Question 1

For Investment A, the probability of the return being 20 percent is 0.5, 10 percent is 0.4, and -10 percent is 0.1. Compute the standard deviation for the investment with the given information. 
A)85.0%
B)15.0%
C)34.0%
D)17.0%
E)9.0%

Accepted Answer

The expected return is 14%. The variance is calculated as 0.5*(20-14)^2 + 0.4*(10-14)^2 + 0.1*(-10-14)^2 = 81. The standard deviation is the square root of the variance, which is 9.0%.

Question 2

An investment's possible payoffs are −10 percent, 10 percent, and 30 percent. The probabilities that these payoffs will occur are 0.30, 0.40, and 0.30, respectively. What is the expected rate of return on the investment?
A)10.0%
B)9.5%
C)15.0%
D)12.5%
E)13.0%

Accepted Answer

The expected rate of return is calculated by multiplying each possible payoff by its probability and then summing these products. Thus, it is (−10% * 0.30) + (10% * 0.40) + (30% * 0.30) = −3% + 4% + 9% = 10%.

Question 3

Which of the following statements about diversification is correct?
A)Portfolio diversification reduces the variability of returns on an individual stock.
B)When the company specific risk has been diversified, the inherent risk that remains is the market risk, which is constant for all securities in the market.
C)A stock with a beta of −1.0 has maximum nondiversifiable risk.
D)When two perfectly positively correlated stocks with the same risk are combined, the portfolio risk is equal to the risk associated with the individual stocks.
E)The systematic risk of a stock with a beta of zero is equal to its unsystematic risk.

Accepted Answer

D

Question 4

The difference between the expected rate of return on a given risky asset and the expected rate of return on a less risky asset is known as the _____. 
A)standard deviation of returns
B)variance of returns
C)actual rate of return
D)risk premium
E)risk-adjusted return

Accepted Answer

The difference between the expected rate of return on a risky asset and a less risky asset is commonly referred to as the risk premium. It is the compensation a risk-averse investor would demand for bearing the risk of a particular investment. Therefore, the correct option is D.

Question 5

Dividing the standard deviation of the returns of a stock by the stock's expected return gives us the stock's _____. 
A)variance
B)risk premium
C)coefficient of variation
D)beta
E)correlation coefficient

Accepted Answer

The coefficient of variation (CV) is calculated by dividing the standard deviation of a security's returns by its expected return. It measures an investment's risk per unit of return and can be used to compare the risk of different securities, which makes it a helpful tool when constructing a diversified portfolio.

Question 6

The greater the variability of the possible returns on an investment, _____. 
A)the lesser the expected return
B)the lower the standard deviation of the investment
C)the higher the actual return on the investment
D)the riskier the investment
E)the lower the beta of the investment

Accepted Answer

Variability in returns indicates uncertainty and potential for losses, hence making the investment riskier. Therefore, the correct option is D - the riskier the investment.

Question 7

The standard deviation of the returns of Stock A is 45.9 percent, and the standard deviation of the returns of Stock B is 52.7 percent. Which of the following statements about the stocks is correct?
A)Stock A has a wider (more dispersed) probability distribution than Stock B, and hence lower total risk.
B)Stock A has a tighter probability distribution than Stock B, and hence lower total risk.
C)Stock B has a wider (more dispersed) probability distribution than Stock A, and hence lower total risk.
D)Stock B has a tighter probability distribution than Stock A, and hence lower total risk.
E)Stock B has a lower risk than Stock A, but nothing can be said about their probability distributions.

Accepted Answer

The standard deviation is a measure of the dispersion or spread of a set of values. A higher standard deviation indicates a wider spread of values. Since Stock A has a standard deviation of 45.9 percent, which is lower than Stock B's 52.7 percent, Stock A has a tighter probability distribution than Stock B. This generally implies lower total risk for Stock A compared to Stock B, assuming the standard deviation is used as a measure of risk.

Question 8

The _____ of an investment is a measure of the tightness, or variability, of its set of returns. 
A)correlation coefficient
B)standard deviation of the returns
C)beta coefficient
D)coefficient of variation
E)expected return

Accepted Answer

The standard deviation of the returns measures the variability or volatility of an investment's returns, indicating how much the returns can deviate from the average return.

Question 9

The larger the standard deviation of returns on an investment, the _____. 
A)greater the chance that it will provide regular return to its investors
B)lower the chance that its realized return will be negative
C)greater the chance that its realized return will be equal to its expected return
D)lower the chance that its expected return will differ significantly from its market return
E)greater the chance that its realized return will differ significantly from its expected return

Accepted Answer

A larger standard deviation of returns indicates a greater variability in the returns, and hence a greater chance that the realized return will differ significantly from the expected return. This increases the risk associated with the investment, as investors may not receive the returns they were anticipating.

Question 10

The expected returns for Stocks A, B, C, D, and E are 7 percent, 10 percent, 12 percent, 25 percent, and 18 percent, respectively. The corresponding standard deviations for these stocks are 12 percent, 18 percent, 15 percent, 23 percent, and 15 percent, respectively. Which one of the securities should a risk-averse investor purchase if the investment will be held in isolation (by itself)?
A)A
B)B
C)C
D)D
E)E

Accepted Answer

The answer of The expected returns for Stocks A, B,...

Question 11

The expected rate of return of an investment _____. 
A)equals one of the possible rates of return for that investment
B)equals the required rate of return for the investment
C)is the mean value of the probability distribution of possible outcomes
D)is the median value of the probability distribution of possible outcomes
E)is the mode value of the probability distribution of possible outcomes

Accepted Answer

The expected rate of return is the weighted average of all possible returns, where the weights are the probabilities of each return occurring. It is therefore the mean value of the probability distribution of possible outcomes.

Question 12

Diversification refers to the _____. 
A)reduction of the stand-alone risk of an individual investment, which is measured by its beta coefficient, by combining it with other investments in a portfolio
B)reduction of the stand-alone risk of an individual investment, which is measured by the standard deviation of its returns, by combining it with other investments in a portfolio
C)reduction of the systematic risk of an individual investment, which is measured by its beta coefficient, by combining it with other investments in a portfolio
D)reduction of the systematic risk of an individual investment, which is measured by the standard deviation of its returns, by combining it with other investments in a portfolio
E)reduction of the unsystematic risk of an individual investment, which is measured by its beta coefficient, by combining it with other investments in a portfolio

Accepted Answer

Diversification refers to the reduction of the stand-alone risk of an individual investment, which is measured by the standard deviation of its returns, by combining it with other investments in a portfolio. This is achieved by selecting assets with different return characteristics, such as stocks, bonds, and real estate, which tend to respond differently to changing economic and market conditions. By diversifying across different asset classes, investors can reduce their exposure to specific sources of risk and potentially improve the overall risk-return profile of their portfolio.

Question 13

The probability distribution of the payoffs on an investment consists of a _____. 
A)listing of all possible outcomes with a chance of occurrence assigned to each outcome
B)measure of the relationship of one investment with another investment
C)standardized measure of the risk per percentage return
D)listing of the degree of relationship between the probabilities of two payoffs
E)measure of the extent to which the payoffs move with the capital market

Accepted Answer

The probability distribution of the payoffs on an investment lists all possible outcomes with a chance of occurrence assigned to each outcome. This is how we determine the expected value and potential risk of an investment.

Question 14

Combining two stocks to form a portfolio offers maximum diversification benefits when _____. 
A)the stocks have a correlation coefficient equal to 0
B)the stocks have a correlation coefficient equal to +1
C)the stocks have a correlation coefficient equal to -1
D)the both stocks have a coefficients of variation of 0
E)both stocks have a coefficients of variation of -1

Accepted Answer

Maximum diversification benefits are achieved when the stocks in a portfolio have a correlation coefficient of -1, as this indicates that the stocks move in exactly opposite directions, thereby reducing the portfolio's overall risk.

Question 15

Which of the following portfolios would have no diversification benefits?
A)A portfolio consisting of two perfectly positively correlated stocks
B)A portfolio consisting of two perfectly negatively correlated stocks
C)A portfolio consisting of two uncorrelated stocks
D)A portfolio consisting of two stocks with the same standard deviation of returns
E)A portfolio consisting of two stocks with the same beta coefficient

Accepted Answer

A portfolio consisting of two perfectly positively correlated stocks would have no diversification benefits because the returns of both stocks would move in perfect tandem, meaning that any gains in one stock would be offset by losses in the other stock.

Question 16

Darren has the option of investing in either Stock A or Stock B. There is a 45 percent chance that the return on Stock A will be 25 percent, a 25 percent chance it will be 14 percent, and a 30 percent chance it will be 4 percent. There is a 45 percent chance that the return on Stock B will be 30 percent, a 25 percent chance it will be 9 percent, and a 30 percent chance it will be2 percent. What is the expected rates of return on Stock A and Stock B?
A)13.65%; 12.85%
B)14.75%; 13.75%
C)15.95%; 16.35%
D)16.80%; 11.45%
E)14.33%; 13.67%

Accepted Answer

The answer of Darren has the option of investing in...

Question 17

If the standard deviation of returns from an investment is zero, then:
A)the risk associated with the investment is more than that of the investments that provide risk-free return.
B)the expected return from the investment is higher than that of those investments whose standard deviation is greater than zero.
C)the scatter of the possible outcome from the investment is high and its investors demand higher return.
D)the scatter of the possible outcome from the investment is low and its investors demand higher return.
E)there is no risk associated with the investment; that is, the investment is risk free, because there is only one possible payoff.

Accepted Answer

If the standard deviation of returns from an investment is zero, then it means that there is only one possible payoff and there is no scatter of possible outcomes. This also means that there is no risk associated with the investment, making it a risk-free investment.

Question 18

Which of the following statements gives the best definition/description of the risk that is associated with an investment?
A)The total risk of an investment is the chance that it will earn a negative return.
B)The total risk of an investment is the chance that it will earn a positive return.
C)The total risk of an investment is the chance that it will earn a return other than the one that is expected.
D)The total risk of an investment is measured by its beta coefficient.
E)The total risk of an investment can be determined by computing its expected return.

Accepted Answer

The total risk of an investment is the chance that it will earn a return other than the one that is expected. This includes both the possibility of earning a higher return than anticipated, as well as the possibility of earning a lower return or even losing money. It encompasses all types of risk associated with an investment, including market risk, credit risk, inflation risk, and interest rate risk. The other options do not provide a comprehensive definition of investment risk.

Question 19

The variance of the returns of Stock X is 62.5 percent, and the expected return from the stock is 18 percent. Calculate the coefficient of variation of the stock. 
A)3.47
B)0.44
C)40.98
D)0.29
E)1.86

Accepted Answer

The coefficient of variation (CV) is calculated as the standard deviation (σ) divided by the mean (μ), expressed as a percentage. First, we need to find the standard deviation of Stock X's returns. Given the variance is 62.5%, the standard deviation is the square root of the variance, which is sqrt(62.5%) = 7.91%. The mean (expected return) is 18%. Thus, CV = (σ/μ) = (7.91%/18%) = 0.44.

Question 20

Which of the following measures captures the effects of both risk and return, which makes it a better measure than standard deviation for evaluating stand-alone risk in situations where investments differ with respect to both their amounts of total risk and their expected returns?
A)Probability distribution of the investment's returns
B)Expected average rate of returns of the investment
C)Correlation coefficient of one investment with another investment
D)Coefficient of variation
E)Beta coefficient

Accepted Answer

The coefficient of variation (CV) is a ratio that measures the stand-alone risk of an investment relative to its expected return. It takes into account the differences in the total risk and expected returns of different investments, making it a better measure than standard deviation for evaluating stand-alone risk. The CV is calculated as the standard deviation of the investment divided by its expected return.

Quiz 8: Risk and Rates of Return

For Investment A, the probability of the return being 20 percent is 0.5, 10 percent is 0.4, and -10 percent is 0.1. Compute the standard deviation for the investment with the given information.

An investment's possible payoffs are −10 percent, 10 percent, and 30 percent. The probabilities that these payoffs will occur are 0.30, 0.40, and 0.30, respectively. What is the expected rate of return on the investment?

Which of the following statements about diversification is correct?

The difference between the expected rate of return on a given risky asset and the expected rate of return on a less risky asset is known as the _____.

Dividing the standard deviation of the returns of a stock by the stock's expected return gives us the stock's _____.

The greater the variability of the possible returns on an investment, _____.

The standard deviation of the returns of Stock A is 45.9 percent, and the standard deviation of the returns of Stock B is 52.7 percent. Which of the following statements about the stocks is correct?

The _____ of an investment is a measure of the tightness, or variability, of its set of returns.

The larger the standard deviation of returns on an investment, the _____.

The expected rate of return of an investment _____.

Diversification refers to the _____.

The probability distribution of the payoffs on an investment consists of a _____.

Combining two stocks to form a portfolio offers maximum diversification benefits when _____.

Which of the following portfolios would have no diversification benefits?

If the standard deviation of returns from an investment is zero, then:

Which of the following statements gives the best definition/description of the risk that is associated with an investment?

The variance of the returns of Stock X is 62.5 percent, and the expected return from the stock is 18 percent. Calculate the coefficient of variation of the stock.

Which of the following measures captures the effects of both risk and return, which makes it a better measure than standard deviation for evaluating stand-alone risk in situations where investments differ with respect to both their amounts of total risk and their expected returns?