Exercises on Risk and Return

1. a. b. c. d. ANS:

The expected return on an investment in stock is the expected dividend payments the anticipated capital gains the sum of expected dividends and capital gains less than the realized return C

2. The holding period return (HPR) on a share of stock is equal to A) the capital gain yield during the period, plus the inflation rate. B) the capital gain yield during the period, plus the dividend yield. C) the current yield, plus the dividend yield. D) the dividend yield, plus the risk premium. E) the change in stock price. Answer: B Use the following to answer questions 3-5: You have been given this probability distribution for the holding period return for KMP stock:

3.

What is the expected holding period return for KMP stock? A) 10.40% B) 9.32% C) 11.63% D) 11.54% E) 10.88% Answer: A Difficulty: Moderate Rationale: HPR = .30 (18%) + .50 (12%) + .20 (-5%) = 10.4% 4. A) B) C) D) E) What is the expected standard deviation for KMP stock? 6.91% 8.13% 7.79% 7.25% 8.85%

Answer: B Difficulty: Difficult Rationale: s = [.30 (18 - 10.4)2 + .50 (12 - 10.4)2 + .20 (-5 - 10.4)2]1/2 = 8.13% 5. What is the expected variance for KMP stock? A) 66.04% B) 69.96% C) 77.04% D) 63.72% E) 78.45%

Answer: A Difficulty: Difficult Rationale: s = [.30 (18 - 10.4)2 + .50 (12 - 10.4)2 + .20 (-5 - 10.4)2] = 66.04% 6. An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980. What is the holding period return on his investment? A) 1.52% B) 0.50% C) 1.92% D) 0.01% E) None of the above Answer: E Difficulty: Easy Rationale: HPR = ($15+980-985)/$985 = .010152284 = approximately 1.02%.

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7. You purchase a share of Boeing stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding period return? A) 4.44% B) 2.22% C) 3.33% D) 5.56% E) none of the above Answer: D Difficulty: Moderate Rationale: HPR = (92 - 90 + 3) / 90 = 5.56% 8. Toyota stock has the following probability distribution of expected prices one year from now:

If you buy Toyota today for $55 and it will pay a dividend during the year of $4 per share, what is your expected holding period return on Toyota? A) 17.72% B) 18.89% C) 17.91% D) 18.18% E) None of the above Answer: D Difficulty: Difficult Rationale: E(P1) = .25 (54/55 - 1) + .40 (64/55 - 1) + .35 (74/55 - 1) = 18.18%. Use the following to answer question 9: You have been given this probability distribution for the holding period return for Cheese, Inc stock:

9.

Assuming that the expected return on Cheese's stock is 14.35%, what is the standard deviation of these returns? A) 4.72% B) 6.30% C) 4.38% D) 5.74% E) None of the above Answer: D Difficulty: Moderate Rationale: Variance = .20*(24-14.35)2 + .45*(15-14.35)2 + .35*(8-14.35)2 = 32.9275. Standard deviation = 32.9275.1/2 = 5.74.

10. When comparing investments with different horizons the ____________ provides the more accurate comparison. A) arithmetic average B) effective annual rate C) average annual return D) historical annual average E) none of the above Answer: B

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