Question 1

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

Accepted Answer

A risk averse investor is someone who is more likely to choose an investment that offers greater certainty, even if it may have lower potential returns, over an investment that has a greater potential for returns but comes with greater risk.

Question 2

The rate of exchange between future consumption and current consumption is the

Accepted Answer

The rate of exchange between future consumption and current consumption is best represented by the pure rate of interest, which is the rate at which individuals are willing to trade present consumption for future consumption.

Question 3

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

Accepted Answer

Arithmetic means and geometric means are the two most common calculations used by investors to measure return performance. The arithmetic mean calculates the average return over a period of time, while the geometric mean calculates the compounded annual growth rate of an investment over a period of time.

Question 4

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

Accepted Answer

The risk premium is the expected return on an investment over the risk-free rate, not a measure of risk like standard deviation or variance, which quantify the volatility of returns.

Question 5

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.

Accepted Answer

This statement accurately describes the nature of an investment.

Question 6

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

Accepted Answer

Nominal in this context means that the rate is not adjusted for inflation or other factors, and simply reflects the market interest rate.

Question 7

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

Accepted Answer

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

Question 8

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

Accepted Answer

The yield on a T-bill is influenced by several factors including the expected rate of inflation, which is the rate at which the purchasing power of money is expected to decline over time. If there is a change in the expected rate of inflation, it can lead to a significant change in the yield of a T-bill. For example, if inflation is expected to increase, investors require a higher yield to compensate for the decrease in purchasing power of money. Therefore, the change in yield is most likely attributable to a change in the expected rate of inflation.

Question 9

The line that reflects the combination of risk and return available on alternative investments is referred to as the security market line (SML).

Accepted Answer

The security market line (SML) is a graphical representation of the relationship between risk and return, specifically for the capital asset pricing model (CAPM). It shows the expected return for a given level of risk and serves as a benchmark for evaluating the performance of individual investments or portfolios.

Question 10

Nominal rates are averages of all possible real rates.

Accepted Answer

Nominal rates are not related to real rates, but rather refer to the standardized or advertised interest rates that do not take into account inflation or any other factors that might affect the value of money over time. Therefore, nominal rates cannot be calculated as averages of real rates, which are adjusted for inflation and other factors to reflect the true purchasing power of money.

Question 11

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.

Accepted Answer

The statement is false. In fact, the geometric mean is generally smaller than the arithmetic mean, especially in volatile series, because it takes into account the compounding effect of returns.

Question 12

The real risk-free rate is affected by two factors:

Accepted Answer

The real risk-free rate is fundamentally influenced by individuals' time preference for income consumption and the set of investment opportunities available in the economy. These factors determine how much people are willing to save or invest at present for future returns, impacting the real risk-free rate.

Question 13

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

Accepted Answer

The variance of expected returns is not equal to the square root of expected returns. The variance is a measure of spread or variability around the expected return, whereas the square root of expected returns would give the standard deviation of returns. These two measures are not equivalent.

Question 14

The expected return is the average of all possible returns.

Accepted Answer

The answer of The expected return is the average of...

Question 15

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

Accepted Answer

The risk premium is primarily related to the expected return over the risk-free rate, often influenced by market risk factors, not directly by operating earnings, sales volatility, or inflation.

Question 16

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.

Accepted Answer

The geometric mean, not the arithmetic mean, is the superior measure for indicating the compound annual rate of return because it takes into account the effect of compounding over time, which the arithmetic mean does not.

Question 17

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

Accepted Answer

The answer of The holding period return (HPR) is equal...

Question 18

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

Accepted Answer

The answer of Investors are willing to forgo current consumption...

Question 19

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

Accepted Answer

The pure rate of interest is the rate at which future dollars and current dollars are exchanged, which is expressed in terms of interest rate or discount rate. Hence, the given statement is true.

Question 20

The basic trade-off in the investment process is

Accepted Answer

The basic trade-off in the investment process is between the expected rate of return for a given investment instrument and its degree of risk. Investors usually expect higher returns from higher-risk investments, but these investments also have a greater potential for loss. Lower-risk investments typically have lower returns, but offer more stability and consistency. Therefore, the investor must weigh the potential risks and rewards of a particular investment before deciding to invest.

Quiz 1: The Investment Setting