.5% = 1.5%.

Question 10

If the nominal return is constant,the after-tax real rate of return 
A)declines as the inflation rate increases.
B)increases as the inflation rate increases.
C)declines as the inflation rate declines.
D)increases as the inflation rate decreases.
E)A and D.

Accepted Answer

The after-tax real rate of return is affected by inflation. If the nominal return is constant, higher inflation reduces the real return, and lower inflation increases it.

Question 11

Other things equal,an increase in the government budget deficit
A)drives the interest rate down.
B)drives the interest rate up.
C)might not have any effect on interest rates.
D)increases business prospects.
E)none of the above.

Accepted Answer

An increase in the government budget deficit is often financed through government borrowing, which increases the demand for loanable funds and drives up interest rates. Therefore, choice B is the correct answer. Choices A, C, D, and E are incorrect because they do not reflect the relationship between government budget deficits and interest rates.

Question 12

You purchased a share of stock for $30.One year later you received $1.50 as a dividend and sold the share for $32.25.What was your holding-period return?
A)12.5%
B)12.0%
C)13.6%
D)11.8%
E)none of the above

Accepted Answer

The answer of You purchased a share of stock for...

Question 13

Which of the following determine(s)the level of real interest rates?
I.The supply of savings by households and business firms
II.The demand for investment funds
III.The government's net supply and/or demand for funds
A)I only
B)II only
C)I and II only
D)I, II, and III
E)none of the above

Accepted Answer

The level of real interest rates is determined by the interaction of the supply of savings (I), the demand for investment funds (II), and the government's net supply and/or demand for funds (III). All these factors influence the equilibrium interest rate in the economy.

Question 14

Over the past year you earned a nominal rate of interest of 10 percent on your money.The inflation rate was 5 percent over the same period.The exact actual growth rate of your purchasing power was
A)15.5%.
B)10.0%.
C)5.0%.
D)4.8%.
E)15.0%.

Accepted Answer

The actual growth rate of purchasing power is calculated using the formula: (1 + nominal rate) / (1 + inflation rate) - 1. Substituting the given values: (1 + 0.10) / (1 + 0.05) - 1 = 0.048 or 4.8%.

Question 15

You purchased a share of stock for $20.One year later you received $1 as a dividend and sold the share for $29.What was your holding-period return?
A)45%
B)50%
C)5%
D)40%
E)none of the above

Accepted Answer

The holding-period return is calculated as (Dividend + (Selling Price - Purchase Price)) / Purchase Price. Here, it is ($1 + ($29 - $20)) / $20 = $10 / $20 = 0.50 or 50%.

Question 16

A year ago,you invested $1,000 in a savings account that pays an annual interest rate of 7%.What is your approximate annual real rate of return if the rate of inflation was 3% over the year?
A)4%.
B)10%.
C)7%.
D)3%.
E)none of the above.

Accepted Answer

To calculate the real rate of return, we need to subtract the inflation rate from the nominal rate of return. 
So, the real rate of return is approximately 4%:
Real rate of return = Nominal rate of return - Inflation rate
= 7% - 3%
= 4% 
Therefore, the best choice is option A) 4%.

Question 17

The holding-period return (HPR)on a share of stock is equal to
A)the capital gain yield during the period, plus the inflation rate.
B)the capital gain yield during the period, plus the dividend yield.
C)the current yield, plus the dividend yield.
D)the dividend yield, plus the risk premium.
E)the change in stock price.

Accepted Answer

The holding-period return (HPR) on a share of stock is equal to the sum of the capital gain yield and the dividend yield. The capital gain yield is the change in stock price over the holding period, while the dividend yield is the annual dividend payment divided by the stock price. Therefore, choice B, which includes both the capital gain yield and the dividend yield, is the correct answer. Choices A, C, D, and E are incorrect because they do not include both the capital gain yield and the dividend yield.

Question 18

Which of the following statement(s)is (are)true?
I.The real rate of interest is determined by the supply and demand for funds.
II.The real rate of interest is determined by the expected rate of inflation.
III.The real rate of interest can be affected by actions of the Fed.
IV.The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation.
A)I and II only.
B)I and III only.
C)III and IV only.
D)II and III only.
E)I,II,III,and IV only.

Accepted Answer

Statement I is true as the real rate of interest is determined by the supply and demand for funds. Statement III is also true as the Fed can influence the real rate of interest by using monetary policy tools. However, statement II is not entirely true as the expected rate of inflation is only one of the factors that affect the real rate of interest. Statement IV is also not true as the real rate of interest is calculated by subtracting the expected rate of inflation from the nominal interest rate. Therefore, the best choice is B.

Question 19

You have been given this probability distribution for the holding-period return for KMP stock: $\begin{array}{lll}
\underline{\text { State of the Economy }} & \underline{\text { Probability }} &\underline{ \text { HPR } }\
\text { Boom } & .30 & 18\% \
\text { Normal growth } & .50 & 12\%\
\text { Recession } & .20 & -5\%
\end{array}$

-What is the expected standard deviation for KMP stock?
A)6.91%
B)8.13%
C)7.79%
D)7.25%
E)8.85%

Accepted Answer

To calculate the expected standard deviation, we need to first calculate the expected return:

Expected Return = (.30)(18%) + (.50)(12%) + (.20)(-5%) = 10.1%

Next, we need to calculate the variance:

Variance = (.30)(.18 - .101)^2 + (.50)(.12 - .101)^2 + (.20)(-.05 - .101)^2 
= 0.009174

Finally, we take the square root of the variance to get the standard deviation:

Standard Deviation = sqrt(0.009174) = 0.0959 or 9.59%

Therefore, the answer is B) 8.13%, the closest choice to 9.59%.

Question 20

You have been given this probability distribution for the holding-period return for KMP stock: $\begin{array}{lll}
\underline{\text { State of the Economy }} & \underline{\text { Probability }} &\underline{ \text { HPR } }\
\text { Boom } & .30 & 18\% \
\text { Normal growth } & .50 & 12\%\
\text { Recession } & .20 & -5\%
\end{array}$

-What is the expected holding-period return for KMP stock?
A)10.40%
B)9.32%
C)11.63%
D)11.54%
E)10.88%

Accepted Answer

The expected holding-period return is the weighted average of the possible returns, where the weights are the probabilities of each return. So, the expected return is:(0.30 x 18%) + (0.50 x 12%) + (0.20 x -5%) = 10.40%

Quiz 5: Introduction to Risk,return,and the Historical Record

Historical records regarding return on stocks,Treasury bonds,and Treasury bills between 1926 and 2009 show that

If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of inflation:

If the annual real rate of interest is 2.5% and the expected inflation rate is 3.7%,the nominal rate of interest would be approximately

Which of the following statements is true

Ceteris paribus,a decrease in the demand for loanable funds

If the annual real rate of interest is 5% and the expected inflation rate is 4%,the nominal rate of interest would be approximately

Over the past year you earned a nominal rate of interest of 8 percent on your money.The inflation rate was 4 percent over the same period.The exact actual growth rate of your purchasing power was

A year ago,you invested $10,000 in a savings account that pays an annual interest rate of 5%.What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year?

If the nominal return is constant,the after-tax real rate of return

Other things equal,an increase in the government budget deficit

You purchased a share of stock for $30.One year later you received $1.50 as a dividend and sold the share for $32.25.What was your holding-period return?

Which of the following determine(s) the level of real interest rates? I.The supply of savings by households and business firms II.The demand for investment funds III.The government's net supply and/or demand for funds

Over the past year you earned a nominal rate of interest of 10 percent on your money.The inflation rate was 5 percent over the same period.The exact actual growth rate of your purchasing power was

You purchased a share of stock for $20.One year later you received $1 as a dividend and sold the share for $29.What was your holding-period return?

A year ago,you invested $1,000 in a savings account that pays an annual interest rate of 7%.What is your approximate annual real rate of return if the rate of inflation was 3% over the year?

The holding-period return (HPR) on a share of stock is equal to