Question 1

A holding period return is calculated by adding the current income to the capital gains and dividing this sum by the

Accepted Answer

The holding period return is calculated by adding the current income (dividends or interest) to the capital gains (difference between selling price and purchase price) and dividing this sum by the beginning investment value. Therefore, the correct choice is B.

Question 2

The return that fully compensates for the risk of an investment is called the risk-free rate of return.

Accepted Answer

The return that fully compensates for the risk of an investment is called the required rate of return, not the risk-free rate of return. The risk-free rate of return is the theoretical rate of return of an investment that has zero risks.

Question 3

The holding period return is an excellent method for comparing a short-term investment to a long-term investment.

Accepted Answer

The holding period return is useful for comparing returns on investments held for different lengths of time, but it is not necessarily the best method for comparing short-term and long-term investments since they may have different levels of risk and potential for growth. Other factors, such as annualized return and risk-adjusted return, may provide more accurate comparisons between different types of investments.

Question 4

To compute the present value of $1,000 discounted at the rate of 5% per year, to be received at the end of 3 years, you should use the following EXCEL command.

Accepted Answer

The answer of To compute the present value of $1,000...

Question 5

The holding period return should not be used when analyzing investments with unequal holding periods.

Accepted Answer

The holding period return is only appropriate for analyzing investments that have equal holding periods. Otherwise, it can lead to inaccurate comparisons and conclusions.

Question 6

Historically, the real rate of return in the United States has tended to be

Accepted Answer

Historically, the real rate of return in the United States has tended to be between 0.5 and 2%.

Question 7

Christopher purchased 200 shares of ABC stock at $21.25 per share.After nine months, he sold all of his shares at a price of $19.88 a share.Jake received a total of $0.55 per share in dividends during the time he owned the shares.Jake's holding period return is

Accepted Answer

The answer of Christopher purchased 200 shares of ABC stock...

Question 8

The markets in general are paying a 2% real rate of return.Inflation is expected to be 3%.ABC stock commands a 6% risk premium.What is the expected rate of return on ABC stock?

Accepted Answer

The formula for expected rate of return is:
Expected rate of return = Real rate of return + Inflation + Risk premium

Given:
Real rate of return = 2%
Inflation = 3%
Risk premium = 6%

Expected rate of return = 2% + 3% + 6% = 11%

Therefore, the expected rate of return on ABC stock is 11%. The correct choice is D.

Question 9

Which of the following is(are)issue characteristics of an investment?
I.type of investment such as stocks or bonds
II.state of the economy
III.coupon or dividend payments
IV.time to maturity

Accepted Answer

I, III, and IV are all characteristics of investments. The type of investment (such as stocks or bonds) will dictate its risk and return characteristics. Coupon or dividend payments are important considerations for income investors, while time to maturity is important for investors looking to lock in returns over a specific time horizon. The state of the economy can also affect investment returns, but it is not a characteristic of the investment itself.

Question 10

The required return on Beta stock is 14%.The risk-free rate of return is 4% and the real rate of return is 2%.How much are investors requiring as compensation for risk?

Accepted Answer

The difference between the required return on Beta stock (14%) and the risk-free rate of return (4%) represents the risk premium investors are requiring for investing in a risky asset. Therefore, 14% - 4% = 10%. This is the compensation investors are requiring for risk, which corresponds to choice B.

Question 11

Brittany purchased a stock for $14 a share and sold it six months later for $15.50.While she owned the stock, Britanny received two quarterly dividends of $0.16 per share.Brittany's holding period return on this stock is

Accepted Answer

The answer of Brittany purchased a stock for $14 a...

Question 12

The risk-free rate is equal to the real rate of return plus

Accepted Answer

The risk-free rate is equal to the real rate of return plus an expected inflation premium. This is because inflation reduces the purchasing power of money over time, so investors require compensation for this loss of value. The real rate of return represents the return on an investment adjusted for inflation, while the expected inflation premium is the amount of compensation investors anticipate receiving to account for the effects of inflation. The risk premium, on the other hand, is the additional return investors demand to compensate them for the risk of loss associated with a particular investment.

Question 13

One reason that the holding period return should not be used to compare long-term investments is that it does not consider the time value of money.

Accepted Answer

The holding period return only looks at the gain or loss from buying and selling an investment during a certain period of time, but does not account for the impact of inflation and interest on the value of money over time. Therefore, it is not an accurate way to compare long-term investments.

Question 14

The required return on a risky investment includes a real rate of return, an inflation premium and a risk premium.

Accepted Answer

This is correct. The required return on a risky investment is calculated as the sum of the real rate of return, inflation premium, and risk premium. The real rate of return is the return that would be earned in the absence of inflation and any risk. The inflation premium compensates investors for the expected inflation during the investment period. The risk premium compensates investors for the riskiness of the investment relative to a risk-free investment such as a Treasury bond.

Question 15

If the risk-free rate of return is less than the inflation rate, the real rate of return is negative.

Accepted Answer

This is because inflation erodes the purchasing power of money over time, so even if an investment earns a return equal to the inflation rate, the investor is not actually making any real gains. If the risk-free rate of return is lower than the inflation rate, the investor's real rate of return will be negative, meaning they are losing purchasing power over time.

Question 16

To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, you should use he following EXCEL command.

Accepted Answer

To compute the present value of an annuity, we need to use the PV function in EXCEL. The PV function allows us to calculate the present value of a stream of cash flows or an annuity, discounted at a given interest rate. Therefore, Answer D is the correct choice.

Question 17

David has purchased an investment that he expects to produce an annual cash flow of $3,000 for five years.He requires an 8% rate of return compounded annually.What is the maximum amount that David can pay and still earn the required rate of return?

Accepted Answer

The answer of David has purchased an investment that he...

Question 18

The required rate of return on the Daisy Corporation's common stock is 11%, the current real rate of return in the market is 1%, and the market's risk-free rate of return is 4%.In this case, the risk premium associated with Daisy's stock is

Accepted Answer

The risk premium is the difference between the required rate of return and the risk-free rate of return. 
Risk premium = Required rate of return - Risk-free rate of return 
= 11% - 4% 
= 7% 
Therefore, the answer is C) 7%.

Question 19

To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, you should enter the following variables into a financial calculator

Accepted Answer

The present value of an annuity involves the number of periods (N), the interest rate (i), and the payment amount (PMT). Choice A correctly includes N=3, i=5, and PMT=1000. Choice B includes FV instead of PMT, which is not applicable to computing the present value of an annuity. Choice C includes a different interest rate, which would result in a different present value calculation. Choice D only includes one payment instead of three.

Question 20

Which one following will lower required rates of return?

Accepted Answer

Lower rates of inflation decrease the risk of losing money due to inflation, which makes investors feel more confident and lowers their required rates of return.

Quiz 4: Return and Risk