Question 1

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

Accepted Answer

While variance is one way to measure risk, it is not necessarily the best measure. Other measures, such as standard deviation or beta, may provide a better understanding of the risk associated with a specific investment. It ultimately depends on the context and nature of the investment in question.

Question 2

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

Accepted Answer

This is true because the variance is calculated by squaring the deviations of each return from the mean and then taking the average of those squared deviations. Since squaring will always result in a larger number than the original value, the variance will always be larger than the standard deviation which is the square root of the variance.

Question 3

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

The total return of a stock is made up of two components: capital gain and income. If a stock has a capital gain of 50 percent, then its income component must be 50 percent in order to have a total return of 100 percent. Therefore, the income component cannot be zero if the total return is 100 percent.

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 to its shareholders. However, there is also a capital appreciation component of return that comes from an increase in the stock price over time.

Question 5

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 6

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. This ratio represents the percentage increase or decrease in the stock's value. It does not include any dividends or other income received from the stock.

Question 7

The coefficient of variation is a good measure of the amount of risk that an asset will contribute to a diversified portfolio of assets.

Accepted Answer

The coefficient of variation measures the amount of risk per unit of return and is therefore useful in comparing the risk of different assets contributed to a portfolio. It allows investors to evaluate the risk-return tradeoff of assets and build a diversified portfolio with optimal risk levels.

Question 8

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 9

If the price of an asset has not increased or decreased 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

If the price of an asset has not changed, there cannot be any dividend or interest payments received on the asset, therefore the total return on the asset will be equal to the capital appreciation component return.

Question 10

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

Accepted Answer

This is because the higher the risk, the higher the potential for loss and therefore, investors will require a higher rate of return to compensate for that risk. Conversely, investments with lower risk will generally have lower rates of return.

Question 11

The coefficient of variation divides the variance of the returns of an asset by the expected rate of return of that asset.

Accepted Answer

The coefficient of variation divides the standard deviation of the returns of an asset by the mean (average) return of that asset, not the variance by the expected rate of return.

Question 12

If you are building a portfolio, then you desire those assets to have a correlation coefficient of one.

Accepted Answer

If all assets in a portfolio have a correlation coefficient of one, then they move together in the same direction with the same magnitude. This would result in a portfolio that is not diverse and therefore, could be considered riskier. A more desirable portfolio would have assets with low or negative correlation coefficients, as it would provide greater diversification and potentially lower overall risk.

Question 13

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 the 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 the payoff for winning the bet is $10, then the probability of winning cannot be 100 percent. The expected value formula is: 
(expected payoff) x (probability of winning) + (payoff if you lose) x (probability of losing) = expected cash receipt 
In this case: 
$10 x (probability of winning) + $0 x (probability of losing) = $9 
Solving for probability of winning: 
probability of winning = $9/$10 = 0.9 or 90 percent. Therefore, the answer is false as the probability of winning is not 100 percent.

Question 14

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

Accepted Answer

The standard deviation is the square root of the variance, which is always a non-negative value. Therefore, the standard deviation cannot be negative.

Question 15

The variance of a distribution can be a negative value.

Accepted Answer

The variance of a distribution cannot be negative. It is always a non-negative value, as it is calculated as the average of the squared deviations from the mean.

Question 16

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 17

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

Accepted Answer

The total return includes both capital gains and dividends. If the stock paid dividends, the selling price could be less than $110.

Question 18

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 statement is true according to the principle of expected value in probability theory.

Question 19

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 a bell-shaped curve that is completely characterized by its mean and standard deviation. Additionally, the mean is the center point of the distribution, and 50% of the probability falls below it, while the other 50% falls above it.

Question 20

Variance is equal to the square root of standard deviation.

Accepted Answer

The square root of variance is equal to standard deviation.

Quiz 7: Risk and Return