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Chapter 12 Some Lessons from Capital Market History Answer Key

1. Last year, T-bills returned 2 percent while your investment in large-company stocks earned

an average of 5 percent. Which one of the following terms refers to the difference between

these two rates of return?

A. risk premium

B. geometric return

C. arithmetic

D. standard deviation

E. variance

Refer to section 12.3

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-1

Section: 12.3

Topic: Risk premium

2. Which one of the following best defines the variance of an investment's annual returns over

a number of years?

A. The average squared difference between the arithmetic and the geometric average annual

returns.

B. The squared summation of the differences between the actual returns and the average

geometric return.

C. The average difference between the annual returns and the average return for the period.

D. The difference between the arithmetic average and the geometric average return for the

period.

E. The average squared difference between the actual returns and the arithmetic average

return.

Refer to section 12.4

AACSB: N/A

Bloom's: Comprehension

Difficulty: Intermediate

Learning Objective: 12-1

Section: 12.4

Topic: Variance

A. average rate of return

B. volatility

C. probability

D. risk premium

E. real returns

Refer to section 12.4

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-1

Section: 12.4

Topic: Standard deviation

4. Which one of the following is defined by its mean and its standard deviation?

A. arithmetic nominal return

B. geometric real return

C. normal distribution

D. variance

E. risk premium

Refer to section 12.4

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-1

Section: 12.4

Topic: Normal distribution

5. The average compound return earned per year over a multi-year period is called the _____

average return.

A. arithmetic

B. standard

C. variant

D. geometric

E. real

Refer to section 12.5

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-1

Section: 12.5

Topic: Geometric average return

6. The return earned in an average year over a multi-year period is called the _____ average

return.

A. arithmetic

B. standard

C. variant

D. geometric

E. real

Refer to section 12.5

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-1

Section: 12.5

Topic: Arithmetic average return

7. Assume that the market prices of the securities that trade in a particular market fairly reflect

the available information related to those securities. Which one of the following terms best

defines that market?

A. riskless market

B. evenly distributed market

C. zero volatility market

D. Blume's market

E. efficient capital market

Refer to section 12.6

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Efficient capital market

8. Which one of the following statements best defines the efficient market hypothesis?

A. Efficient markets limit competition.

B. Security prices in efficient markets remain steady as new information becomes available.

C. Mispriced securities are common in efficient markets.

D. All securities in an efficient market are zero net present value investments.

E. Profits are removed as a market incentive when markets become efficient.

Refer to section 12.6

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Efficient markets

9. Stacy purchased a stock last year and sold it today for $3 a share more than her purchase

price. She received a total of $0.75 in dividends. Which one of the following statements is

correct in relation to this investment?

A. The dividend yield is expressed as a percentage of the selling price.

B. The capital gain would have been less had Stacy not received the dividends.

C. The total dollar return per share is $3.

D. The capital gains yield is positive.

E. The dividend yield is greater than the capital gains yield.

Refer to section 12.1

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Returns

10. Which one of the following correctly describes the dividend yield?

A. next year's annual dividend divided by today's stock price

B. this year's annual dividend divided by today's stock price

C. this year's annual dividend divided by next year's expected stock price

D. next year's annual dividend divided by this year's annual dividend

E. the increase in next year's dividend over this year's dividend divided by this year's dividend

Refer to section 12.1

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Dividend yield

11. Bayside Marina just announced it is decreasing its annual dividend from $1.64 per share

to $1.50 per share effective immediately. If the dividend yield remains at its preannouncement level, then you know the stock price:

A. was unaffected by the announcement.

B. increased proportionately with the dividend decrease.

C. decreased proportionately with the dividend decrease.

D. decreased by $0.14 per share.

E. increased by $0.14 per share.

Refer to section 12.1

AACSB: N/A

Bloom's: Comprehension

Difficulty: Intermediate

Learning Objective: 12-1

Section: 12.1

Topic: Dividend yield

12. Which one of the following statements related to capital gains is correct?

A. The capital gains yield includes only realized capital gains.

B. An increase in an unrealized capital gain will increase the capital gains yield.

C. The capital gains yield must be either positive or equal to zero.

D. The capital gains yield is expressed as a percentage of the sales price.

E. The capital gains yield represents the total return earned by an investor.

Refer to section 12.1

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Capital gains yield

I. The capital gains yield can be positive, negative, or zero.

II. The dividend yield can be positive, negative, or zero.

III. The total return can be positive, negative, or zero.

IV. Neither the dividend yield nor the total return can be negative.

A. I only

B. I and II only

C. I and III only

D. I and IV only

E. IV only

Refer to section 12.1

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Stock returns

14. The real rate of return on a stock is approximately equal to the nominal rate of return:

A. multiplied by (1 + inflation rate).

B. plus the inflation rate.

C. minus the inflation rate.

D. divided by (1 + inflation rate).

E. divided by (1- inflation rate).

Refer to section 12.3

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-1

Section: 12.3

Topic: Real return

15. As long as the inflation rate is positive, the real rate of return on a security will be ____

the nominal rate of return.

A. greater than

B. equal to

C. less than

D. greater than or equal to

E. unrelated to

Refer to section 12.3

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-1

Section: 12.3

Topic: Real return

16. Small-company stocks, as the term is used in the textbook, are best defined as the:

A. 500 newest corporations in the U.S.

B. firms whose stock trades OTC.

C. smallest twenty percent of the firms listed on the NYSE.

D. smallest twenty-five percent of the firms listed on NASDAQ.

E. firms whose stock is listed on NASDAQ.

Refer to section 12.2

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.2

Topic: Small-company stocks

17. Which one of the following statements is a correct reflection of the U.S. markets for the

period 1926-2007?

A. U.S. Treasury bill returns never exceeded a 9 percent return in any one year during the

period.

B. U.S. Treasury bills provided a positive rate of return each and every year during the period.

C. Inflation equaled or exceeded the return on U.S. Treasury bills every year during the

period.

D. Long-term government bonds outperformed U.S. Treasury bills every year during the

period.

E. National deflation occurred at least once every decade during the period.

Refer to section 12.2

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.2

Topic: Historical record

18. Which one of the following categories of securities had the highest average return for the

period 1926-2007?

A. U.S. Treasury bills

B. large company stocks

C. small company stocks

D. long-term corporate bonds

E. long-term government bonds

Refer to section 12.3

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.3

Topic: Historical returns

19. Which one of the following categories of securities had the lowest average risk premium

for the period 1926-2007?

A. long-term government bonds

B. small company stocks

C. large company stocks

D. long-term corporate bonds

E. U.S. Treasury bills

Refer to section 12.3

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-3

Section: 12.3

Topic: Risk premium

20. Which one of the following categories of securities has had the most volatile returns over

the period 1926-2007?

A. long-term corporate bonds

B. large-company stocks

C. intermediate-term government bonds

D. U.S. Treasury bills

E. small-company stocks

Refer to section 12.4

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-3

Section: 12.4

Topic: Historical riskss

21. Which one of the following statements correctly applies to the period 1926-2007?

A. Large-company stocks earned a higher average risk premium than did small-company

stocks.

B. Intermediate-term government bonds had a higher average return than long-term corporate

bonds.

C. Large-company stocks had an average annual return of 14.7 percent.

D. Inflation averaged 2.6 percent for the period.

E. U.S. Treasury bills had a positive average real rate of return.

Refer to section 12.3

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.3

Topic: Historical returns

22. Which one of the following time periods is associated with high rates of inflation?

A. 1929-1933

B. 1957-1961

C. 1978-1981

D. 1992-1996

E. 2001-2005

Refer to section 12.2

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.2

Topic: Inflation

23. Which one of the following statements concerning U.S. Treasury bills is correct for the

period 1926- 2007?

A. The annual rate of return always exceeded the annual inflation rate.

B. The average risk premium was 0.7 percent.

C. The annual rate of return was always positive.

D. The average excess return was 1.1 percent.

E. The average real rate of return was zero.

Refer to sections 12.2 and 12.3

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.2 and 12.3

Topic: Historical returns

24. Which one of the following is a correct ranking of securities based on their volatility over

the period of 1926-2007? Rank from highest to lowest.

A. large company stocks, U.S. Treasury bills, long-term government bonds

B. small company stocks, long-term corporate bonds, large company stocks

C. small company stocks, long-term corporate bonds, intermediate-term government bonds

D. large company stocks, small company stocks, long-term government bonds

E. intermediate-term government bonds, long-term corporate bonds, U.S. Treasury bills

Refer to section 12.4

AACSB: N/A

Bloom's: Knowledge

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Historical riskss

25. What was the highest annual rate of inflation during the period 1926-2007?

A. between 0 and 3 percent

B. between 3 and 5 percent

C. between 5 and 10 percent

D. between 10 and 15 percent

E. between 15 and 20 percent

Refer to section 12.2

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.2

Topic: Inflation

A. return on a security minus the inflation rate.

B. return on a risky security minus the risk-free rate.

C. risk premium on a risky security minus the risk-free rate.

D. the risk-free rate plus the inflation rate.

E. risk-free rate minus the inflation rate.

Refer to section 12.3

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-1

Section: 12.3

Topic: Excess return

27. Which one of the following earned the highest risk premium over the period 1926-2007?

A. long-term corporate bonds

B. U.S. Treasury bills

C. small-company stocks

D. large-company stocks

E. long-term government bonds

Refer to section 12.3

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-3

Section: 12.3

Topic: Risk premium

28. What was the average rate of inflation over the period of 1926-2007?

A. less than 2.0 percent

B. between 2.0 and 2.5 percent

C. between 2.5 and 3.0 percent

D. between 3.0 and 3.5 percent

E. greater than 3.5 percent

Refer to section 12.3

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.3

Topic: Inflation

29. Assume that you invest in a portfolio of large-company stocks. Further assume that the

portfolio will earn a rate of return similar to the average return on large-company stocks for

the period 1926-2007. What rate of return should you expect to earn?

A. less than 10 percent

B. between 10 and 12.5 percent

C. between 12.5 and 15 percent

D. between 15 and 17.5 percent

E. more than 17.5 percent

Refer to section 12.3

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.3

Topic: Historical returns

30. The average annual return on small-company stocks was about _____ percent greater than

the average annual return on large-company stocks over the period 1926-2007.

A. 3

B. 5

C. 7

D. 9

E. 11

Refer to section 12.3

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.3

Topic: Historical returns

31. Which one of the following was the least volatile over the period of 1926-2007?

A. large-company stocks

B. inflation

C. long-term corporate bonds

D. U.S. Treasury bills

E. intermediate-term government bonds

Refer to section 12.4

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-3

Section: 12.4

Topic: Historical risks

A. The greater the volatility of returns, the greater the risk premium.

B. The lower the volatility of returns, the greater the risk premium.

C. The lower the average return, the greater the risk premium.

D. The risk premium is unrelated to the average rate of return.

E. The risk premium is not affected by the volatility of returns.

Refer to sections 12.3 and 12.4

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-3

Section: 12.3 and 12.4

Topic: Risk premium

I. relatively low risk

II. relatively low rate of return

III. relatively high standard deviation

IV. relatively large risk premium

A. II only

B. III only

C. I and II only

D. II and III only

E. III and IV only

Refer to section 12.4

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-3

Section: 12.4

Topic: Frequency distribution

A. decrease the risk premium.

B. increase the risk premium.

C. decrease the real return.

D. decrease the risk-free rate.

E. increase the risk-free rate.

Refer to section 12.4

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-3

Section: 12.4

Topic: Risk premium

35. If the variability of the returns on large-company stocks were to increase over the longterm, you would expect which of the following to occur as a result?

I. decrease in the average rate of return

II. increase in the risk premium

III. increase in the 68 percent probability range of the frequency distribution of returns

IV. decrease in the standard deviation

A. I only

B. IV only

C. II and III only

D. I and III only

E. II and IV only

Refer to section 12.4

AACSB: N/A

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Variability of returns

36. Which one of the following statements is correct based on the historical record for the

period 1926-2007?

A. The standard deviation of returns for small-company stocks was double that of largecompany stocks.

B. U.S. Treasury bills had a zero standard deviation of returns because they are considered to

be risk-free.

C. Long-term government bonds had a lower return but a higher standard deviation on

average than did long-term corporate bonds.

D. Inflation was less volatile than the returns on U.S. Treasury bills.

E. Long-term government bonds underperformed intermediate-term government bonds.

Refer to section 12.4

AACSB: N/A

Bloom's: Comprehension

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Historical returns and risks

37. What is the probability that small-company stocks will produce an annual return that is

more than one standard deviation below the average?

A. 1.0 percent

B. 2.5 percent

C. 5.0 percent

D. 16 percent

E. 32 percent

Refer to section 12.4

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-3

Section: 12.4

Topic: Probability distribution

38. According to Jeremy Siegel, the real return on stocks over the long-term has averaged

about:

A. 6.8 percent

B. 8.7 percent

C. 10.4 percent

D. 12.3 percent

E. 14.8 percent

Refer to section 12.5

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-2

Section: 12.5

Topic: Historical returns

39. The historical record for the period 1926-2007 supports which one of the following

statements?

A. A higher-risk security will provide a higher rate of return next year than will a lower-risk

security.

B. If you need a stated amount of money next year, your best investment option today for

those funds would be long-term government bonds.

C. Increased long-run potential returns are obtained by lowering risks.

D. It is possible for small-company stocks to more than double in value in any one given year.

E. Inflation was positive each year throughout the period of 1926-2007.

Refer to sections 12.2 and 12.4

AACSB: N/A

Bloom's: Knowledge

Difficulty: Intermediate

Learning Objective: 12-2

Section: 12.2 and 12.4

Topic: Historical returns

40. Which of the following statements are true based on the historical record for 1926-2007?

I. Risk and potential reward are inversely related.

II. Risk-free securities produce a positive real rate of return each year.

III. Returns are more predictable over the short-term than they are over the long-term.

IV. Bonds are generally a safer investment than are stocks.

A. I only

B. IV only

C. II and III only

D. II and IV only

E. II, III, and IV only

Refer to sections 12.3 and 12.4

AACSB: N/A

Bloom's: Comprehension

Difficulty: Intermediate

Learning Objective: 12-2

Section: 12.3 and 12.4

Topic: Historical returns and risks

41. Estimates of the rate of return on a security based on a historical arithmetic average will

probably tend to _____ the expected return for the long-term while estimates using the

historical geometric average will probably tend to _____ the expected return for the shortterm.

A. overestimate; overestimate

B. overestimate; underestimate

C. underestimate; overestimate

D. underestimate; underestimate

E. accurately; accurately

Refer to section 12.5

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-1

Section: 12.5

Topic: Blume's formula

A. compute an accurate historical rate of return.

B. determine a stock's true current value.

C. consider compounding when estimating a rate of return.

D. determine the actual real rate of return.

E. project future rates of return.

Refer to section 12.5

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-1

Section: 12.5

Topic: Blume's formula

43. Which two of the following are the most likely reasons why a stock price might not react

at all on the day that new information related to the stock issuer is released?

I. insiders knew the information prior to the announcement

II. investors need time to digest the information prior to reacting

III. the information has no bearing on the value of the firm

IV. the information was anticipated

A. I and II only

B. I and III only

C. II and III only

D. II and IV only

E. III and IV only

Refer to section 12.6

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

44. Which one of the following is most indicative of a totally efficient stock market?

A. extraordinary returns earned on a routine basis

B. positive net present values on stock investments over the long-term

C. zero net present values for all stock investments

D. arbitrage opportunities which develop on a routine basis

E. realizing negative returns on a routine basis

Refer to section 12.6

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

45. Which one of the following statements is correct concerning market efficiency?

A. Real asset markets are more efficient than financial markets.

B. If a market is efficient, arbitrage opportunities should be common.

C. In an efficient market, some market participants will have an advantage over others.

D. A firm will generally receive a fair price when it issues new shares of stock.

E. New information will gradually be reflected in a stock's price to avoid any sudden change

in the price of the stock.

Refer to section 12.6

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

A. the markets are continually reacting to old information as that information is absorbed.

B. the markets are continually reacting to new information.

C. arbitrage trading is limited.

D. current trading systems require human intervention.

E. investments produce varying levels of net present values.

Refer to section 12.6

AACSB: N/A

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

47. Inside information has the least value when financial markets are:

A. weak form efficient.

B. semiweak form efficient.

C. semistrong form efficient.

D. strong form efficient.

E. inefficient.

Refer to section 12.6

AACSB: N/A

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

48. According to theory, studying historical stock price movements to identify mispriced

stocks:

A. is effective as long as the market is only semistrong form efficient.

B. is effective provided the market is only weak form efficient.

C. is ineffective even when the market is only weak form efficient.

D. becomes ineffective as soon as the market gains semistrong form efficiency.

E. is ineffective only in strong form efficient markets.

Refer to section 12.6

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

49. Which of the following statements related to market efficiency tend to be supported by

current evidence?

I. Markets tend to respond quickly to new information.

II. It is difficult for investors to earn abnormal returns.

III. Short-run prices are difficult to predict accurately based on public information.

IV. Markets are most likely weak form efficient.

A. I and III only

B. II and IV only

C. I and IV only

D. I, III, and IV only

E. I, II, and III only

Refer to section 12.6

AACSB: N/A

Bloom's: Comprehension

Difficulty: Intermediate

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

50. If you excel in analyzing the future outlook of firms, you would prefer the financial

markets be ____ form efficient so that you can have an advantage in the marketplace.

A. weak

B. semiweak

C. semistrong

D. strong

E. perfect

Refer to section 12.6

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

51. You are aware that your neighbor trades stocks based on confidential information he

overhears at his workplace. This information is not available to the general public. This

neighbor continually brags to you about the profits he earns on these trades. Given this, you

would tend to argue that the financial markets are at best _____ form efficient.

A. weak

B. semiweak

C. semistrong

D. strong

E. perfect

Refer to section 12.6

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

52. The U.S. Securities and Exchange Commission periodically charges individuals with

insider trading and claims those individuals have made unfair profits. Given this, you would

be most apt to argue that the markets are less than _____ form efficient.

A. weak

B. semiweak

C. semistrong

D. strong

E. perfect

Refer to section 12.6

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

53. Individuals who continually monitor the financial markets seeking mispriced securities:

A. earn excess profits over the long-term.

B. make the markets increasingly more efficient.

C. are never able to find a security that is temporarily mispriced.

D. are overwhelmingly successful in earning abnormal profits.

E. are always quite successful using only historical price information as their basis of

evaluation.

Refer to section 12.6

Bloom's: Comprehension

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

54. One year ago, you purchased a stock at a price of $32.16. The stock pays quarterly

dividends of $0.20 per share. Today, the stock is selling for $28.20 per share. What is your

capital gain on this investment?

A. -$4.16

B. -$3.96

C. -$3.76

D. -$3.16

E. -$2.96

Capital gain = $28.20 - $32.16 = -$3.96

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Capital gain

55. Six months ago, you purchased 100 shares of stock in Global Trading at a price of $38.70

a share. The stock pays a quarterly dividend of $0.15 a share. Today, you sold all of your

shares for $40.10 per share. What is the total amount of your dividend income on this

investment?

A. $15

B. $30

C. $45

D. $50

E. $60

Dividend income = ($0.15 2) 100 = $30

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Dividend income

56. A year ago, you purchased 400 shares of Stellar Wood Products, Inc. stock at a price of

$8.62 per share. The stock pays an annual dividend of $0.10 per share. Today, you sold all of

your shares for $4.80 per share. What is your total dollar return on this investment?

A. -$382

B. -$372

C. -$1,528

D. -$1,488

E. -$1,360

Total dollar return = ($4.80 - $8.62 + $0.10) 400 = -$1,488

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Total dollar return

57. You own 400 shares of Western Feed Mills stock valued at $51.20 per share. What is the

dividend yield if your annual dividend income is $352?

A. 1.68 percent

B. 1.72 percent

C. 1.83 percent

D. 1.13 percent

E. 1.21 percent

Dividend yield = ($352/400)/$51.20 = 1.72 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Dividend yield

58. West Wind Tours stock is currently selling for $48 a share. The stock has a dividend yield

of 2.6 percent. How much dividend income will you receive per year if you purchase 200

shares of this stock?

A. $24.96

B. $36.20

C. $124.80

D. $362.00

E. $249.60

Dividend income = $48 0.026 200 = $249.60

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Dividend yield

59. One year ago, you purchased a stock at a price of $47.50 a share. Today, you sold the

stock and realized a total loss of 22.11 percent. Your capital gain was -$12.70 a share. What

was your dividend yield?

A. 4.63 percent

B. 4.88 percent

C. 5.02 percent

D. 12.67 percent

E. 14.38 percent

Dividend yield = -0.2211 - (-12.70/$47.50) = 4.63 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Dividend yield

60. You just sold 600 shares of Wesley, Inc. stock at a price of $31.09 a share. Last year, you

paid $30.92 a share to buy this stock. Over the course of the year, you received dividends

totaling $1.20 per share. What is your total capital gain on this investment?

A. -$618

B. -$102

C. $102

D. $618

E. $720

Capital gain = ($31.09 - $30.92) 600 = $102

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Capital gain

61. Last year, you purchased 500 shares of Analog Devices, Inc. stock for $11.16 a share. You

have received a total of $120 in dividends and $7,190 from selling the shares. What is your

capital gains yield on this stock?

A. 26.70 percent

B. 26.73 percent

C. 28.85 percent

D. 29.13 percent

E. 31.02 percent

Capital gains yield = [($7,190/500) - $11.16]/$11.16 = 28.85 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Capital gains yield

62. Today, you sold 200 shares of Indian River Produce stock. Your total return on these

shares is 5.65 percent. You purchased the shares one year ago at a price of $31.10 a share. You

have received a total of $100 in dividends over the course of the year. What is your capital

gains yield on this investment?

A. 3.68 percent

B. 4.04 percent

C. 5.67 percent

D. 7.26 percent

E. 7.41 percent

Capital gains yield = .0565 - [($100/$200)/$31.10] = 4.04 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Capital gains yield

63. Four months ago, you purchased 1,500 shares of Lakeside Bank stock for $11.20 a share.

You have received dividend payments equal to $0.25 a share. Today, you sold all of your

shares for $8.60 a share. What is your total dollar return on this investment?

A. -$3,900

B. -$3,525

C. -$3,150

D. -$2,950

E. -$2,875

Total dollar return = ($8.60 - $11.20 + $0.25) 1,500 = -$3,525

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Dollar returns

64. One year ago, you purchased 500 shares of Best Wings, Inc. stock at a price of $9.60 a

share. The company pays an annual dividend of $0.10 per share. Today, you sold all of your

shares for $15.60 a share. What is your total percentage return on this investment?

A. 38.46 percent

B. 39.10 percent

C. 39.72 percent

D. 62.50 percent

E. 63.54 percent

Total percentage return = ($15.60 - $9.60 + $0.10)/$9.60 = 63.54 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.1

Topic: Percentage return

65. Last year, you purchased a stock at a price of $47.10 a share. Over the course of the year,

you received $2.40 per share in dividends while inflation averaged 3.4 percent. Today, you

sold your shares for $49.50 a share. What is your approximate real rate of return on this

investment?

A. 6.30 percent

B. 6.79 percent

C. 7.18 percent

D. 9.69 percent

E. 10.19 percent

Nominal return = ($49.50 - $47.10 + $2.40)/$47.10 = 10.19 percent

Approximate real return = 0.1019 - 0.034 = 6.79 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.3

Topic: Approximate real return

66. One year ago, you purchased 200 shares of a stock at a price of $54.18 a share. Today, you

sold those shares for $40.25 a share. During the past year, you received total dividends of

$164 while inflation averaged 4.2 percent. What is your approximate real rate of return on this

investment?

A. -24.20 percent

B. -28.40 percent

C. -20.00 percent

D. 20.00 percent

E. 24.20 percent

Nominal return = [$40.25 - $54.18 + ($164/200)]/$54.18 = -0.2420

Approximate real return = -0.2420 - 0.042 = -28.40 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.3

Topic: Approximate real return

67. What is the amount of the excess return on a U.S. Treasury bill if the risk-free rate is 2.8

percent and the market rate of return is 8.35 percent?

A. 0.00 percent

B. 2.80 percent

C. 5.55 percent

D. 8.35 percent

E. 11.15 percent

There is no excess return, or risk premium, for a risk-free security such as the T-bill.

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.3

Topic: Risk-free security

68. A stock had returns of 11 percent, -18 percent, -21 percent, 5 percent, and 34 percent over

the past five years. What is the standard deviation of these returns?

A. 18.74 percent

B. 20.21 percent

C. 20.68 percent

D. 22.60 percent

E. 23.49 percent

Average return = (0.11 - 0.18 - 0.21 + 0.05 + 0.34)/5 = .022;

= [1/(5 - 1)] [(0.11 - 0.022)2 + (-0.18 - 0.022)2 + (-0.21 -0.022)2 + (0.05 - 0.022)2 + (0.34 0.022)2] = 22.60 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Intermediate

Learning Objective: 12-1

Section: 12.4

Topic: Standard deviation

69. The common stock of Air United, Inc., had annual returns of 15.6 percent, 2.4 percent,

-11.8 percent, and 32.9 percent over the last four years, respectively. What is the standard

deviation of these returns?

A. 13.29 percent

B. 14.14 percent

C. 16.50 percent

D. 17.78 percent

E. 19.05 percent

Average return = (0.156 + 0.024 - 0.118 + 0.329)/4 = -.09775

=[1/(4 - 1)] [(0.156 - 0.09775)2 + (0.024 - 0.09775)2 + (-0.118 - 0.09775)2 + (0.329 0.09775)2] = 19.05 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Intermediate

Learning Objective: 12-1

Section: 12.4

Topic: Standard deviation

70. A stock had annual returns of 3.6 percent, -8.7 percent, 5.6 percent, and 11.1 percent over

the past four years. Which one of the following best describes the probability that this stock

will produce a return of 20 percent or more in a single year?

A. less than 0.1 percent

B. less than 0.5 percent but greater than 0.1 percent

C. less than 1.0 percent but greater the 0.5 percent

D. less than 2.5 percent but greater than 1.0 percent

E. less than 5 percent but greater than 2.5 percent

Average return = (0.036 - 0.087 + 0.056 + 0.111)/4 = 0.0290

= [1/(4 - 1)] [(0.036 - 0.029)2 + (-0.087 - 0.029)2 + (0.056 - 0.029)2 + (0.111 - 0.029)2] =

0.0836

Upper end of 95 percent range = 0.0290 + (2 0.0836) = 19.62 percent

Upper end of 99 percent range = 0.0290 + (3 0.0836) = 27.98 percent

A return of 20 percent or more in a single year has between a 1 percent and a 2.5 percent

probability of occurring in any one year.

AACSB: Analytic

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Probability of occurrence

71. A stock has an expected rate of return of 13 percent and a standard deviation of 21

percent. Which one of the following best describes the probability that this stock will lose at

least half of its value in any one given year?

A. 0.1 percent

B. 0.5 percent

C. 1.0 percent

D. 2.5 percent

E. 5.0 percent

Lower bound of 99 percent range = 0.13 - (3 0.21) = -50 percent

Probability of losing 50 percent or more in any one year is 0.5 percent.

AACSB: Analytic

Bloom's: Analysis

Difficulty: Basic

Learning Objective: 12-3

Section: 12.4

Topic: Probability of occurrence

72. A stock has returns of 18 percent, 11 percent, -21 percent, and 6 percent for the past four

years. Based on this information, what is the 95 percent probability range of returns for any

one given year?

A. -13.56 to 20.56 percent

B. -24.60 to 31.80 percent

C. -30.62 to 37.62 percent

D. -47.68 to 54.68 percent

E. -71.73 to 71.73 percent

Average return = (0.18 + 0.11 - 0.21 + 0.06)/4 = 0.035

= (0.18 - 0.035)2 + (0.11 - 0.035)2 + (-0.21 - 0.035)2 + (0.06 - 0.035)2] = .170587

95% probability range = 0.035 (2 0.170587) percent = -30.62 to 37.62 percent

AACSB: Analytic

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Probability of occurrence

73. Your friend is the owner of a stock which had returns of 25 percent, -36 percent, 1 percent,

and 16 percent for the past three years. Your friend thinks the stock may be able to achieve a

return of 50 percent or more in a single year. Based on these returns, what is the probability

that your friend is correct?

A. less than 0.5 percent

B. greater than 0.5 percent but less than 1.0 percent

C. greater than 1.0 percent but less than 2.5 percent

D. greater than 2.5 percent but less than 16 percent

E. greater than 16.0 percent

Average return = (0.25 - 0.36 + 0.01 + 0.16)/4 = 0.015

= [1/(4 - 1)] [(0.25 - 0.015)2 + (-0.36 - 0.015)2 + (0.01 - 0.015)2 + (0.16 - 0.015)2] =

0.2689

Upper end of 68 percent range = 0.015 + (1 0.2689) = 28.39 percent

Upper end of 95 percent range = 0.015 + (2 0.2689) = 55.28 percent

The probability of earning at least 50 percent in any one year is greater than 2.5 percent but

less than 16 percent.

AACSB: Analytic

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Probability of occurrence

74. A stock had returns of 15 percent, 8 percent, 12 percent, -21 percent, and -4 percent for the

past five years. Based on these returns, what is the approximate probability that this stock will

return at least 15 percent in any one given year?

A. less than 0.5 percent

B. greater than 0.5 percent but less than 1.0 percent

C. greater than 1.0 percent but less than 2.5 percent

D. greater than 2.5 percent but less than 16 percent

E. greater than 16.0 percent

Average return = (0.15 + 0.08 + 0.12 - 0.21 - 0.04)/5 = 0.02

= [1/(5 - 1)] [(0.15 - 0.02)2 + (0.08 - 0.02)2 + (0.12 - 0.02)2 + (-0.21 - 0.02)2 + (-0.04 0.02)2] = 0.1475

Upper end of 68 percent range = 0.02 + 0.1475 = 16.75 percent

Probability of earning at least 15 percent in any one year is greater than 16 percent.

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Probability of occurrence

75. A stock had returns of 14 percent, 13 percent, -10 percent, and 7 percent for the past four

years. Which one of the following best describes the probability that this stock will lose no

more than 10 percent in any one year?

A. greater than 0.5 but less than 1.0 percent

B. greater than 1.0 percent but less than 2.5 percent

C. greater than 2.5 percent but less than 16 percent

D. greater than 84 percent but less than 97.5 percent

E. greater than 95 percent

Average return = (0.14 + 0.13 - 0.10 + 0.07)/4 = 0.06

= [1/(4 - 1)][(0.14 - 0.06)2 + (0.13 - 0.06)2 + (-0.10 - 0.06)2 + (0.07 - 0.06)2] = 0.11106

Lower bound of 68 percent range = 0.06 - (1 0.11106) = -5.11 percent

Lower bound of 95 percent range = 0.06 - (2 0.11106) = -16.21 percent

Probability of losing more than 10 percent in any given year is between 2.5 and 16 percent.

Thus, the probability of NOT losing more than 10 percent is between 84 and 97.5 percent.

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Probability of occurrence

76. Over the past five years, a stock produced returns of 11 percent, 14 percent, 2 percent, -9

percent, and 5 percent. What is the probability that an investor in this stock will not lose more

than 10 percent in any one given year?

A. greater than 0.5 but less than 1.0 percent

B. greater than 1.0 percent but less than 2.5 percent

C. greater than 2.5 percent but less than 16 percent

D. greater than 84 percent but less than 97.5 percent

E. greater than 95 percent

Average return = (0.11 + 0.14 + 0.02 - 0.09 + 0.05)/5 = 0.046

= [1/(5 - 1)][(0.11 - 0.046)2 + (0.14 - 0.046)2 + (0.02 - 0.046)2 + (-0.09 - 0.046)2 + (0.05 0.046)2] = 0.08961

Lower bound of 68% probability range = 0.046 - (1 0.08961) = -4.36 percent

Lower bound of 95% probability range = 0.046 - (2 0.08961) = -13.32 percent

The probability of losing 10 percent or more is greater than 2.5 percent but less than 16

percent. Thus, the probability of NOT losing more than 10 percent is greater than 84 percent

but less than 97.5 percent.

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Probability of occurrence

77. A stock has annual returns of 6 percent, 14 percent, -3 percent, and 2 percent for the past

four years. The arithmetic average of these returns is _____ percent while the geometric

average return for the period is _____ percent.

A. 4.57; 4.75

B. 4.75; 4.57

C. 6.33; 6.19

D. 6.19; 6.33

E. 6.33; 6.33

Arithmetic average = (0.06 + 0.14 - 0.03 + 0.02)/4 = 4.75 percent

Geometric return = (1.06 1.14 0.97 1.02).25 - 1 = 4.57 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.5

Topic: Arithmetic and geometric returns

78. A stock has annual returns of 13 percent, 21 percent, -12 percent, 7 percent, and -6 percent

for the past five years. The arithmetic average of these returns is _____ percent while the

geometric average return for the period is _____ percent.

A. 3.89; 3.62

B. 3.89; 4.60

C. 3.62; 3.89

D. 4.60; 3.62

E. 4.60; 3.89

Arithmetic average = (0.13 + 0.21- 0.12 + 0.07 - 0.06)/5 = 4.60 percent

Geometric return = (1.13 1.21 0.88 1.07 0.94).20 - 1 = 3.89 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.5

Topic: Arithmetic and geometric returns

79. A stock had returns of 16 percent, 4 percent, 8 percent, 14 percent, -9 percent, and -5

percent over the past six years. What is the geometric average return for this time period?

A. 4.26 percent

B. 4.67 percent

C. 5.13 percent

D. 5.39 percent

E. 5.60 percent

Geometric average = (1.16 1.04 1.08 1.14 0.91 0.95)1/6 - 1 = 4.26 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.5

Topic: Geometric return

80. A stock had the following prices and dividends. What is the geometric average return on

this stock?

A. -15.87 percent

B. -15.21 percent

C. -13.33 percent

D. -12.91 percent

E. -11.48 percent

Return for year 2 = ($16.62 - $16.40 + $0.50)/$16.40 = 4.3902 percent

Return for year 3 = ($15.48 - $16.62 + $0.50)/$16.62 = -3.8508 percent

Return for year 4 = ($9.15 - $15.48 + $0.25)/$15.48 = -39.2765 percent

Geometric return = (1.043902 0.961492 0.607235)1/3 - 1 = -15.21 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

Learning Objective: 12-1

Section: 12.5

Topic: Geometric return

81. Over the past fifteen years, the common stock of The Flower Shoppe, Inc. has produced

an arithmetic average return of 12.2 percent and a geometric average return of 11.5 percent.

What is the projected return on this stock for the next five years according to Blume's

formula?

A. 11.70 percent

B. 11.89 percent

C. 12.00 percent

D. 12.03 percent

E. 12.12 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Intermediate

Learning Objective: 12-1

Section: 12.5

Topic: Blume's formula

82. Based on past 26 years, Westerfield Industrial Supply's common stock has yielded an

arithmetic average rate of return of 9.63 percent. The geometric average return for the same

period was 8.57 percent. What is the estimated return on this stock for the next 4 years

according to Blume's formula?

A. 8.70 percent

B. 8.92 percent

C. 9.13 percent

D. 9.38 percent

E. 9.50 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Intermediate

Learning Objective: 12-1

Section: 12.5

Topic: Blume's formula

83. A stock has a geometric average return of 14.6 percent and an arithmetic average return of

15.5 percent based on the last 33 years. What is the estimated average rate of return for the

next 6 years based on Blume's formula?

A. 14.79 percent

B. 14.96 percent

C. 15.28 percent

D. 15.36 percent

E. 15.42 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Intermediate

Learning Objective: 12-1

Section: 12.5

Topic: Blume's formula

Essay Questions

The current stock price reflects the following information for each form of efficiency:

Bloom's: Knowledge

Difficulty: Basic

Learning Objective: 12-4

Section: 12.6

Topic: Market efficiency

85. What are the two primary lessons learned from capital market history? Use historical

information to justify that these lessons are correct.

First, there is a reward for bearing risk, and second, the greater the risk, the greater the

potential reward. As evidence, students should provide a brief discussion of the historical rates

of return and the related standard deviations of the various asset classes discussed in the text.

Feedback: Refer to sections 12.3 and 12.4

Bloom's: Comprehension

Difficulty: Intermediate

Learning Objective: 12-2 and 12-3

Section: 12.3 and 12.4

Topic: Capital market history

86. How can an investor lose money on a stock while making money on a bond investment if

there is a reward for bearing risk? Aren't stocks riskier than bonds?

There is a reward for bearing risk over the long-term. However, the nature of risk implies the

returns on a high risk security will be more volatile than the returns on a low risk security.

Thus, stocks can produce lower returns in the short run. It is the acceptance of this risk that

justifies the potential long-term reward.

Feedback: Refer to section 12.3

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-2

Section: 12.3

Topic: Risk and return

87. Shawn earned an average return of 14.6 percent on his investments over the past 20 years

while the S&P 500, a measure of the overall market, only returned an average of 13.9 percent.

Explain how this can occur if the stock market is efficient.

An investor can purchase securities that have a higher level of risk than the overall market.

In an efficient market, these securities will earn a higher return over the long-term as

compensation for the assumption of the increased risk. This is the first lesson of the capital

markets: There is a reward for bearing risk.

Feedback: Refer to section 12.3

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-2 and 12-3

Section: 12.3

Topic: Risk and return

88. You want to invest in an index fund which directly correlates to the overall U.S. stock

market. How can you determine if the market risk premium you are expecting to earn is

reasonable for the long-term?

You could compare your expectation to the historical market risk premium for the United

States, as well as other industrialized countries, realizing of course, that the future will not be

exactly like the past. Nevertheless, this should indicate whether or not your expectation is at

least reasonable.

Feedback: Refer to section 12.4

Bloom's: Analysis

Difficulty: Intermediate

Learning Objective: 12-3

Section: 12.4

Topic: Historical risk premium

89. Suppose a stock had an initial price of $80 per share, paid a dividend of $1.35 per share

during the year, and had an ending share price of $87. What was the capital gains yield?

A. 1.55 percent

B. 1.69 percent

C. 8.05 percent

D. 8.75 percent

E. 10.44 percent

Capital gains yield = ($87 - $80)/$80 = 8.75 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

EOC #: 12-2

Learning Objective: 12-1

Section: 12.1

Topic: Capital gains yield

90. Suppose you bought a 15 percent coupon bond one year ago for $950. The face value of

the bond is $1,000. The bond sells for $985 today. If the inflation rate last year was 9 percent,

what was your total real rate of return on this investment?

A. -4.88 percent

B. -5.32 percent

C. 9.61 percent

D. 9.78 percent

E. 10.47 percent

Nominal return = ($985 - $950 + $150)/$950 = 0.1947

Real return = [(1 + 0.1947)/(1 + 0.09)] - 1 = 9.61 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

EOC #: 12-4

Learning Objective: 12-1

Section: 12.3

Topic: Nominal and real returns

A. 10.79 percent

B. 12.60 percent

C. 13.48 percent

D. 14.42 percent

E. 15.08 percent

Average return = (0.07 + 0.25 + 0.14 - 0.15 + 0.16)/5 = 0.094

Standard deviation = [1/(5 - 1)] [(0.07 - 0.094)2 + (0.25 - 0.094)2 +(0.14 - 0.094)2 +(-0.15 0.094)2 + (0.16 - 0.094)2] = 15.08 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

EOC #: 12-7

Learning Objective: 12-1

Section: 12.4

Topic: Standard deviation

92. You've observed the following returns on Crash-n-Burn Computer's stock over the past

five years: 2 percent, -12 percent, 27 percent, 22 percent, and 18 percent. What is the variance

of these returns?

A. 0.02070

B. 0.02588

C. 0.01725

D. 0.01684

E. 0.02633

Average = (0.02 - 0.12 + 0.27 + 0.22 + 0.18)/5 = 0.114

Variance = [1/(5 - 1)] [(0.02 - 0.114)2 + (-0.12 - 0.114)2 + (0.27 - 0.114)2 + (0.22 - 0.114)2 +

(0.18 - 0.114)2] = 0.02588

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

EOC #: 12-9

Learning Objective: 12-1

Section: 12.4

Topic: Variance

93. You've observed the following returns on Crash-n-Burn Computer's stock over the past

five years: 3 percent, -10 percent, 24 percent, 22 percent, and 12 percent. Suppose the average

inflation rate over this time period was 3.6 percent and the average T-bill rate was 4.8 percent.

Based on this information, what was the average nominal risk premium?

A. 5.15 percent

B. 5.40 percent

C. 6.01 percent

D. 6.37 percent

E. 6.60 percent

Average return = (0.03 - 0.10 + 0.24 + 0.22 + 0.12)/5 = 0.102

Average nominal risk premium = 0.102 - 0.048 = 5.40 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Basic

EOC #: 12-10

Learning Objective: 12-1

Section: 12.3

Topic: Nominal risk premium

94. You bought one of Great White Shark Repellant Co.'s 10 percent coupon bonds one year

ago for $760. These bonds pay annual payments, have a face value of $1,000, and mature 14

years from now. Suppose you decide to sell your bonds today when the required return on the

bonds is 14 percent. The inflation rate over the past year was 3.7 percent. What was your total

real return on this investment?

A. 8.97 percent

B. 9.11 percent

C. 9.18 percent

D. 9.44 percent

E. 9.58 percent

Real return = [(1 + 0.13147)/(1 + 0.037)] - 1 = 9.11 percent

AACSB: Analytic

Bloom's: Analysis

Difficulty: Intermediate

EOC #: 12-13

Learning Objective: 12-1

Section: 12.3

Topic: Real return

95. You find a certain stock that had returns of 4 percent, -5 percent, -15 percent, and 16

percent for four of the last five years. The average return of the stock for the 5-year period

was 13 percent. What is the standard deviation of the stock's returns for the five-year period?

A. 21.39 percent

B. 24.98 percent

C. 27.16 percent

D. 31.23 percent

E. 34.02 percent

Return for missing year: 0.04 - 0.05 - 0.15 + 0.16 + x = 0.13 5; x = 65 percent

Std dev = [1/(5 - 1)] [(0.04 - 0.13)2 + (-0.05 - 0.13)2 + (-0.15 - 0.13)2 + (0.16 - 0.13)2 + (0.65

- 0.13)2 = 31.23 percent

AACSB: Analytic

Bloom's: Analysis

Difficulty: Intermediate

EOC #: 12-14

Learning Objective: 12-3

Section: 12.4

Topic: Standard deviation

96. A stock had returns of 12 percent, 16 percent, 13 percent, 19 percent, 15 percent, and -6

percent over the last six years. What is the geometric average return on the stock for this

period?

A. 10.90 percent

B. 11.18 percent

C. 13.56 percent

D. 14.76 percent

E. 15.01 percent

Geometric average = (1.12 1.16 1.13 1.19 1.15 0.94)1/6 - 1 = 11.18 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Intermediate

EOC #: 12-15

Learning Objective: 12-1

Section: 12.5

Topic: Geometric average return

97. Assume that the returns from an asset are normally distributed. The average annual return

for the asset is 18.1 percent and the standard deviation of the returns is 32.5 percent. What is

the approximate probability that your money will triple in value in a single year?

A. less than 0.5 percent

B. less than 1 percent but greater than 0.5 percent

C. less then 2.5 percent but greater than 1 percent

D. less than 5 percent but greater than 2.5 percent

E. less than 10 percent but greater than 5 percent

The upper tail of the 99 percent range = 0.181 + (3 0.325) = 1.156 = 115.6 percent, which is

less than the 200 percent required to triple your money. Thus, the probability of occurrence is

less than 0.5 percent.

AACSB: Analytic

Bloom's: Analysis

Difficulty: Basic

EOC #:12-17

Learning Objective: 12-3

Section: 12.4

Topic: Probability ranges

98. Over a 34-year period an asset had an arithmetic return of 13 percent and a geometric

return of 10.5 percent. Using Blume's formula, what is your best estimate of the future annual

returns over the next 10 years?

A. 11.18 percent

B. 11.27 percent

C. 11.84 percent

D. 12.32 percent

E. 12.46 percent

AACSB: Analytic

Bloom's: Application

Difficulty: Intermediate

EOC #: 12-20

Learning Objective: 12-1

Section: 12.5

Topic: Blume's formula

Key

1.

You own a stock that you think will produce a return of 11 percent in

a good economy and 3 percent in a poor economy. Given the

probabilities of each state of the economy occurring, you anticipate

that your stock will earn 6.5 percent next year. Which one of the

following terms applies to this 6.5 percent?

A.

B.

C.

D.

E.

arithmetic return

historical return

expected return

geometric return

required return

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Expected return

2.

different stocks valued at $82,500 total. Which one of the following

terms most applies to Suzie's investments?

A.

B.

C.

D.

E.

index

portfolio

collection

grouping

risk-free

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-02 The impact of diversification.

Section: 13.2

Topic: Portfolio

3.

value today of $121,300. Fifteen percent of that total is invested in

Wise Man Foods. The 15 percent is a measure of which one of the

following?

A.

B.

C.

D.

E.

portfolio return

portfolio weight

degree of risk

price-earnings ratio

index value

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-02 The impact of diversification.

Section: 13.2

Topic: Portfolio weight

4.

A.

B.

C.

D.

E.

unsystematic

diversifiable

systematic

asset-specific

total

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.4

Topic: Systematic risk

5.

suddenly drop in value by about 20 percent. What type of risk does

this news flash represent?

A.

B.

C.

D.

E.

portfolio

nondiversifiable

market

unsystematic

total

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.4

Topic: Unsystematic risk

6.

eliminate all of the unsystematic risk.

B. concentrating an investment in three companies all within the

same industry will greatly reduce the systematic risk.

C. spreading an investment across five diverse companies will not

lower the total risk.

D. spreading an investment across many diverse assets will eliminate

all of the systematic risk.

E. spreading an investment across many diverse assets will eliminate

some of the total risk.

Refer to section 13.5

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-02 The impact of diversification.

Section: 13.5

Topic: Diversification

7.

The _____ tells us that the expected return on a risky asset depends

only on that asset's nondiversifiable risk.

A.

B.

C.

D.

E.

systematic risk principle

open markets theorem

law of one price

principle of diversification

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.6

Topic: Systematic risk

8.

present in a particular risky asset relative to the systematic risk

present in an average risky asset?

A.

B.

C.

D.

E.

beta

reward-to-risk ratio

risk ratio

standard deviation

price-earnings ratio

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.6

Topic: Beta

9.

created when expected returns are graphed against security betas?

A.

B.

C.

D.

E.

reward-to-risk matrix

portfolio weight graph

normal distribution

security market line

market real returns

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Security market line

10.

market line?

A.

B.

C.

D.

E.

reward-to-risk ratio

market standard deviation

beta coefficient

risk-free interest rate

market risk premium

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Security market line

11.

relationship between the expected return on a security and the level

of that security's systematic risk?

A.

B.

C.

D.

E.

time value of money equation

unsystematic risk equation

market performance equation

expected risk formula

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Capital asset pricing model

12.

return the firm requires on this project is referred to as the:

A.

B.

C.

D.

E.

expected return.

market rate of return.

internal rate of return.

cost of capital.

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.8

Topic: Cost of capital

13.

is equal to the:

B. arithmetic average of the returns for each economic state.

C. summation of the individual expected rates of return.

D. weighted average of the returns for each economic state.

E. return for the economic state with the highest probability of

occurrence.

Refer to section 13.1

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Expected return

14.

probabilities is:

A. guaranteed to equal the actual average return on the stock for the

next five years.

B. guaranteed to be the minimal rate of return on the stock over the

next two years.

C. guaranteed to equal the actual return for the immediate twelve

month period.

D. a mathematical expectation based on a weighted average and not

an actual anticipated outcome.

E. the actual return you should anticipate as long as the economic

forecast remains constant.

Refer to section 13.1

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Expected return

15.

on the stock minus the:

A.

B.

C.

D.

E.

risk-free rate.

inflation rate.

standard deviation.

variance.

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Risk premium

16.

A.

B.

C.

D.

E.

total

nondiversifiable

unsystematic

systematic

economic

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.1

Topic: Standard deviation

17.

average where the weights are based on the:

A.

B.

C.

D.

E.

market price per share of each stock.

market value of the investment in each stock.

original amount invested in each stock.

cost per share of each stock held.

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Expected return

18.

factors?

I. percentage of the portfolio invested in each individual security

II. projected states of the economy

III. the performance of each security given various economic states

IV. probability of occurrence for each state of the economy

A.

B.

C.

D.

E.

II and IV only

I, III, and IV only

II, III, and IV only

I, II, III, and IV

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Expected return

19.

I. can never exceed the expected return of the best performing

security in the portfolio.

II. must be equal to or greater than the expected return of the worst

performing security in the portfolio.

III. is independent of the unsystematic risks of the individual

securities held in the portfolio.

IV. is independent of the allocation of the portfolio amongst individual

securities.

A.

B.

C.

D.

E.

II and IV only

I and II only

I, II, and III only

I, II, III, and IV

AACSB: Analytic

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2 and 13.6

Topic: Expected return

20.

A. will equal the variance of the most volatile stock in the portfolio.

B. may be less than the variance of the least risky stock in the

portfolio.

C. must be equal to or greater than the variance of the least risky

stock in the portfolio.

D. will be a weighted average of the variances of the individual

securities in the portfolio.

E. will be an arithmetic average of the variances of the individual

securities in the portfolio.

Refer to section 13.5

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-02 The impact of diversification.

Section: 13.5

Topic: Diversification

21.

securities held in the portfolio.

B. can never be less than the standard deviation of the most risky

security in the portfolio.

C. must be equal to or greater than the lowest standard deviation of

any single security held in the portfolio.

D. is an arithmetic average of the standard deviations of the

individual securities which comprise the portfolio.

E. can be less than the standard deviation of the least risky security

in the portfolio.

Refer to section 13.2

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Standard deviation

22.

B. is a weighed average of the standard deviations of the individual

securities held in that portfolio.

C. measures the amount of diversifiable risk inherent in the portfolio.

D. serves as the basis for computing the appropriate risk premium for

that portfolio.

E. can be less than the weighted average of the standard deviations

of the individual securities held in that portfolio.

Refer to section 13.5

AACSB: Analytic

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 13-02 The impact of diversification.

Section: 13.5

Topic: Standard deviation

23.

portfolio of 20 securities with multiple states of the economy when

both the securities and the economic states have unequal weights?

A. Given the unequal weights of both the securities and the economic

states, the standard deviation of the portfolio must equal that of

the overall market.

B. The weights of the individual securities have no effect on the

expected return of a portfolio when multiple states of the economy

are involved.

C. Changing the probabilities of occurrence for the various economic

states will not affect the expected standard deviation of the

portfolio.

D. The standard deviation of the portfolio will be greater than the

highest standard deviation of any single security in the portfolio

given that the individual securities are well diversified.

E. Given both the unequal weights of the securities and the economic

states, an investor might be able to create a portfolio that has an

expected standard deviation of zero.

Refer to section 13.2

AACSB: Analytic

Blooms: Analyze

Difficulty: 2 Medium

Learning Objective: 13-02 The impact of diversification.

Section: 13.2

Topic: Standard deviation

24.

return on Sussex stock?

B. The labor union representing Sussex' employees unexpectedly

called a strike.

C. This morning, Sussex confirmed that its CEO is retiring at the end

of the year as was anticipated.

D. The price of Sussex stock suddenly declined in value because

researchers accidentally discovered that one of the firm's products

can be toxic to household pets.

E. The board of directors made an unprecedented decision to give

sizeable bonuses to the firm's internal auditors for their efforts in

uncovering wasteful spending.

Refer to section 13.3

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.3

Topic: Expected return

25.

B. The expected return minus the unexpected return is equal to the

total return.

C. Over time, the average return is equal to the unexpected return.

D. The expected return includes the surprise portion of news

announcements.

E. Over time, the average unexpected return will be zero.

Refer to section 13.3

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.3

Topic: Unexpected returns

26.

is correct?

B. Unexpected returns over time have a negative effect on the total

return of a firm.

C. Unexpected returns are relatively predictable in the short-term.

D. Unexpected returns generally cause the actual return to vary

significantly from the expected return over the long-term.

E. Unexpected returns can be either positive or negative in the short

term but tend to be zero over the long-term.

Refer to section 13.3

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.3

Topic: Unexpected returns

27.

precipitously

B. a flood washes away a firm's warehouse

C. a city imposes an additional one percent sales tax on all products

D. a toymaker has to recall its top-selling toy

E. corn prices increase due to increased demand for alternative fuels

Refer to section 13.4

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.4

Topic: Systematic risk

28.

Unsystematic risk:

B. is compensated for by the risk premium.

C.

is measured by beta.

D.

is measured by standard deviation.

E.

is related to the overall economy.

Refer to section 13.4

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.4

Topic: Unsystematic risk

29.

B.

a national sales tax is adopted

C. inflation decreases at the national level

D. an increased feeling of prosperity is felt around the globe

E. consumer spending on entertainment decreased nationally

Refer to section 13.4

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.4

Topic: Unsystematic risk

30.

risk of a portfolio?

A.

B.

C.

D.

E.

adding bonds to a stock portfolio

adding international securities into a portfolio of U.S. stocks

adding U.S. Treasury bills to a risky portfolio

adding technology stocks to a portfolio of industrial stocks

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5

Topic: Unsystematic risk

31.

unsystematic risk?

B. Eliminating unsystematic risk is the responsibility of the individual

investor.

C. Unsystematic risk is rewarded when it exceeds the market level of

unsystematic risk.

D. Beta measures the level of unsystematic risk inherent in an

individual security.

E. Standard deviation is a measure of unsystematic risk.

Refer to sections 13.5 and 13.6

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5 and 13.6

Topic: Unsystematic risk

32.

standard deviation is added to the portfolio.

B. Every portfolio that contains 25 or more securities is free of

unsystematic risk.

C. The systematic risk of a portfolio can be effectively lowered by

adding T-bills to the portfolio.

D. Adding five additional stocks to a diversified portfolio will lower the

portfolio's beta.

E. Stocks that move in tandem with the overall market have zero

betas.

Refer to section 13.5

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5

Topic: Risk

33.

investor?

A.

B.

C.

D.

E.

systematic risk

unsystematic risk

market risk

nondiversifiable risk

systematic portion of a surprise

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5

Topic: Unsystematic risk

34.

I. earthquake damages an entire town

II. federal government imposes a $100 fee on all business entities

III. employment taxes increase nationally

IV. toymakers are required to improve their safety standards

A.

B.

C.

D.

E.

II and IV only

II and III only

I and IV only

I, III, and IV only

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-02 The impact of diversification.

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5

Topic: Unsystematic risk

35.

risks?

I. Diversifiable risks can be essentially eliminated by investing in

thirty unrelated securities.

II. There is no reward for accepting diversifiable risks.

III. Diversifiable risks are generally associated with an individual firm

or industry.

IV. Beta measures diversifiable risk.

A.

B.

C.

D.

E.

II and IV only

I and IV only

I, II and III only

I, II, III, and IV

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5 and 13.6

Topic: Unsystematic risk

36.

A.

B.

C.

D.

E.

energy costs increase

core inflation increases

a firm's sales decrease

taxes decrease

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-02 The impact of diversification.

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5

Topic: Unsystematic risk

37.

I. Nondiversifiable risk is measured by beta.

II. The risk premium increases as diversifiable risk increases.

III. Systematic risk is another name for nondiversifiable risk.

IV. Diversifiable risks are market risks you cannot avoid.

A.

B.

C.

D.

E.

II and IV only

I and II only

III and IV only

I, II, and III only

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5

Topic: Systematic and unsystematic risk

38.

A.

B.

C.

D.

E.

eliminate all risks.

eliminate asset-specific risk.

eliminate systematic risk.

lower both returns and risks.

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-02 The impact of diversification.

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5

Topic: Diversification

39.

diversified?

A.

B.

C.

D.

E.

a decrease in the portfolio beta

an increase in the portfolio rate of return

an increase in the portfolio standard deviation

a decrease in the portfolio standard deviation

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5

Topic: Diversification

40.

the diversifiable risk from a portfolio?

A.

B.

C.

D.

E.

5

10

25

50

75

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-02 The impact of diversification.

Learning Objective: 13-03 The systematic risk principle.

Section: 13.5

Topic: Diversification

41.

A.

B.

C.

D.

E.

the mean.

beta.

the geometric average.

the standard deviation.

the arithmetic average.

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-03 The systematic risk principle.

Section: 13.6

Topic: Systematic risk

42.

systematic risk in a security?

A.

B.

C.

D.

E.

standard deviation of the returns

expected rate of return

risk-free rate

market risk premium

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

43.

portfolio beta?

B. A portfolio beta is a weighted average of the betas of the

individual securities contained in the portfolio.

C. A portfolio beta cannot be computed from the betas of the

individual securities comprising the portfolio because some risk is

eliminated via diversification.

D. A portfolio of U.S. Treasury bills will have a beta of +1.0.

E. The beta of a market portfolio is equal to zero.

Refer to section 13.6

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.6

Topic: Beta

44.

A.

B.

C.

D.

E.

a beta of 1.0.

a beta of 0.0.

a standard deviation of 1.0.

a standard deviation of 0.0.

a variance of 1.0.

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.6

Topic: Beta

45.

estimate the amount of additional reward you will receive for

purchasing a risky asset instead of a risk-free asset?

I. asset's standard deviation

II. asset's beta

III. risk-free rate of return

IV. market risk premium

A.

B.

C.

D.

E.

II and IV only

III and IV only

I, III, and IV only

I, II, III, and IV

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

46.

_____.

A.

B.

C.

D.

E.

beta; alpha

beta; standard deviation

alpha; beta

standard deviation; beta

standard deviation; variance

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.6

Topic: Risk measures

47.

The intercept point of the security market line is the rate of return

which corresponds to:

A.

B.

C.

D.

E.

the market rate.

a return of zero.

a return of 1.0 percent.

the market risk premium.

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Security market line

48.

A stock with an actual return that lies above the security market line

has:

B. more risk than that warranted by CAPM.

C. a higher return than expected for the level of risk assumed.

D. less systematic risk than the overall market.

E. a return equivalent to the level of risk assumed.

Refer to section 13.7

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Security market line

49.

return is 3 percent. Lexant stock has 3 percent less systematic risk

than the market and has an actual return of 12 percent. This stock:

A.

is underpriced.

B.

is correctly priced.

C. will plot below the security market line.

D.

will plot on the security market line.

E. will plot to the right of the overall market on a security market line

graph.

Refer to section 13.7

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Security market line

50.

Which one of the following will be constant for all securities if the

market is efficient and securities are priced fairly?

A.

B.

C.

D.

E.

variance

standard deviation

reward-to-risk ratio

beta

risk premium

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Reward-to-risk ratio

51.

ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of

1.29. This information implies that:

A. stock A is riskier than stock B and both stocks are fairly priced.

B. stock A is less risky than stock B and both stocks are fairly priced.

C. either stock A is underpriced or stock B is overpriced or both.

D. either stock A is overpriced or stock B is underpriced or both.

E. both stock A and stock B are correctly priced since stock A is

riskier than stock B.

Refer to section 13.7

AACSB: Analytic

Blooms: Analyze

Difficulty: 2 Medium

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Reward-to-risk ratio

52.

B. adding the risk-free rate of return to the market rate of return.

C. subtracting the risk-free rate of return from the inflation rate.

D. subtracting the risk-free rate of return from the market rate of

return.

E. multiplying the risk-free rate of return by a beta of 1.0.

Refer to section 13.7

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Market risk premium

53.

The excess return earned by an asset that has a beta of 1.34 over

that earned by a risk-free asset is referred to as the:

A.

B.

C.

D.

E.

risk premium.

systematic return.

total return.

real rate of return.

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Risk premium

54.

the slope of the security market line if the security is priced fairly.

A.

B.

C.

D.

E.

real return

actual return

nominal return

risk premium

expected return

AACSB: Analytic

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Reward-to-risk ratio

55.

following?

I. a risk-free asset has no systematic risk.

II. beta is a reliable estimate of total risk.

III. the reward-to-risk ratio is constant.

IV. the market rate of return can be approximated.

A.

B.

C.

D.

E.

II and IV only

I, III, and IV only

II, III, and IV only

I, II, III, and IV

AACSB: Analytic

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

56.

bearing the risk of an individual security depends upon the:

B. market risk premium and the amount of systematic risk inherent in

the security.

C. risk free rate, the market rate of return, and the standard deviation

of the security.

D. beta of the security and the market rate of return.

E. standard deviation of the security and the risk-free rate of return.

Refer to section 13.7

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Risk premium

57.

Which one of the following should earn the most risk premium based

on CAPM?

B.

stock with a beta of 1.38

C.

stock with a beta of 0.74

D.

U.S. Treasury bill

E.

portfolio with a beta of 1.01

Refer to section 13.7

AACSB: Analytic

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Risk premium

58.

consists of $4,000 invested in stock A with a beta of 1.47 and $3,000

in stock B with a beta of 0.54. You have another $9,000 to invest and

want to divide it between an asset with a beta of 1.74 and a risk-free

asset. How much should you invest in the risk-free asset?

A.

B.

C.

D.

E.

$3,965.52

$4,425.29

$4,902.29

$5,034.48

$5,683.92

+ (x/$16,000)(1.74) + (($9,000 - x)/$16,000)(0); Investment in riskfree asset = $9,000 - $3,965.52 = $5,034.48

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.2 and 13.6

Topic: Portfolio beta

59.

a risk-free asset. $5,000 is invested in stock A. Stock A has a beta of

1.76 and stock B has a beta of 0.89. How much needs to be invested

in stock B if you want a portfolio beta of 1.10?

A.

B.

C.

D.

E.

$3,750.00

$4,333.33

$4,706.20

$4,943.82

$5,419.27

(($12,000 - $5,000 - x)/$12,000)(0); x = $4,943.82

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.2 and 13.6

Topic: Portfolio beta

60.

a booming economy, 9 percent in a normal economy, and lose 33

percent in a recessionary economy. There is a 5 percent probability of

a boom and a 75 percent chance of a normal economy. What is your

expected rate of return on this stock?

A.

B.

C.

D.

E.

-3.40 percent

-2.25 percent

1.65 percent

2.60 percent

3.50 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Expected return

61.

percent in a recession, 6 percent in a normal economy, and lose 4

percent in a booming economy. The probability of a boom is 5

percent while the probability of a recession is 45 percent. What is the

expected rate of return on this stock?

A.

B.

C.

D.

E.

8.52

8.74

8.65

9.05

9.28

percent

percent

percent

percent

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Expected return

62.

information, what is the difference in the expected returns of these

two securities?

A.

B.

C.

D.

E.

-0.85 percent

2.70 percent

3.05 percent

13.45 percent

13.55 percent

E(r)B = (0.45 0.17) + (0.55 -0.31) = -9.40 percent

Difference = -6.70 percent - (-9.40 percent) = 2.70 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Expected return

63.

Jerilu Markets has a beta of 1.09. The risk-free rate of return is 2.75

percent and the market rate of return is 9.80 percent. What is the risk

premium on this stock?

A.

B.

C.

D.

E.

6.47

7.03

7.68

8.99

9.80

percent

percent

percent

percent

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.1

Topic: Risk premium

64.

return 16.5 percent. If the economy falls into a recession, the stock's

return is projected at a negative 11.6 percent. The probability of a

normal economy is 80 percent while the probability of a recession is

20 percent. What is the variance of the returns on this stock?

A.

B.

C.

D.

E.

0.010346

0.012634

0.013420

0.013927

0.014315

Var = 0.80 (0.165 - 0.1088)2 + 0.20 (-0.116 - 0.1088)2 = 0.012634

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Variance

65.

expected to be 21 percent in a boom economy, 11 percent in a

normal economy, and only 3 percent in a recessionary economy. The

probabilities of these economic states are 10 percent for a boom, 70

percent for a normal economy, and 20 percent for a recession. What

is the variance of the returns on this common stock?

A.

B.

C.

D.

E.

0.002150

0.002606

0.002244

0.002359

0.002421

Var = 0.10 (0.21 - 0.104)2 + 0.70 (0.11 - 0.104)2 + 0.20 (0.03 0.104)2 = 0.002244

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Variance

66.

The returns on the common stock of New Image Products are quite

cyclical. In a boom economy, the stock is expected to return 32

percent in comparison to 14 percent in a normal economy and a

negative 28 percent in a recessionary period. The probability of a

recession is 25 percent while the probability of a boom is 20 percent.

What is the standard deviation of the returns on this stock?

A.

B.

C.

D.

E.

21.41

21.56

25.83

32.08

39.77

percent

percent

percent

percent

percent

Var = 0.20 (0.32 - 0.071)2 + 0.55 (0.14 - 0.071)2 + 0.25 (-0.28 0.071)2 = 0.045819

Std dev = 0.045819 = 21.41 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Standard deviation

67.

following information?

A.

B.

C.

D.

E.

1.57

2.03

2.89

3.42

4.01

percent

percent

percent

percent

percent

Var = 0.30 (0.15 - 0.126)2 + 0.65 (0.12 - 0.126)2 + 0.05 (0.06 0.126)2 = 0.000414

Std dev = 0.000414 = 2.03 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Standard deviation

68.

portfolio has an expected return of 9.8 percent. Stock A has an

expected return of 11.4 percent while stock B is expected to return

6.4 percent. What is the portfolio weight of stock A?

A.

B.

C.

D.

E.

59

68

74

81

87

percent

percent

percent

percent

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Portfolio weight

69.

You own the following portfolio of stocks. What is the portfolio weight

of stock C?

A.

B.

C.

D.

E.

39.85

42.86

44.41

48.09

52.65

percent

percent

percent

percent

percent

$18) + (100 $47)] = $10,800/$27,100 = 39.85 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Portfolio weight

70.

You own a portfolio with the following expected returns given the

various states of the economy. What is the overall portfolio expected

return?

A.

B.

C.

D.

E.

6.49 percent

8.64 percent

8.87 percent

9.86 percent

10.23 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Expected return

71.

percent in stock A, 55 percent in stock B, and the remainder in stock

C?

A.

B.

C.

D.

E.

-1.06 percent

2.38 percent

2.99 percent

5.93 percent

6.10 percent

E(r)Normal = (0.25 0.11) + (0.55 0.08) + (0.20 0.13) = .0975

E(r)Bust = (0.25 -0.23) + (0.55 0.05) + (0.20 0.25) = 0.02

E(r)Portfolio = (0.05 0.109) + (0.45 0.0975) + (0.50 0.02) = 5.93

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Expected return

72.

A.

B.

C.

D.

E.

11.48

12.37

13.03

13.42

13.97

percent

percent

percent

percent

percent

+ $5,000 + $11,400 = $24,800; E(r) = ($8,400/$24,800) (0.12) +

($5,000/$24,800) (0.07) + ($11,400/$24,800) (0.15) = 12.37 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Expected return

73.

between stocks K and L given the following information?

A.

B.

C.

D.

E.

11.13

11.86

12.25

13.32

14.40

percent

percent

percent

percent

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Expected return

74.

stock M and $4,500 of stock N if the economy enjoys a boom period?

A.

B.

C.

D.

E.

10.93

11.16

12.55

12.78

13.69

percent

percent

percent

percent

percent

$4,500)] [0.05] = 13.69 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Expected return

75.

percent in stock S and 40 percent in stock T?

A.

B.

C.

D.

E.

.000017

.000023

.000118

.000136

.000161

E(r)Normal = (0.60 0.13) + (0.40 0.10) = 0.118

E(r)Portfolio = (0.20 0.13) + (0.80 0.118) = 0.1204

VarPortfolio = 0.20 (0.13 - 0.1204)2] + 0.80 (0.118 - 0.1204)2 = .000023

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 13-02 The impact of diversification.

Section: 13.2

Topic: Variance

76.

of stock G and $6,600 of stock H?

A.

B.

C.

D.

E.

.000709

.000848

.001475

.001554

.001568

$6,600)][0 .13] = 0.166

E(r)Normal = [$5,400/($5,400 + $6,600)][0.13] + [$6,600/($5,400 +

$6,600)][0.05] = 0.086

E(r)Portfolio = (0.36 0.166) + (0.64 0.086) = 0.1148

VarPortfolio = [0.36 (0.166 - 0.1148)2] + [0.64 (0.086 - 0.1148)2] =

0.001475

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Variance

77.

invested 52 percent in stock Q and 48 percent in stock R?

A.

B.

C.

D.

E.

1.66

2.47

2.63

3.28

3.41

percent

percent

percent

percent

percent

E(r)Normal = (0.52 0.08) + (0.48 0.11) = 0.0944

E(r)Portfolio = (0.10 .0.1496) + (0.90 0.0944) = 0.09992

VarPortfolio = [0.10 (0.1496 - 0.09992)2] + [0.90 (0.0944 0.09992)2] = 0.000274

Std dev = 0.000274 = 1.66 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Standard deviation

78.

which consists of stocks S and T? Stock S is valued at $21,000.

A.

B.

C.

D.

E.

2.07

2.61

3.36

3.49

3.63

percent

percent

percent

percent

percent

[0.05] = 0.092

E(r)Normal = [$21,000/$30,000] [0.08] + [($30,000 - $21,000)/$30,000]

[0.06] = 0.074

E(r)Bust = [$21,000/$30,000] [-0.05] + [($30,000 - $21,000)/$30,000]

[0.08] = -0.011

E(r)Portfolio = (0.05 0.092) + (0.85 0.074) + (0.10 -0.011) =

0.0664

VarPortfolio = [0.05 (0.074 - 0.0664)2] + [0.85 (0.068 - 0.0664)2] +

[0.10 (0.028 - 0.0664)2] = .000680940

Std dev = 0.000680940 = 2.61 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Standard deviation

79.

invested in stocks A, B, and C? Twenty five percent of the portfolio is

invested in stock A and 40 percent is invested in stock C.

A.

B.

C.

D.

E.

6.31

6.49

7.40

7.83

8.72

percent

percent

percent

percent

percent

E(r)Normal = (0.25 0.08) + (0.35 0.10) + (0.40 0.15) = 0.115

E(r)Bust = (0.25 -0.03) + (0.35 0.19) + (0.40 -0.25) = -0.041

E(r)Portfolio = (0.05 0.1515) + (0.55 0.115) + (0.40 -0.041) =

0.054425

VarPortfolio = [0.05 (0.1515 - 0.054425)2] + [0.55 (0.115 0.054425)2] + [0.40 (-0.041 - 0.054425)2] = 0.006132

Std dev = .006132 = 7.83 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Standard deviation

80.

A.

B.

C.

D.

E.

.95

1.01

1.05

1.09

1.23

BetaPortfolio = ($6,700/$18,200 1.41) + ($4,900/$18,200 1.23) +

($8,500/$18,200 0.79) = 1.09

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.6

Topic: Beta

81.

stock Y, and 45 percent of stock Z. Stock X has a beta of 1.16, stock Y

has a beta of 1.47, and stock Z has a beta of 0.42. What is the beta

of your portfolio?

A.

B.

C.

D.

E.

0.87

1.09

1.13

1.18

1.21

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.6

Topic: Beta

82.

U.S. Treasury bills, 30 percent stock A, and 30 percent stock B. Stock

A has a risk-level equivalent to that of the overall market. What is the

beta of stock B?

A.

B.

C.

D.

E.

1.47

1.52

1.69

1.84

2.73

The beta of a risk-free asset is zero. The beta of the market is 1.0.

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.6

Topic: Beta

83.

You would like to combine a risky stock with a beta of 1.68 with U.S.

Treasury bills in such a way that the risk level of the portfolio is

equivalent to the risk level of the overall market. What percentage of

the portfolio should be invested in the risky stock?

A.

B.

C.

D.

E.

32

40

54

60

68

percent

percent

percent

percent

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.6

Topic: Beta

84.

The market has an expected rate of return of 11.2 percent. The longterm government bond is expected to yield 5.8 percent and the U.S.

Treasury bill is expected to yield 3.9 percent. The inflation rate is 3.6

percent. What is the market risk premium?

A.

B.

C.

D.

E.

6.0

7.3

7.6

8.5

9.3

percent

percent

percent

percent

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: Risk premium

85.

The risk-free rate of return is 3.9 percent and the market risk

premium is 6.2 percent. What is the expected rate of return on a

stock with a beta of 1.21?

A.

B.

C.

D.

E.

10.92

11.40

12.22

12.47

12.79

percent

percent

percent

percent

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

86.

percent. The return on the market is 10.8 percent and the risk-free

rate of return is 3.8 percent. What is the beta of this stock?

A.

B.

C.

D.

E.

.92

1.23

1.33

1.41

1.56

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

87.

expected return of 14.29 percent. The risk-free rate of return is 3.7

percent. What is the expected market risk premium?

A.

B.

C.

D.

E.

7.02 percent

7.90 percent

10.63 percent

11.22 percent

11.60 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

88.

return on the market is 11.34 percent. The stock's beta is 1.51. What

is the risk-free rate of return?

A.

B.

C.

D.

E.

2.22

2.31

2.42

2.50

2.63

percent

percent

percent

percent

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

89.

Thayer Farms stock has a beta of 1.12. The risk-free rate of return is

4.34 percent and the market risk premium is 7.92 percent. What is

the expected rate of return on this stock?

A.

B.

C.

D.

E.

8.35 percent

9.01 percent

10.23 percent

13.21 percent

13.73 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

90.

actual expected return of 15.26 percent. The risk-free rate of return is

4.3 percent and the market rate of return is 12.01 percent. Which one

of the following statements is true given this information?

A. The actual expected stock return will graph above the Security

Market Line.

B.

The stock is underpriced.

C. To be correctly priced according to CAPM, the stock should have an

expected return of 21.95 percent.

D. The stock has less systematic risk than the overall market.

E. The actual expected stock return indicates the stock is currently

underpriced.

E(r) = 0.043 + 1.14 (0.1201 - 0.043) = 13.09 percent

The stock is underpriced because its actual expected return is greater

than the CAPM return.

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

91.

rate of return is 3.7 percent and the market risk premium is 8.8

percent?

A.

B.

C.

D.

E.

A

B

C

D

E

E(r)B = 0.037 + (0.97 0.088) = 0.1224

E(r)C = 0.037 + (1.22 0.088) = 0.1444 Stock C is correctly priced.

E(r)D = 0.037 + (1.37 0.088) = 0.1576

E(r)E = 0.037 + (1.68 0.088) = 0.1848

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

92.

rate of return is 3.2 percent and the market rate of return is 11.76

percent?

A.

B.

C.

D.

E.

A

B

C

D

E

E(r)B = 0.0354 + [1.09 (0.1176 - 0.0354)] = 0.1250 Stock B is

correctly priced.

E(r)C = 0.0354 + [1.18 (0.1176 - 0.0354)] = 0.1324

E(r)D = 0.0354 + [1.34 (0.1176 - 0.0354)] = 0.1456

E(r)E = 0.0354 + [1.62 (0.1176 - 0.0354)] = 0.1686

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

93.

You own a portfolio that has $2,000 invested in Stock A and $3,500

invested in Stock B. The expected returns on these stocks are 14

percent and 9 percent, respectively. What is the expected return on

the portfolio?

A.

B.

C.

D.

E.

10.06

10.50

10.82

11.13

11.41

percent

percent

percent

percent

percent

$3,500)] [0.09] = 10.82 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

EOC: 13-2

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.1

Topic: Expected return

94.

You have $10,000 to invest in a stock portfolio. Your choices are Stock

X with an expected return of 13 percent and Stock Y with an

expected return of 8 percent. Your goal is to create a portfolio with an

expected return of 12.4 percent. All money must be invested. How

much will you invest in stock X?

A.

B.

C.

D.

E.

$800

$1,200

$4,600

$8,800

$9,200

Investment in Stock X = 0.88($10,000) = $8,800

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

EOC: 13-4

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Expected return

95.

What is the expected return and standard deviation for the following

stock?

A.

B.

C.

D.

E.

15.49 percent; 14.67 percent

18.80 percent; 14.95 percent

18.80 percent; 15.74 percent

18.80 percent'; 16.01 percent

2 = 0.10(-0.19 - 0.188)2 + 0.60(0.17 - 0.188)2 + 0.30(0.35 - 0.188)2

= 0.022356

= 0.022356 = 14.95 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

EOC: 13-7

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Standard deviation

96.

comprised of the following three stocks?

A.

B.

C.

D.

E.

16.33

18.60

19.67

20.48

21.33

percent

percent

percent

percent

percent

E(Rp)Bust = (0.15 + 0.11 + 0.17)/3 = 0.1433

E(Rp) = 0.64(0.21) + 0.36(0.1433) = 18.60 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

EOC: 13-9

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Expected return

97.

percent in Stock B. What is the standard deviation of your portfolio

given the following information?

A.

B.

C.

D.

E.

12.38

12.64

12.72

12.89

13.97

percent

percent

percent

percent

percent

E(Rp)Good = 0.3(0.10) + 0.4(0.13) + 0.3(0.11) = 0.115

E(Rp)Poor = 0.3(0.03) + 0.4(0.05) + 0.3(0.05) = 0.044

E(Rp)Bust = 0.3(-0.04) + 0.4(-0.09) + 0.3(-0.09) = -0.075

E(Rp) = 0.25(0.31) + 0.25(0.115) + 0.25(0.044) + 0.25(-0.075) =

0.0985

p2 = 0.25(0.31 - 0.0985)2 + 0.25(0.115 - 0.0985)2 + 0.25(0.044 0.0985)2 + 0.25(-0.075 - 0.0985)2 = 0.019519250

p = 0.019519250 = 13.97 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

EOC: 13-10

Learning Objective: 13-01 How to calculate expected returns.

Section: 13.2

Topic: Standard deviation

98.

stocks. One of the stocks has a beta of 1.9 and the total portfolio is

equally as risky as the market. What is the beta of the second stock?

A.

B.

C.

D.

E.

0.75

0.80

0.94

1.00

1.10

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

EOC: 13-12

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.6

Topic: Beta

99.

percent, and the market risk premium is 5 percent. What is the

stock's beta?

A.

B.

C.

D.

E.

1.08

1.16

1.29

1.32

1.35

AACSB: Analytic

Blooms: Analyze

Difficulty: 1 Easy

EOC: 13-14

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

risk-free asset currently earns 5.1 percent. The beta of a portfolio

comprised of these two assets is 0.85. What percentage of the

portfolio is invested in the stock?

A.

B.

C.

D.

E.

71

77

84

89

92

percent

percent

percent

percent

percent

AACSB: Analytic

Blooms: Apply

Difficulty: 1 Easy

EOC: 13-17

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

percent in Stock C. What is the expected risk premium on the

portfolio if the expected T-bill rate is 3.3 percent?

A.

B.

C.

D.

E.

11.47

12.38

16.67

24.29

25.82

percent

percent

percent

percent

percent

E(Rp)Normal = 0.35(0.31) + 0.35(0.18) + 0.30(0.04) = 0.1835

E(Rp)Bust = 0.35(0.17) + 0.35(-0.17) + 0.30(-0.64) = -0.192

E(Rp) = 0.45(0.51) + 0.50(0.229) + 0.05(-0.122) = 0.2912

RPi = 0.2912 - 0.033 = 29.99 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

EOC: 13-23

Learning Objective: 13-02 The impact of diversification.

Section: 13.1

Topic: Portfolio risk premium

what is the return on the market?

A.

B.

C.

D.

E.

13.99

14.42

14.67

14.78

15.01

percent

percent

percent

percent

percent

RM: 0.12 = 0.0133 + 0.8(RM - 0.0133); RM = 14.67 percent

AACSB: Analytic

Blooms: Apply

Difficulty: 2 Medium

EOC: 13-27

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

The market risk premium is 8 percent, and the risk-free rate is 3.6

percent. The beta of stock I is _____ and the beta of stock II is _____.

A.

B.

C.

D.

E.

2.08;

2.08;

3.21;

4.47;

4.03;

2.47

2.76

3.84

3.89

3.71

BI: 0.358 = 0.036 + BI (0.08); BI = 4.03

E(RII) = 0.06(-0.35) + 0.69(0.35) + 0.25(0.45) = 0.333

BII: 0.333 = 0.036 + BII (0.08); BII = 3.71

AACSB: Analytic

Blooms: Analyze

Difficulty: 2 Medium

EOC: 13-26

Learning Objective: 13-04 The security market line and the risk-return trade-off.

Section: 13.7

Topic: CAPM

Assume the capital asset pricing model holds and stock A's beta is

greater than stock B's beta by 0.21. What is the expected market risk

premium?

A.

B.

C.

D.

E.

8.8 percent

9.5 percent

12.6 percent

17.9 percent

20.0 percent

E(RB) = 0.22(-0.27) + 0.48(0.05) + 0.30(0.28) = .0486

SlopeSML = (.0906 - 0.0486)/0.21 = 20 percent

AACSB: Analytic

Blooms: Analyze

Difficulty: 2 Medium

EOC: 13-28

Learning Objective: 13-03 The systematic risk principle.

Section: 13.7

Topic: Security market line

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