Question 1

Consider the following historical returns for Big Diesel Incorporated and inflation for the United States economy:  What is the average real return for Big Diesel over the five-year time period?

Accepted Answer

avg.nominal return = (.05+.09-.08+.05+.20)/5 = .31/5 = .062
avg.inflation = (.02 + .02 + .022 + .022 +.022 )= .106/5 = .0212
1 + avg.real return = ( 1 + nom )/ (1 + infl)= (1.062)/(1.0212)= 1.04
Avg.real return = 4.00%

Question 2

NARRBEGIN: Big Diesel Incorporated
Big Diesel Incorporated
Consider the following historical returns for Big Diesel Incorporated:
 
-Refer to Big Diesel Incorporated.What is the standard deviation of the returns over the five year time period?

Accepted Answer

avg.return = (.05 + .09 - .08 + .05 + .20)/5 = .31/5 = .062 sum of squared deviations = (.05 - .062)² + (.09-.062)² + (-.08-.062)² + (.05-.062)² + (.2-.062)² = .04028 standard deviation = (1/4 * 0.04028)^.5 =.1003

Question 3

If the standard deviation of a diversified portfolio is 20% and if the stocks in that portfolio are positively correlated,then what would we expect the average standard deviation of stocks in that portfolio to be?

Accepted Answer

When stocks in a portfolio are positively correlated, they move in the same direction and have a higher combined risk. This means that the average standard deviation of stocks in the portfolio would be expected to be greater than the standard deviation of the diversified portfolio, which is 20%.

Question 4

NARRBEGIN: Exhibit 6-1
Exhibit 6-1
Suppose that an investor bought a bond last year for $980.The bond pays a 7% annual coupon and has a face value of $1,000.Today,the same bond is selling for $960.
-Refer to Exhibit 6-1.If the investor sells the bond this morning,what is the total dollar return of the investment?

Accepted Answer

= $70 + (-$20)= $50

Question 5

NARRBEGIN: Terry Corporation
Terry Corporation
One year ago,Jason purchased 50 shares of Terry Corporation stock at $20 per share.Today,one year later,the stock pays a $2 per share dividend and the price is now $22 per share.
-Refer to Terry Corporation.What is the total dollar return on the investment for the one year?

Accepted Answer

Last year = 50 * $20 = $1,000
This year = 50 * ($22 + $2)= $1,200
Dollar gain = $1,200 - $1,000 = $200

Question 6

NARRBEGIN: Big Diesel Incorporated
Big Diesel Incorporated
Consider the following historical returns for Big Diesel Incorporated:
 
-Refer to Big Diesel Incorporated.What is the average return over the five year time period?

Accepted Answer

avg.return = (.05 + .09 - .08 + .05 + .20)/5 = .31/5 = .062

Question 7

You are presented with 4 distinct investment opportunities involving a Treasury Bill,a Treasury Bond,a Corporate Bond,and a Stock.You are told that each of these investments are expected to produce (after the cash is paid out then no other cash flows are anticipated)$100 one year from now.Which asset should be the least expensive today,in terms of dollars that you will have to pay for the asset?

Accepted Answer

Greatest risk ==== greatest discount rate ===? cheapest price today
Stocks

Question 8

Based upon the following levels of risk,which stock should have the highest price if each stock is expected to produce the same level of cash over the future life of each asset?

Accepted Answer

Least systematic risk ====> lowest discount rate ====> highest price
Stock C

Question 9

NARRBEGIN: Terry Corporation
Terry Corporation
One year ago,Jason purchased 50 shares of Terry Corporation stock at $20 per share.Today,one year later,the stock pays a $2 per share dividend and the price is now $22 per share.
-Refer to Terry Corporation.What is the total percentage return on the investment for the one year?

Accepted Answer

r = ( $2 + ($22-$20))/$20 = $4 / $20 = .20

Question 10

NARRBEGIN: Terry Corporation
Terry Corporation
One year ago,Jason purchased 50 shares of Terry Corporation stock at $20 per share.Today,one year later,the stock pays a $2 per share dividend and the price is now $22 per share.
-Refer to Terry Corporation.What is the capital gains yield on the investment for the one year?

Accepted Answer

Capital gain = ($22 - $20)/ $20 = .10

Question 11

If we are able to eliminate all of the unsystematic risk in a portfolio then,what is the result?

Accepted Answer

If all unsystematic risk is eliminated from a portfolio, only systematic risk will remain. This means that the portfolio will be fully exposed to factors such as fluctuations in the overall market, interest rates, and inflation. However, it is not a risk-free portfolio as it is still subject to systematic risk. Option A is incorrect because a risk-free portfolio implies no risk at all, which is not possible in the context of investing. Option C is incorrect because the expected return of a portfolio depends on the systematic risk exposure and the expected returns of the individual assets in the portfolio. Option D is incorrect because it is possible to eliminate unsystematic risk by diversifying the portfolio across a variety of assets.

Question 12

Stock X has 3 units of systematic risk and 2 units of unsystematic risk while Stock Y has 3 units of systematic risk and 4 units of unsystematic risk.If Stock X is priced to generate an 8% return for investors then what do we know about the return that Stock Y should be priced to return?

Accepted Answer

Both stocks have the same systematic risk, which is the risk that affects the entire market and is priced into the expected return. Unsystematic risk is diversifiable and does not affect the expected return. Therefore, Stock Y should also be priced to return 8%.

Question 13

NARRBEGIN: Hillary
Hillary Investments
Between 1999 and 2003,Hillary Investments has produced returns as follows:
 
-Calculate the expected return for Hillary Investments.

Accepted Answer

(.08 + .03 + -.01 + -.05 + -.03)/5 = .004

Question 14

NARRBEGIN: Exhibit 6-1
Exhibit 6-1
Suppose that an investor bought a bond last year for $980.The bond pays a 7% annual coupon and has a face value of $1,000.Today,the same bond is selling for $960.
-Refer to Exhibit 6-1.If the investor sells the bond this morning,what is the total percentage return of the investment?

Accepted Answer

r =($70 + ($960-$980))/$980 = 5.10%

Question 15

Inflation,recession,and higher interest rates are economic events that are characterized as:

Accepted Answer

Inflation, recession, and higher interest rates are macroeconomic events that affect the overall market and cannot be diversified away. This type of risk is known as market risk.

Question 16

NARRBEGIN: Big Diesel Incorporated
Big Diesel Incorporated
Consider the following historical returns for Big Diesel Incorporated:
 
-Refer to Big Diesel Incorporated.If we assume that these returns represent the full sample of Big Diesel returns,what is the 95% confidence interval for Big Diesel returns next year?

Accepted Answer

avg.return = (.05 + .09 - .08 + .05 + .20)/5 = .31/5 = .062 sum of squared deviations = (.05 - .062)² + (.09 - .062)² + (-.08 - .062)² + (.05-.062)² + (.2-.062)² = .04028 standard deviation = (1/4 * 0.04028)^.5 =.1003 .062 ± 2*.1003 = -.1386,.2686

Question 17

What is the risk premium?

Accepted Answer

The risk premium is the difference in annual returns between a risky asset (such as common stocks) and a risk-free asset (such as Treasury bills). It represents the additional return that investors require to invest in a riskier asset. Choice A is incorrect because Treasury bonds are considered a risk-free asset, and therefore do not have a risk premium. Choice C is incorrect because the annual return on Treasury bonds is not considered the risk premium. Choice D is incorrect because the variance in stock market returns is a measure of risk, but not specifically the risk premium.

Question 18

NARRBEGIN: Hillary
Hillary Investments
Between 1999 and 2003,Hillary Investments has produced returns as follows:
 
-What is the variance of the return of Hillary Investments?

Accepted Answer

((.08 - .004)² + (.03 - .004)² + (-.01 - .004)² + (-.05 - .004)² + (-.03 - .004)²)/ (5 - 1)= .00268

Question 19

You have the choice of introducing either Stock X or Stock Y into your fully diversified portfolio.Both stocks have 5 units of systematic risk while Stock X has 6 units of unsystematic risk and Stock Y has 8 units of unsystematic risk.Which stock offers the greatest opportunity from diversification?

Accepted Answer

The answer of You have the choice of introducing either...

Question 20

Which of the following asset classes would give you the greatest probability of achieving a return that is closest to its expected return?

Accepted Answer

Treasury bills have a low level of risk and are considered a safe investment. The expected return on Treasury bills is typically lower than other asset classes but the probability of achieving a return closest to its expected return is higher compared to other asset classes.

Quiz 6: The Trade-Off Between Risk and Return

Consider the following historical returns for Big Diesel Incorporated and inflation for the United States economy: What is the average real return for Big Diesel over the five-year time period?

NARRBEGIN: Big Diesel Incorporated Big Diesel Incorporated Consider the following historical returns for Big Diesel Incorporated: -Refer to Big Diesel Incorporated.What is the standard deviation of the returns over the five year time period?