Deck 1: An Overview of the Investment Process

Question 1

In the phrase "nominal risk free rate," nominal means

A) Computed.
B) Historical.
C) Market.
D) Average.
E) Risk adverse.

Answer 1

C

Question 2

The holding period return (HPR)is equal to the holding period yield (HPY)stated as a percentage.

Answer 2

False

Question 3

The arithmetic mean is a superior measure of the long-term performance because it indicates the compound annual rate of return based on the ending value of the investment versus its beginning value.

Answer 3

False

Question 4

The rate of exchange between certain future dollars and certain current dollars is known as the pure rate of interest.

Question 5

The geometric mean of a series of returns is always larger than the arithmetic mean and the difference increases with the volatility of the series.

Question 6

The coefficient of variation is a measure of

A) Central tendency.
B) Absolute variability.
C) Absolute dispersion.
D) Relative variability.
E) Relative return.

Question 7

An investment is the current commitment of dollars over time to derive future payments to compensate the investor for the time funds are committed,the expected rate of inflation and the uncertainty of future payments.

Question 8

The risk premium is a function of the volatility of operating earnings,sales volatility and inflation.

Question 9

Nominal rates are averages of all possible real rates.

Question 10

The basic trade-off in the investment process is

A) between the anticipated rate of return for a given investment instrument and its degree of risk.
B) between understanding the nature of a particular investment and having the opportunity to purchase it.
C) between high returns available on single instruments and the diversification of instruments into a portfolio.
D) between the desired level of investment and possessing the resources necessary to carry it out.
E) None of the above.

Question 11

The nominal risk free rate of interest is a function of

A) The real risk free rate and the investment's variance.
B) The prime rate and the rate of inflation.
C) The T-bill rate plus the inflation rate.
D) The tax free rate plus the rate of inflation.
E) The real risk free rate and the rate of inflation.

Question 12

Investors are willing to forgo current consumption in order to increase future consumption for a nominal rate of interest.

Question 13

The coefficient of variation is the expected return divided by the standard deviation of the expected return.

Question 14

The variance of expected returns is equal to the square root of the expected returns.

Question 15

The expected return is the average of all possible returns.

Question 16

The rate of exchange between future consumption and current consumption is

A) The nominal risk-free rate.
B) The coefficient of investment exchange.
C) The pure rate of interest.
D) The consumption/investment paradigm.
E) The expected rate of return.

Question 17

The two most common calculations investors use to measure return performance are arithmetic means and geometric means.

Question 18

An individual who selects the investment that offers greater certainty when everything else is the same is known as a risk averse investor.

Question 19

Two measures of the risk premium are the standard deviation and the variance.

Question 20

The ____ the variance of returns,everything else remaining constant,the ____ the dispersion of expectations and the ____ the risk.

A) Larger, greater, lower
B) Larger, smaller, higher
C) Larger, greater, higher
D) Smaller, greater, lower
E) Smaller, greater, greater

Question 21

What will happen to the security market line (SML)if the following events occur,other things constant: (1)inflation expectations increase,and (2)investors become more risk averse?

A) Shift up and keep the same slope
B) Shift up and have less slope
C) Shift up and have a steeper slope
D) Shift down and keep the same slope
E) Shift down and have less slope

Question 22

The uncertainty of investment returns associated with how a firm finances its investments is known as

A) Business risk.
B) Liquidity risk.
C) Exchange rate risk.
D) Financial risk.
E) Market risk.

Question 23

Which of the following is not a component of the required rate of return?

A) Expected rate of inflation
B) Time value of money
C) Risk
D) Holding period return
E) All of the above are components of the required rate of return

Question 24

A decrease in the expected real growth in the economy,all other things constant,will cause the security market line to

A) Shift up
B) Shift down
C) Have a steeper slope
D) Have a flatter slope
E) Remain unchanged

Question 25

All of the following are major sources of uncertainty EXCEPT

A) Business risk
B) Financial risk
C) Default risk
D) Country risk
E) Liquidity risk

Question 26

The total risk for a security can be measured by its

A) Beta with the market portfolio
B) Systematic risk
C) Standard deviation of returns
D) Unsystematic risk
E) Alpha with the market portfolio

Question 27

Unsystematic risk refers to risk that is

A) Undiversifiable
B) Diversifiable
C) Due to fundamental risk factors
D) Due to market risk
E) None of the above

Question 28

Sources of risk for an investment include

A) Variance of returns and business risk
B) Coefficient of variation of returns and financial risk
C) Business risk and financial risk
D) Variance of returns and coefficient of variation of returns
E) All of the above

Question 29

Modern portfolio theory assumes that most investors are

A) Risk averse
B) Risk neutral
C) Risk seekers
D) Risk tolerant
E) None of the above

Question 30

The increase in yield spreads in late 2008 and early 2009 indicated that

A) Credit risk premiums decreased
B) Market risk premiums increased
C) Investors are more confident of the future cash flows of bonds
D) Non-investment grade bonds are less risky
E) Government bonds are no longer a risk free investment

Question 31

The security market line (SML)graphs the expected relationship between

A) Business risk and financial risk
B) Systematic risk and unsystematic risk
C) Risk and return
D) Systematic risk and unsystematic return
E) None of the above

Question 32

The real risk-free rate is affected by a two factors;

A) The relative ease or tightness in capital markets and the expected rate of inflation.
B) The expected rate of inflation and the set of investment opportunities available in the economy.
C) The relative ease or tightness in capital markets and the set of investment opportunities available in the economy.
D) Time preference for income consumption and the relative ease or tightness in capital markets.
E) Time preference for income consumption and the set of investment opportunities available in the economy.

Question 33

Measures of risk for an investment include

A) Variance of returns and business risk
B) Coefficient of variation of returns and financial risk
C) Business risk and financial risk
D) Variance of returns and coefficient of variation of returns
E) All of the above

Question 34

If a significant change is noted in the yield of a T-bill,the change is most likely attributable to

A) A downturn in the economy.
B) A static economy.
C) A change in the expected rate of inflation.
D) A change in the real rate of interest.
E) A change in risk aversion.

Question 35

Which of the following is least likely to move a firm's position to the right on the Security Market Line (SML)?

A) An increase in the firm's beta
B) Adding more financial debt to the firm's balance sheet relative to equity
C) Changing the business strategy to include new product lines with more volatile expected cash flows
D) Investors perceive the stock as being more risky
E) An increase in the risk-free required rate of return.

Question 36

A decrease in the market risk premium,all other things constant,will cause the security market line to

A) Shift up
B) Shift down
C) Have a steeper slope
D) Have a flatter slope
E) Remain unchanged

Question 37

The variability of operating earnings is associated with

A) Business risk.
B) Liquidity risk.
C) Exchange rate risk.
D) Financial risk.
E) Market risk.

Question 38

Two factors that influence the nominal risk-free rate are;

A) The relative ease or tightness in capital markets and the expected rate of inflation.
B) The expected rate of inflation and the set of investment opportunities available in the economy.
C) The relative ease or tightness in capital markets and the set of investment opportunities available in the economy.
D) Time preference for income consumption and the relative ease or tightness in capital markets.
E) Time preference for income consumption and the set of investment opportunities available in the economy.

Question 39

Which of the following is not a component of the risk premium?

A) Business risk
B) Financial risk
C) Liquidity risk
D) Exchange rate risk
E) Unsystematic market risk

Question 40

The ability to sell an asset quickly at a fair price is associated with

A) Business risk.
B) Liquidity risk.
C) Exchange rate risk.
D) Financial risk.
E) Market risk.

Question 41

Use the Information Below for the Following Problem(S)
You have concluded that next year the following relationships are possible:

Refer to Exhibit 1.4.Compute the coefficient of variation for your portfolio.

A) 0.043
B) 0.12
C) 1.40
D) 0.69
E) 1.04

Question 42

Use the Information Below for the Following Problem(S)
Suppose you bought a GM corporate bond on January 25, 2001 for $750, on January 25, 2004 sold it for $650.00.
Refer to Exhibit 1.2.What was your annual holding period return?

A) 0.8667
B) -0.1333
C) 0.0333
D) 0.9534
E) -0.0466

Question 43

Use the Information Below for the Following Problem(S)
You have concluded that next year the following relationships are possible:

Refer to Exhibit 1.4.What is your expected rate of return [E(Rᵢ)] for next year?

A) 4.25%
B) 6.00%
C) 6.25%
D) 7.75%
E) 8.00%

Question 44

Use the Information Below for the Following Problem(S)
Suppose you bought a GM corporate bond on January 25, 2001 for $750, on January 25, 2004 sold it for $650.00.
Refer to Exhibit 1.2.What was your annual holding period yield?

A) -0.0466
B) -0.1333
C) 0.0333
D) 0.3534
E) 0.8667

Question 45

Use the Information Below for the Following Problem(S)
The common stock of XMen Inc. had the following historic prices.

Refer to Exhibit 1.3.What was your geometric mean annual yield for the investment in XMen?

A) 0.25
B) 0.40
C) 1.8
D) 0.1247
E) 0.1462

Question 46

Use the Information Below for the Following Problem(S)
The common stock of XMen Inc. had the following historic prices.

Refer to Exhibit 1.3.What was your annual holding period yield (Annual HPY)?

A) 0.1462
B) 0.1247
C) 1.8
D) 0.40
E) 0.25

Question 47

Use the Information Below for the Following Problem(S)
You are provided with the following information:
Nominal return on risk-free asset = 4.5%
Expected return for asset i = 12.75%
Expected return on the market portfolio = 9.25%
Refer to Exhibit 1.6.Calculate the risk premium for the market portfolio.

A) 4.5%
B) 8.25%
C) 4.75%
D) 3.5%
E) None of the above

Question 48

Use the Information Below for the Following Problem(S)
Assume you bought 100 shares of NewTech common stock on January 15, 2003 at $50.00 per share and sold it on January 15, 2004 for $40.00 per share.
Refer to Exhibit 1.1.What was your holding period return?

A) -10%
B) -0.8
C) 25%
D) 0.8
E) -20%

Question 49

Use the Information Below for the Following Problem(S)
Assume that during the past year the consumer price index increased by 1.5 percent and the securities listed below returned the following nominal rates of return.
$\begin{array}{c}\begin{array}{l}\text {U.S. Govermment T-bills}\\\text {U. S. Lonf-term bonfs}\end{array}\begin{array}{r}2.75 \% \\4.75 \%\end{array}\end{array}$

-Refer to Exhibit 1.5.If next year the real rates all rise by 10 percent while inflation climbs from 1.5 percent to 2.5 percent,what will be the nominal rate of return on each security?

A) 1.24% and 1.52%
B) 1.35% and 3.52%
C) 3.89% and 6.11%
D) 3.52% and 3.89%
E) 1.17% and 6.11%

Question 50

Use the Information Below for the Following Problem(S)
Consider the following information
Nominal annual return on U.S. government T-bills for year 2009 = 3.5%
Nominal annual return on U.S. government long-term bonds for year 2009 = 4.75%
Nominal annual return on U.S. large-cap stocks for year 2009= 8.75%
Consumer price index January 1, 2009 = 165
Consumer price index December 31, 2009 = 169
Refer to Exhibit 1.7.Calculate the annual real rate of return for U.S.T-bills.

A) 2.26%
B) 1.81%
C) -0.5%
D) 1.05%
E) None of the above

Question 51

Given investments A and B with the following risk return characteristics,which one would you prefer and why?

A) Investment A because it has the highest expected return.
B) Investment A because it has the lowest relative risk.
C) Investment B because it has the lowest absolute risk.
D) Investment B because it has the lowest coefficient of variation.
E) Investment A because it has the highest coefficient of variation.

Question 52

Use the Information Below for the Following Problem(S)
The common stock of XMen Inc. had the following historic prices.

Refer to Exhibit 1.3.What was your holding period return for the time period 3/1/1999 to 3/1/2004?

A) 0.1247
B) 1.8
C) 0.1462
D) 0.40
E) 0.25

Question 53

Use the Information Below for the Following Problem(S)
Consider the following information
Nominal annual return on U.S. government T-bills for year 2009 = 3.5%
Nominal annual return on U.S. government long-term bonds for year 2009 = 4.75%
Nominal annual return on U.S. large-cap stocks for year 2009= 8.75%
Consumer price index January 1, 2009 = 165
Consumer price index December 31, 2009 = 169
Refer to Exhibit 1.7.Calculate the annual real rate of return for U.S.long-term bonds.

A) 3.06%
B) 2.27%
C) 2.51%
D) 3.5%
E) None of the above

Question 54

Use the Information Below for the Following Problem(S)
Assume that during the past year the consumer price index increased by 1.5 percent and the securities listed below returned the following nominal rates of return.
$\begin{array}{c}\begin{array}{l}\text {U.S. Govermment T-bills}\\\text {U. S. Lonf-term bonfs}\end{array}\begin{array}{r}2.75 \% \\4.75 \%\end{array}\end{array}$

-Refer to Exhibit 1.5.What are the real rates of return for each of these securities?

A) 4.29% and 6.32%
B) 1.23% and 4.29%
C) 3.20% and 6.32%
D) 1.23% and 3.20%
E) 3.75% and 5.75%

Question 55

Use the Information Below for the Following Problem(S)
Consider the following information
Nominal annual return on U.S. government T-bills for year 2009 = 3.5%
Nominal annual return on U.S. government long-term bonds for year 2009 = 4.75%
Nominal annual return on U.S. large-cap stocks for year 2009= 8.75%
Consumer price index January 1, 2009 = 165
Consumer price index December 31, 2009 = 169
Refer to Exhibit 1.7.Compute the rate of inflation for the year 2009.

A) 2.42%
B) 4.0%
C) 1.69%
D) 1.24%
E) None of the above

Question 56

Use the Information Below for the Following Problem(S)
You have concluded that next year the following relationships are possible:

Refer to Exhibit 1.4.Compute the standard deviation of the rate of return for the one year period.

A) 0.65%
B) 1.45%
C) 4.0%
D) 6.25%
E) 6.4%

Question 57

Use the Information Below for the Following Problem(S)
You are provided with the following information:
Nominal return on risk-free asset = 4.5%
Expected return for asset i = 12.75%
Expected return on the market portfolio = 9.25%
Refer to Exhibit 1.6.Calculate the risk premium for asset i.

A) 4.5%
B) 8.25%
C) 4.75%
D) 3.5%
E) None of the above

Question 58

Use the Information Below for the Following Problem(S)
Assume you bought 100 shares of NewTech common stock on January 15, 2003 at $50.00 per share and sold it on January 15, 2004 for $40.00 per share.
Refer to Exhibit 1.1.What was your holding period yield?

A) -10%
B) -0.8
C) 25%
D) 0.8
E) -20%

Question 59

If over the past 20 years the annual returns on the S&P 500 market index averaged 12% with a standard deviation of 18%,what was the coefficient of variation?

A) 0.6
B) 0.6%
C) 1.5
D) 1.5%
E) 0.66%

Question 60

Use the Information Below for the Following Problem(S)
The common stock of XMen Inc. had the following historic prices.

Refer to Exhibit 1.3.What was your arithmetic mean annual yield for the investment in XMen Industries.

A) 0.1462
B) 0.1247
C) 1.8
D) 0.40
E) 0.25

Question 61

Use the Information Below for the Following Problem(S)
Consider the following information
Nominal annual return on U.S. government T-bills for year 2009 = 3.5%
Nominal annual return on U.S. government long-term bonds for year 2009 = 4.75%
Nominal annual return on U.S. large-cap stocks for year 2009= 8.75%
Consumer price index January 1, 2009 = 165
Consumer price index December 31, 2009 = 169
Refer to Exhibit 1.7.Calculate the annual real rate of return for U.S.large-cap stocks.

A) 7.06%
B) 6.18%
C) 4.75%
D) 3.75%
E) None of the above

Question 62

Economists project the long-run real growth rate for the next five years to be 2.5 percent and the average annual rate of inflation over this five year period to be 3 percent.What is the expected nominal rate of return over the next five years?

A) 0.500 percent
B) 1.056 percent
C) 2.750 percent
D) 5.500 percent
E) 5.575 percent

Question 63

Use the Information Below for the Following Problem(S)
You purchased 100 shares of GE common stock on January 1, for $29 a share. A year later you received $1.25 in dividends per share and you sold it for $28 a share.
Refer to Exhibit 1.9.Calculate your holding period return (HPR)for this investment in GE stock.

A) 0.9655
B) 1.0086
C) 1.0357
D) 1.0804
E) 1.0973

Question 64

Use the Information Below for the Following Problem(S)
Assume that you hold a two stock portfolio. You are provided with the following information on your holdings:
$$\begin{array} { c c c c } \text { stack } & \text { shares } & \text { Price(t) } & \text { Price } ( \mathrm { t } + 1 ) \\\hline 1 & 15 & 10 & 12 \\2 & 25 & 15 & 16\end{array}$$

-Refer to Exhibit 1.8.Calculate the HPY for stock 1.

A) 10%
B) 20%
C) 15%
D) 12%
E) 7%

Question 65

Use the Information Below for the Following Problem(S)
The annual rates of return of Stock Z for the last four years are 0.10, 0.15, -0.05, and 0.20, respectively.
Refer to Exhibit 1.10.Compute the standard deviation of the annual rate of return for Stock Z.

A) 0.0070
B) 0.0088
C) 0.0837
D) 0.0935
E) 0.1145

Question 66

Use the Information Below for the Following Problem(S)
The annual rates of return of Stock Z for the last four years are 0.10, 0.15, -0.05, and 0.20, respectively.
Refer to Exhibit 1.10.Compute the coefficient of variation for Stock Z.

A) 0.837
B) 0.935
C) 1.070
D) 1.145
E) 1.281

Question 67

Use the Information Below for the Following Problem(S)
You purchased 100 shares of GE common stock on January 1, for $29 a share. A year later you received $1.25 in dividends per share and you sold it for $28 a share.
Refer to Exhibit 1.9.Calculate your holding period yield (HPY)for this investment in GE stock.

A) -0.0345
B) -0.0090
C) 0.0086
D) 0.0643
E) 0.0804

Question 68

Use the Information Below for the Following Problem(S)
Assume that you hold a two stock portfolio. You are provided with the following information on your holdings:

Refer to Exhibit 1.8.Calculate the HPY for stock 2.

A) 5%
B) 6%
C) 7%
D) 8%
E) 10%

Question 69

Use the Information Below for the Following Problem(S)
Assume that you hold a two stock portfolio. You are provided with the following information on your holdings:
$$\begin{array} { c c c c } \text { stack } & \text { shares } & \text { Price(t) } & \text { Price } ( \mathrm { t } + 1 ) \\\hline 1 & 15 & 10 & 12 \\2 & 25 & 15 & 16\end{array}$$

-Refer to Exhibit 1.8.Calculate the market weights for stock 1 and 2 based on period t values.

A) 39% for stock 1 and 61% for stock 2
B) 50% for stock 1 and 50% for stock 2
C) 71% for stock 1 and 29% for stock 2
D) 29% for stock 1 and 71% for stock 2
E) None of the above

Question 70

Use the Information Below for the Following Problem(S)
Assume that you hold a two stock portfolio. You are provided with the following information on your holdings:
$$\begin{array} { c c c c } \text { stack } & \text { shares } & \text { Price(t) } & \text { Price } ( \mathrm { t } + 1 ) \\\hline 1 & 15 & 10 & 12 \\2 & 25 & 15 & 16\end{array}$$

-Refer to Exhibit 1.8.Calculate the HPY for the portfolio.

A) 10.6%
B) 6.95%
C) 13.5%
D) 10%
E) 15.7%

Question 71

Use the Information Below for the Following Problem(S)
The annual rates of return of Stock Z for the last four years are 0.10, 0.15, -0.05, and 0.20, respectively.
Refer to Exhibit 1.10.Compute the geometric mean rate of return for Stock Z.

A) 0.051
B) 0.074
C) 0.096
D) 0.150
E) 1.090

Question 72

Use the Information Below for the Following Problem(S)
The annual rates of return of Stock Z for the last four years are 0.10, 0.15, -0.05, and 0.20, respectively.
Refer to Exhibit 1.10.Compute the arithmetic mean annual rate of return for Stock Z.

A) 0.03
B) 0.04
C) 0.06
D) 0.10
E) 0.40