Question 1

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 are considered to be a risk-free asset with a fixed return. As a result, the return on Treasury Bills is expected to be very close to its expected return. The other asset classes mentioned have some level of volatility and risk associated with them, which could result in a return that deviates from their expected return.

Question 2

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 3

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 4

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 5

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

Accepted Answer

If we are able to eliminate all of the unsystematic risk in a portfolio, we are left with only systematic risk. This means that the portfolio's return will be solely based on macroeconomic factors and not affected by company-specific events. However, this does not mean that the portfolio is risk-free as systematic risk cannot be diversified away.

Question 6

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, the portfolio standard deviation will be higher than the average standard deviation of the individual stocks. Therefore, we would expect the average standard deviation of stocks in that portfolio to be greater than 20%.

Question 7

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.
-What is the risk premium?

Accepted Answer

The risk premium is defined as the difference in annual returns between common stocks and Treasury bills. In this scenario, we have information about the common stock in Terry Corporation and can assume that Treasury bills are the risk-free investment option. Therefore, the risk premium is the additional return earned from investing in the common stock of Terry Corporation compared to the risk-free rate offered by Treasury bills.

Question 8

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 9

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 10

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 11

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 12

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 13

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 14

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

Accepted Answer

Inflation, recession, and higher interest rates affect the overall market and the economy as a whole, making them examples of market risk. They cannot be diversified away through investing in a single company or sector, so they are not company-specific or diversifiable risk. They are also considered systematic risk because they affect the entire market and cannot be controlled through diversification.

Question 15

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 16

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

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 18

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 level of systematic risk, which is the risk that affects the entire market and is compensated by the market. Unsystematic risk is diversifiable and does not affect the expected return in a well-diversified portfolio. Therefore, Stock Y should also be priced to return 8%.

Question 19

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 20

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

Quiz 6: The Trade-Off Between Risk and Return

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

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?

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?

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

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

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?

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. -What is the risk premium?

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?

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?

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?

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

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?

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?

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?

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?

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

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?