Question 1

The capital appreciation component of a stock's return considers the change in price of a stock divided by the initial price of the stock.

Accepted Answer

The capital appreciation component of a stock's return is calculated by dividing the change in price of a stock by the initial price of the stock, which is also known as the percentage increase in the stock price over time. This helps investors to understand the contribution of price increase to the total return generated by a stock investment.

Question 2

The smaller the range of expected future returns, the greater the risk of a given investment as measured by its mean.

Accepted Answer

The statement is incorrect. The smaller the range of expected future returns, the lower the risk of a given investment as it indicates a more predictable outcome. The risk of an investment is measured by its standard deviation, not its mean.

Question 3

Variance is equal to the square root of standard deviation.

Accepted Answer

The square root of variance is equal to the standard deviation.

Question 4

The income component of return for a common stock comes from the cash dividend a firm pays.

Accepted Answer

The income component of return for a common stock comes from the cash dividend a firm pays. However, there is also the capital appreciation component that comes from any increase in the stock's market value.

Question 5

The rate of return that investors require for an investment depends on the risk associated with
that investment.

Accepted Answer

This statement is true. Generally, investors require a higher rate of return for investments with higher risk, to compensate for the potential loss of their investment.

Question 6

The best measure of assessing the risk of an investment is its variance.

Accepted Answer

Variance is one measure of risk, but it is not the best or only measure. Other measures such as standard deviation, beta, and value at risk (VaR) may also be used to assess investment risk. It is important to use a combination of measures to get a comprehensive understanding of the risk associated with an investment.

Question 7

Robert paid $100 for a stock one year ago. The total return on the stock was 10 percent. This means that the stock must be selling for $110 today.

Accepted Answer

The total return on the stock includes both capital appreciation and any dividends received. It is possible that the stock appreciated in value by 10% but also paid out a dividend, resulting in a total return that is greater than 10%. Additionally, factors such as supply and demand in the market can also affect the current price of the stock. Therefore, it cannot be assumed that the stock is selling for $110 today.

Question 8

The standard deviation of a distribution can be a negative value.

Accepted Answer

The standard deviation is always a non-negative value because it is a measure of the spread or dispersion of data from the mean. Therefore, it cannot be negative.

Question 9

Whenever the outcome of an event has a number of different possibilities that have equal probability of occurrence, then the expected value of the outcome is equal to the simple average of the individual events.

Accepted Answer

This is the definition of a fair game or situation, where each possible outcome has an equal probability of occurring, and the expected value can be calculated as the arithmetic mean of the possible outcomes.

Question 10

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Accepted Answer

Beta measures a stock's volatility relative to the overall market, implying its systematic risk. For an investor holding a well-diversified portfolio, beta remains relevant as it indicates the portfolio's sensitivity to market movements. However, for an investor holding only one stock, beta is less relevant since unsystematic (specific) risk, which can be diversified away, significantly impacts that stock's total risk.

Question 11

The expected return on the market portfolio is equal to the market risk premium.

Accepted Answer

The expected return on the market portfolio is the weighted average of expected returns of individual assets in the portfolio. Market risk premium, on the other hand, is the excess return required by investors to compensate for the risk of investing in the stock market compared to a risk-free investment. While there is a relationship between the two, they are different concepts and not equal to each other.

Question 12

In order to keep the total return of a stock equal to 100 percent, the income component for that stock must be zero.

Accepted Answer

This statement is false. The total return of a stock includes both capital appreciation (the increase in the stock's value) and income (such as dividends paid out by the company). Therefore, a stock can have a total return of 100 percent while still having an income component.

Question 13

If the capital appreciation return from owning a stock is positive, then the total return from owning the same stock can be negative.

Accepted Answer

The answer of If the capital appreciation return from owning...

Question 14

You have placed a wager such that you will either receive nothing if you lose the bet or you will receive $10 if you win the bet. If your expected cash receipt is $9, then there is a 100 percent probability that you will win the wager.

Accepted Answer

If the expected cash receipt is $9 and there is a 100 percent probability of winning the wager, then the wager would have to be $10. However, the amount you receive for winning the bet is also $10, so there is no profit and the expected cash receipt would be $0. Therefore, the statement cannot be true.

Question 15

If you are calculating the variance and standard deviation of percentage returns on a stock, the variance will always be larger than the standard deviation.

Accepted Answer

This statement is true. The variance is calculated by taking the sum of the squared deviations from the mean and dividing by the number of observations. Since squaring a number makes it larger, the variance will always be larger than the square root of the variance, which is the standard deviation.

Question 16

If the price of an asset has increased since the original purchase of the asset, then the total return of the asset (if no dividends were paid during the period) is equal to the capital appreciation component return.

Accepted Answer

Capital appreciation refers to the increase in the market value of an asset. Therefore, if the price of the asset has increased since the original purchase and no dividends were paid, the total return would be equal to the capital appreciation component return.

Question 17

The variance is denominated in squared units, whereas the standard deviation is denominated in the same units as the expected value.

Accepted Answer

Variance is calculated as the average of the squared differences from the mean, resulting in squared units, while standard deviation is the square root of variance, bringing it back to the original units of the data.

Question 18

The normal distribution is completely described by its mean and standard deviation where 50 percent of the distribution's probability is less than the mean and 50 percent greater than the mean.

Accepted Answer

This statement is true. The normal distribution is symmetrical and approximately 68.27% of the observations fall within one standard deviation of the mean, 95.45% of the observations fall within two standard deviations of the mean, and 99.73% of the observations fall within three standard deviations of the mean.

Question 19

The variance of a distribution can be negative.

Accepted Answer

The variance is a measure of spread or dispersion of a distribution and it cannot be negative. It is always non-negative, meaning that it can be zero or any positive value, but never negative.

Question 20

If the returns of two stocks are negatively correlated, then one of them must have a negative beta.

Accepted Answer

If the returns of two stocks are negatively correlated, it means that when one stock goes up, the other tends to go down. This implies that the covariance between the two stocks is negative. Beta is a measure of the systematic risk of a stock, which is the risk that cannot be diversified away. A negative beta indicates that the stock tends to move in the opposite direction of the market. Therefore, if the returns of two stocks are negatively correlated, one of them must have a negative beta.

Quiz 7: Risk and Return