Question 1

Suppose there's a 50% chance of a stock rising by 20% and a 50% chance of it falling by 20%.What is the expected rate of return on the stock?

Accepted Answer

The expected rate of return is calculated as the average of the possible outcomes, weighted by their probabilities. Here, it's (0.5 * 20%) + (0.5 * -20%) = 10% - 10% = 0%.

Question 2

Which of the following financial assets has both the highest risk and highest return for the period of 1926-2015?

Accepted Answer

According to historical data from 1926-2015, small company stocks have had the highest risk and highest return compared to the other financial assets listed. While they have the potential for high returns, they are also considered the riskiest due to their volatility and susceptibility to economic downturns. Larger company stocks are still a good investment option but have lower risk compared to small company stocks. Corporate bonds and Treasury bills have even lower risk but also lower returns.

Question 3

The average investor must weigh the benefits of liquidity against

Accepted Answer

Liquidity refers to the ease with which an asset can be bought or sold, without significantly affecting its market price. However, assets that are highly liquid often have lower returns than less liquid assets, because investors are willing to pay a premium for their convenience and safety. Therefore, investors must weigh the benefits of liquidity against the potential for lower returns.

Question 4

A portfolio is a

Accepted Answer

A portfolio is a collection of assets, such as stocks, bonds, and other investments, held by an individual or entity. The purpose of a portfolio is to diversify risk and potentially generate returns through a mix of different investments.

Question 5

As wealth decreases,which of the following is likely to account for a smaller fraction of a saver's portfolio?

Accepted Answer

The answer of As wealth decreases,which of the following is...

Question 6

Suppose that you own $10,000 worth of stock in General Motors.Adding stock in which of the following companies would be least likely to reduce the risk in your portfolio?

Accepted Answer

Adding stock in Ford would be least likely to reduce the risk in your portfolio because Ford operates in the same industry as General Motors. Diversification reduces risk by investing in assets that are not closely correlated. Since both Ford and General Motors are major players in the automotive industry, their stock prices are likely to be influenced by similar economic factors, market trends, and industry-specific risks.

Question 7

Investors value liquidity in an asset because

Accepted Answer

Investors value liquidity in an asset because it incurs lower selling costs, making it easier to sell and convert to cash. A liquid asset does not necessarily have higher rates of return or lower tax liabilities than less liquid assets. While high information costs may be a potential disadvantage of liquid assets, this is not generally considered a reason for valuing liquidity.

Question 8

Suppose there's an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%.What is the expected rate of return on the stock?

Accepted Answer

To calculate the expected rate of return, we need to take the weighted average of the possible outcomes based on their probabilities.

Expected return = (0.8 x 20%) + (0.2 x -40%) = 16% - 8% = 8%

Therefore, the expected rate of return on the stock is 8%.

Question 9

Which best describes the relationship between the cost of acquiring information and return?

Accepted Answer

A high return must compensate for a high cost of acquiring information, as the investment in acquiring information is justified if the potential return is significant enough to outweigh the costs.

Question 10

Which combination of assets represents the most diversification?

Accepted Answer

Diversification is achieved by investing in assets that do not closely correlate with each other. Holding shares of Google along with Treasury bonds combines equity and debt securities from different sectors, providing more diversification than options A, B, or C, which involve assets within the same asset class or closely related industries.

Question 11

Economists believe that as a saver's wealth increases,the saver will generally

Accepted Answer

As a saver's wealth increases, they are more likely to increase the fraction of wealth held as common stock. This is because with more wealth, savers are often willing to take on more risk for the potential of higher returns, and stocks generally offer higher returns compared to other assets like cash or bonds, albeit with higher risk.

Question 12

Risk that is common to all assets of a certain type is referred to as

Accepted Answer

Systematic risk is the risk that affects all assets of a certain type or across the entire market, such as changes in interest rates, inflation, or geopolitical events. It cannot be diversified away and can only be managed through asset allocation and diversification. Unsystematic risk, on the other hand, is the risk that is specific to a particular company or industry, such as management changes, product recalls, or labor strikes. Idiosyncratic risk is another term for unsystematic risk. Structural risk is not a commonly used term in finance.

Question 13

Suppose there's an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%.Which type of investor would prefer an investment with a guaranteed return of 5%?

Accepted Answer

A risk-averse investor would prefer a guaranteed return of 5% over a risky investment with a potential 80% chance of gaining 20% or a 20% chance of losing 40%. This is because a risk-averse investor prioritizes avoiding losses over gaining higher returns.

Question 14

Why do CDs have lower rates of return than stocks?

Accepted Answer

CDs are typically considered to be less risky investments than stocks because they are insured by the FDIC up to a certain amount. As a result, the rates of return on CDs are generally lower than the potential returns on stocks, which carry more risk. The other options (A, C, and D) are all incorrect as they do not accurately reflect the relationship between CDs and stocks.

Question 15

As wealth decreases,which of the following is likely to account for a larger fraction of a saver's portfolio?

Accepted Answer

As wealth decreases, savers tend to prioritize liquidity and safety, making checking account balances more attractive due to their accessibility and low risk.

Question 16

Given that most investors tend to be risk averse

Accepted Answer

Most investors tend to be risk averse because they are not willing to take on high levels of risk without the promise of a higher return. Therefore, there is a trade-off between risk and return, where higher levels of risk are associated with the potential for higher returns. As a result, investors must weigh the risks and returns of different investment options in order to make informed decisions about their portfolios.

Question 17

Since all assets typically do NOT move together,how can investors typically reduce risk?

Accepted Answer

Diversifying one's portfolio across different asset classes is typically the best way to reduce risk. This means investing in a mix of stocks, bonds, real estate, and other assets rather than relying on just one type of investment. This way, if one asset class performs poorly, the investor's losses are offset by gains in other areas of the portfolio. The other choices (A, C, and D) do not provide the same level of risk reduction as diversification.

Question 18

Which of the following can best be characterized as a "Black Swan" event?

Accepted Answer

A "Black Swan" event is an unpredictable or unforeseen event, typically with extreme consequences. A financial crisis causing credit to dry up is an example of such an event, as it can have widespread, unexpected impacts on the global economy.

Question 19

In an article,"Preparing for the Next Black Swan" (Wall Street Journal,Aug 21,2010),the point is made that diversification may be insufficient in protecting one's portfolio during a "Black Swan" event.Why may this be TRUE?

Accepted Answer

A "Black Swan" event is an extremely rare and unpredictable event that can have a significant impact on financial markets. During such an event, virtually all asset classes may decline at the same time, regardless of how diversified a portfolio is. Therefore, diversification may not be sufficient in protecting one's portfolio during a "Black Swan" event.

Question 20

As a person's wealth increases,which of the following portfolio holdings is likely to increase the least?

Accepted Answer

As a person's wealth increases, it is likely that they will invest more in stocks, money market funds, and bonds as opposed to keeping a large amount of money in a checking account. Therefore, the portfolio holding that is likely to increase the least is a checking account.

Quiz 4: Determining Interest Rates