Question 1

What is the standard deviation of an investment that has the following expected scenario? 18% probability of a recession, 2.0% return; 65% probability of a moderate economy, 9.5% return; 17% probability of a strong economy, 14.2% return.
A) 3.68%
B) 1.23%
C) 8.47%
D) 6.66%

Accepted Answer

The standard deviation is a measure of the volatility of an investment. It is calculated by taking the square root of the variance, which is the average of the squared differences between the expected return and the actual return. In this case, the expected return is 9.5%, and the variance is 13.16%. Therefore, the standard deviation is 3.68%.

Question 2

If there is a 20% chance we will get a 16% return, a 30% chance of getting a 14% return, a 40% chance of getting a 12% return, and a 10% chance of getting an 8% return, what is the expected rate of return?
A) 12%
B) 13%
C) 14%
D) 15%

Accepted Answer

We can calculate the expected rate of return by multiplying the probability of each return with the return itself and adding them up:

Expected rate of return = (20% x 16%) + (30% x 14%) + (40% x 12%) + (10% x 8%)
Expected rate of return = 3.2% + 4.2% + 4.8% + 0.8%
Expected rate of return = 13%

Therefore, the best choice is B) 13% as it represents the expected rate of return.

Question 3

Investments that have earned the highest rates of return over 1995-2015 also have
A) the lowest risk.
B) the highest standard deviation of returns.
C) the largest market capitalization.
D) the least sensitivity to inflation.

Accepted Answer

Investments that have earned the highest rates of return over 1995-2015 tend to have higher risk and volatility, as reflected by a higher standard deviation of returns. This is because higher returns usually come with higher risk, and high-risk investments tend to have more volatile returns. Therefore, option B is the correct answer. The other options (A, C, and D) are not true, as high returns do not necessarily imply low risk, large market capitalization, or low sensitivity to inflation.

Question 4

The higher the standard deviation, the less risk the investment has.

Accepted Answer

The higher the standard deviation, the greater the risk of the investment. Standard deviation measures the amount of variability or fluctuations in the returns of an investment. Higher standard deviation indicates the investment has a wider range of possible outcomes, which means there is a greater chance of experiencing losses or gains. Therefore, a higher standard deviation is associated with higher risk, not less risk.

Question 5

Over the period 1995-2015, the risk-return relationship appears to be
A) negative.
B) perfectly positive.
C) random.
D) generally positive, but not perfect.

Accepted Answer

The word "generally" in option D suggests that there may be some instances where the relationship between risk and return is not positive. However, overall, the relationship tends to be positive. This is consistent with traditional finance theory, which suggests that investors should be compensated with higher returns for taking on more risk. Therefore, D is the best choice.

Question 6

The cash return on an investment is calculated as purchase price-selling price.

Accepted Answer

The cash return on an investment is calculated as selling price - purchase price.

Question 7

You have invested in a project that has the following payoff schedule: Probability of
Payoff Occurrence
$40 .15
$50 .20
$60 .30
$70 .30
$80 .05
What is the expected value of the investment's payoff? (Round to the nearest $1.)
A) $60
B) $65
C) $58
D) $70

Accepted Answer

The expected value is calculated by multiplying each payoff by its probability and summing these products: (0.15 * $40) + (0.20 * $50) + (0.30 * $60) + (0.30 * $70) + (0.05 * $80) = $6 + $10 + $18 + $21 + $4 = $59. Rounding to the nearest $1 gives $59, which is closest to option C, $58.

Question 8

Which of the following best measures an asset's risk?
A) Expected return
B) The standard deviation
C) The probability distribution
D) The cash return

Accepted Answer

The standard deviation is the most commonly used measure of risk in finance. It measures how much the actual returns of an asset vary from its expected return, providing an indication of the asset's volatility and sensitivity to market movements. The higher the standard deviation, the riskier the asset. A higher expected return does not necessarily mean higher risk, as it could be obtained through relatively stable returns. The probability distribution and cash return are important in determining an asset's overall value, but they do not directly measure its risk.

Question 9

Spartan Sofas, Inc. is selling for $50.00 per share today. In one year, Spartan will be selling for $48.00 per share, and the dividend for the year will be $3.00. What is the cash return on Spartan stock?
A) $51.00
B) $1.00
C) $2.00
D) $3.00

Accepted Answer

The cash return is equal to the dividend yield plus the change in stock price. The dividend yield is $3.00/$50.00 = 0.06 or 6%. The change in stock price is ($48.00 - $50.00)/$50.00 = -0.04 or -4%. Therefore, the cash return is 6% - 4% = 2% or $1.00.

Question 10

Investment variances may be either positive or negative.

Accepted Answer

The answer of Investment variances may be either positive or...

Question 11

Over the period 1995-2015, which pair of investments does not perfectly fit the "higher risk, higher return" pattern?
A) Government bonds, treasury bills
B) U.S. equities, corporate bonds
C) U.S. Equities, international equities
D) Corporate bonds, international equities

Accepted Answer

Government bonds and treasury bills are generally considered low-risk investments, with lower returns compared to other investments such as equities and corporate bonds. Therefore, they do not fit the pattern of "higher risk, higher return."

Question 12

Even though an investor expects a positive rate of return, it is possible that the actual return will be negative.

Accepted Answer

This is because there are various factors that can affect the actual return such as market volatility, economic conditions, company performance, and unforeseen events. Therefore, there is always a risk involved in investing, and investors should be prepared for the possibility of a negative return.

Question 13

Which of the following sequences is arranged in the correct order, from highest long-term returns to lowest?
A) International equities, U.S. government bonds, U.S. equities
B) Corporate bonds, treasury bills, international equities
C) International equities, U.S. government bonds, treasury bills
D) Government bonds, emerging market equities, treasury bills

Accepted Answer

Historically, international equities have had the highest long-term returns, followed by U.S. government bonds and then treasury bills.

Question 14

You are considering investing in a firm that has the following possible outcomes: Economic boom: probability of 25%; return of 25%
Economic growth: probability of 60%; return of 15%
Economic decline: probability of 15%; return of -5%
What is the expected rate of return on the investment?
A) 15.0%
B) 11.7%
C) 14.5%
D) 25.0%

Accepted Answer

The answer of You are considering investing in a firm...

Question 15

You purchased the stock of Sargent Motors at a price of $75.75 one year ago today. If you sell the stock today for $89.00, what is your rate of return?
A) 35.00%
B) 12.50%
C) 17.50%
D) 25.00%

Accepted Answer

Rate of return = (selling price - purchase price)/purchase price x 100%

= ($89.00 - $75.75)/$75.75 x 100%

= $13.25/$75.75 x 100%

= 0.175 x 100%

= 17.50%

Therefore, the rate of return is 17.50%, which is option C.

Question 16

Because returns are more certain for the least risky investments, the required return on these investments should be higher than the required returns on more risky investments.

Accepted Answer

The statement is false. The required return on more risky investments should be higher than the required return on less risky investments, as investors demand a higher return for taking on greater risk.

Question 17

Using the following information for McDonovan, Inc.'s stock, calculate their expected return and standard deviation.
State Probability Return
Boom 20% 40%
Normal 60% 15%
Recession 20% (20%)

Accepted Answer

The answer of Using the following information for McDonovan, Inc.'s...

Question 18

The expected rate of return is the weighted average of the possible returns for an investment.

Accepted Answer

The expected rate of return is the weighted average of the possible returns for an investment, taking into account the probability of each possible return occurring.

Question 19

You are considering investing in a firm that has the following possible outcomes: Economic boom: probability of 25%; return of 25%
Economic growth: probability of 60%; return of 15%
Economic decline: probability of 15%; return of -5%
What is the standard deviation of returns on the investment?
A) 84.75%
B) 15.28%
C) 12.47%
D) 9.21

Accepted Answer

The answer of You are considering investing in a firm...

Question 20

You are considering investing in a project with the following possible outcomes: Probability of Investment
States Occurrence Returns
State 1: Economic boom 15% 16%
State 2: Economic growth 45% 12%
State 3: Economic decline 25% 5%
State 4: Depression 15% -5%
Calculate the expected rate of return for this investment.
A) 9.8%
B) 7.0%
C) 8.3%
D) 6.3%

Accepted Answer

The expected rate of return is calculated by multiplying each possible return by its probability of occurrence and adding up the product of all possible outcomes. In this case, the expected rate of return would be:

(0.15*0.16) + (0.45*0.12) + (0.25*0.05) + (0.15*(-0.05)) = 0.024 + 0.054 + 0.0125 - 0.0075 = 0.083 or 8.3%

Therefore, the best choice is C) with an expected return of 8.3%.

Quiz 7: An Introduction to Risk and Return-History of Financial Market Returns

What is the standard deviation of an investment that has the following expected scenario? 18% probability of a recession, 2.0% return; 65% probability of a moderate economy, 9.5% return; 17% probability of a strong economy, 14.2% return.

If there is a 20% chance we will get a 16% return, a 30% chance of getting a 14% return, a 40% chance of getting a 12% return, and a 10% chance of getting an 8% return, what is the expected rate of return?

Investments that have earned the highest rates of return over 1995-2015 also have

The higher the standard deviation, the less risk the investment has.

Over the period 1995-2015, the risk-return relationship appears to be

The cash return on an investment is calculated as purchase price-selling price.

You have invested in a project that has the following payoff schedule: Probability of Payoff Occurrence $40 .15 $50 .20 $60 .30 $70 .30 $80 .05 What is the expected value of the investment's payoff? (Round to the nearest $1.)

Which of the following best measures an asset's risk?

Spartan Sofas, Inc. is selling for $50.00 per share today. In one year, Spartan will be selling for $48.00 per share, and the dividend for the year will be $3.00. What is the cash return on Spartan stock?

Investment variances may be either positive or negative.

Over the period 1995-2015, which pair of investments does not perfectly fit the "higher risk, higher return" pattern?

Even though an investor expects a positive rate of return, it is possible that the actual return will be negative.

Which of the following sequences is arranged in the correct order, from highest long-term returns to lowest?

You are considering investing in a firm that has the following possible outcomes: Economic boom: probability of 25%; return of 25% Economic growth: probability of 60%; return of 15% Economic decline: probability of 15%; return of -5% What is the expected rate of return on the investment?

You purchased the stock of Sargent Motors at a price of $75.75 one year ago today. If you sell the stock today for $89.00, what is your rate of return?

Because returns are more certain for the least risky investments, the required return on these investments should be higher than the required returns on more risky investments.

Using the following information for McDonovan, Inc.'s stock, calculate their expected return and standard deviation. State Probability Return Boom 20% 40% Normal 60% 15% Recession 20% (20%)

The expected rate of return is the weighted average of the possible returns for an investment.

You are considering investing in a firm that has the following possible outcomes: Economic boom: probability of 25%; return of 25% Economic growth: probability of 60%; return of 15% Economic decline: probability of 15%; return of -5% What is the standard deviation of returns on the investment?