Question 1

Investment risk can best be described as the:
A) dispersion of possible returns.
B) elimination of macro risk through diversification.
C) possibility of changes in the cost of capital.
D) level of systematic risk for an undiversified investor.

Accepted Answer

Investment risk can be described as the uncertainty or variability of returns. The dispersion of possible returns represents the range of potential outcomes, which is a key measure of investment risk. Therefore, option A is the best choice as it directly relates to the definition of investment risk. Option B is not accurate because diversification reduces both systematic and unsystematic risk but does not eliminate macro risk entirely. Option C is not entirely accurate because changes in the cost of capital are a factor that affects investment returns, but do not fully describe investment risk. Option D is not accurate as systematic risk affects all investors, diversified or undiversified.

Question 2

Which one of the following companies is most likely to be exposed to the least amount of macro risk?
A) A producer of dog biscuits
B) A regional airline
C) A major commercial bank
D) A machine tool manufacturer

Accepted Answer

A producer of dog biscuits is likely to be exposed to the least amount of macro risk as it is not as heavily impacted by economic or political changes. People tend to continue buying pet food even during economic downturns, and changes in government policies or geopolitical issues are unlikely to affect the demand for dog biscuits.

Question 3

Which one of the following would you expect to represent the broadest-based index of U.S.stocks?
A) Wilshire 5000
B) Dow Jones Industrial Average
C) Standard and Poor's Composite
D) Financial Times Index

Accepted Answer

The Wilshire 5000 is often regarded as the broadest-based index of U.S. stocks because it includes all publicly traded companies in the U.S., ranging from small-cap stocks to large-cap stocks. In contrast, the Dow Jones Industrial Average only tracks 30 large-cap stocks, and the Standard and Poor's Composite includes only 500 stocks. The Financial Times Index also does not represent U.S. stocks as it tracks companies listed on the London Stock Exchange.

Question 4

If the toss of a coin comes down heads,you win a dollar.If it comes down tails,you lose fifty cents.How much would you expect to gain after 20 tosses?
A) $5.00
B) $7.50
C) $10.00
D) $15.00

Accepted Answer

Expected return = 20 × [($1 × 0.5) − (0.50 × 0.5)] = $5.00

Question 5

A project's expected return is 15%,which represents a 35% return in a boom and a 5% return in a stagnant economy.What is the probability of a boom if these are the only two economic states?
A) 18.33%
B) 25.00%
C) 33.33%
D) 50.00%

Accepted Answer

15% = 35%(x) + 5%(1 − x); x = 33.33%

Question 6

A good way to reduce macro risk in a stock portfolio is to invest in stocks that:
A) have only specific risks.
B) have diversified away the macro risk.
C) have low exposure to business cycles.
D) pay guaranteed dividends.

Accepted Answer

Investing in stocks with low exposure to business cycles can help reduce macro risk, as these stocks are less affected by economic downturns and fluctuations.

Question 7

What is the return to an investor who purchases a stock for $30,receives a $1.50 dividend at the end of the year,and then sells the share for $28.50?
A) −5%
B) 0%
C) 5%
D) 10%

Accepted Answer

R = ($28.50 + 1.50 − 30) / $30 = 0%

Question 8

Which one of the following statements is incorrect concerning stock indexes?
A) Indexes have been developed for foreign stocks.
B) Some indexes cover only a specific market sector.
C) Most indexes include all of the publicly-traded common stocks.
D) Some indexes are equally weighted.

Accepted Answer

Most indexes do not include all of the publicly-traded common stocks. Some indexes use a sampling technique to only include a subset of the market, and others may include only a specific subset of stocks, such as small-cap stocks or dividend-paying stocks.

Question 9

The fact that historical returns on Treasury bonds are less volatile than common stock returns indicates that:
A) the variance of Treasury bond returns is zero.
B) the standard deviation of Treasury bond returns is negative.
C) the real return on Treasury bonds has been negative.
D) common stocks should offer a higher return than Treasury bonds.

Accepted Answer

Common stocks typically offer a higher return than Treasury bonds to compensate for their higher risk and volatility.

Question 10

One common reason for reporting standard deviations of percentage returns rather than variances is that standard deviations:
A) are lower.
B) are stated in understandable percentages.
C) account properly for negative returns.
D) take probability estimates into consideration.

Accepted Answer

Standard deviations are often reported because they are in the same units as the data, making them easier to interpret, especially when dealing with percentage returns.

Question 11

Stock A has an expected return of 15%; stock B has an expected return of 8%.What is the expected return on a portfolio is comprised of 60% of Stock A and 40% of Stock B?
A) 12.2%
B) 10.8%
C) 9.1%
D) 14.4%

Accepted Answer

Portfolio: 0.6 × 15% + 0.4 × 8% = 12.2%

Question 12

Individual stocks are:
A) exposed to the same amount of market risk.
B) exposed to differing amounts of market risk.
C) not exposed to market risk; only the general economy is subject to market risk.
D) exposed to differing amounts of market risk but the same amount of specific risk.

Accepted Answer

Individual stocks are exposed to differing amounts of market risk because they are influenced by factors such as company-specific news, industry trends, and overall economic conditions. While some stocks may be more affected by market movements than others, all stocks are also subject to specific risk factors, such as changes in management, product recalls, or legal issues that can affect the performance of the stock.

Question 13

If a stock's returns are volatile,then the stock:
A) cannot be considered a negative risk asset.
B) can still be considered a negative risk asset.
C) has macro risk, but no specific risk.
D) does not offer diversification potential.

Accepted Answer

The stock can still be considered a negative risk asset even if its returns are volatile. Volatility does not necessarily indicate a positive or negative risk, but rather a level of uncertainty. Some investors are willing to bear the risks associated with volatility because they believe it may result in higher returns. Therefore, the stock can still be considered a negative risk asset depending on an investor's risk tolerance and investment objectives.

Question 14

Treasury bonds have provided a higher historical return than Treasury bills,which can be attributed to their:
A) greater default risk.
B) higher level of specific risk.
C) greater exposure to interest rate risk.
D) illiquidity.

Accepted Answer

Treasury bonds have longer maturities compared to Treasury bills, which makes them more exposed to interest rate risk. As interest rates fluctuate, the value of the bond changes, resulting in higher returns for investors. However, this also means that the bond prices can fall if interest rates rise, resulting in higher risk. The other options are not valid explanations as Treasury bonds have lower default risk, lower specific risk, and higher liquidity compared to Treasury bills.

Question 15

When viewing the long-term trend of the price volatility of U.S.stocks,it is readily apparent that volatility has:
A) continually increased.
B) continually decreased.
C) increased and decreased but has no specific pattern.
D) remained constant for years.

Accepted Answer

The long-term trend of price volatility of U.S. stocks has not shown a specific pattern of continually increasing or decreasing. Instead, it has shown periods of both increasing and decreasing volatility over time. While there have been some notable spikes in volatility during major market events like the financial crisis, overall volatility has fluctuated over the years.

Question 16

Periods of market decline are called:
A) discount factors.
B) bull markets.
C) coupons.
D) bear markets.

Accepted Answer

Periods of market decline are known as bear markets.

Question 17

Averaging the deviations from the mean for a portfolio of securities will:
A) compute the standard deviation.
B) compute the variance.
C) equal zero.
D) equal the number of securities in the portfolio.

Accepted Answer

Averaging the deviations from the mean means that the positive and negative deviations cancel each other out, resulting in an average of zero. Therefore, the answer is C - it equals zero.

Question 18

Which one of the following firms is likely to exhibit the least macro risk exposure?
A) Construction company
B) Airline company
C) Gold mining company
D) Auto manufacturer

Accepted Answer

The gold mining company is likely to exhibit the least macro risk exposure as the demand for gold is stable and does not fluctuate with economic conditions. Construction, airlines, and auto manufacturing industries are all heavily influenced by macroeconomic factors such as interest rates, consumer confidence, and global economic conditions.

Question 19

Which one of these is a specific risk?
A) Revision to the corporate tax laws.
B) Inflation increase of 2.3%.
C) Deterioration in the overall economic outlook.
D) A fire at the company's main factory.

Accepted Answer

A fire at the company's main factory is a specific risk because it is a potential event that can be identified and addressed through risk management strategies. The other options are general risks that affect the broader economic or political environment and are beyond the control of the individual company.

Question 20

An investor holds a stock for one year.She then receives a dividend of $10 and sells the stock for $120.If her return was 16%,at what price did she buy the stock?
A) $103.45
B) $64.80
C) $139.20
D) $112.07

Accepted Answer

1.16 = ($120 + $10) / P; P = $112.07

Quiz 11: Introduction to Risk, Return, and the Opportunity Cost of Capital

Investment risk can best be described as the:

Which one of the following companies is most likely to be exposed to the least amount of macro risk?

Which one of the following would you expect to represent the broadest-based index of U.S.stocks?

If the toss of a coin comes down heads,you win a dollar.If it comes down tails,you lose fifty cents.How much would you expect to gain after 20 tosses?

A project's expected return is 15%,which represents a 35% return in a boom and a 5% return in a stagnant economy.What is the probability of a boom if these are the only two economic states?

A good way to reduce macro risk in a stock portfolio is to invest in stocks that:

What is the return to an investor who purchases a stock for $30,receives a $1.50 dividend at the end of the year,and then sells the share for $28.50?

Which one of the following statements is incorrect concerning stock indexes?

The fact that historical returns on Treasury bonds are less volatile than common stock returns indicates that:

One common reason for reporting standard deviations of percentage returns rather than variances is that standard deviations:

Stock A has an expected return of 15%; stock B has an expected return of 8%.What is the expected return on a portfolio is comprised of 60% of Stock A and 40% of Stock B?

Individual stocks are:

If a stock's returns are volatile,then the stock:

Treasury bonds have provided a higher historical return than Treasury bills,which can be attributed to their:

When viewing the long-term trend of the price volatility of U.S.stocks,it is readily apparent that volatility has:

Periods of market decline are called:

Averaging the deviations from the mean for a portfolio of securities will:

Which one of the following firms is likely to exhibit the least macro risk exposure?

Which one of these is a specific risk?

An investor holds a stock for one year.She then receives a dividend of $10 and sells the stock for $120.If her return was 16%,at what price did she buy the stock?