EF5052 Homework01: Ch.

5 & 6

1. A year ago, you invested $1,000 in Citibank’s savings account that pays an
annual interest rate of 9%. What is your approximate annual real rate of return
if the rate of inflation was 4% over the year?
A) 5%
B) 10%
C) 7%
D) 3%
E) 1%

2. Assuming the annual real rate of interest is 4% and the expected inflation rate
is 16%, the nominal rate of interest would be approximately:
A) 1%.
B) 8%.
C) 20%.
D) 15%.
E) none of the above.

3. Today, you purchase a share of stock for $15. One year later you received $1
as dividend and sold the share for $29. What was your holding period return?
A) 45%
B) 50%
C) 5%
D) 100%
E) none of the above

4. Which of the following determine(s) the level of real interest rates?

I) the supply of savings by households and business firms
II) the demand for investment funds
III) the government's net supply and/or demand for funds

A) I only
B) II only
C) I and II only
D) I, II, and III (all of the above)
E) none of the above

5. In our class, the historical records regarding return on stocks, Treasury bonds,
and Treasury bills between 1926 and 2015 show that:
A) stocks offered investors greater rates of return than bonds and bills.
B) stock returns were less volatile than those of bonds and bills.
C) bonds offered investors greater rates of return than stocks and bills.
D) bills outperformed stocks and bonds.
E) treasury bills always offered a rate of return greater than inflation.

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 EF5052 Homework01: Ch. 5 & 6

Use the following to answer questions 6-8:

You have been given this probability distribution for the holding period return for
ABC stock:

S tate o f th e E co n o m y P ro b ab ility H PR
B oom .3 0 18%
N o rm al g ro w th .5 0 12%
R ecessio n .2 0 - 5%

6. What is the expected holding period return for ABC stock?

A) 11.67%
B) 8.33%
C) 10.4%
D) 12.4%
E) 7.88%

7. What is the expected standard deviation for ABC stock?

A) 2.07%
B) 9.96%
C) 7.04%
D) 1.44%
E) 8.13%

8. What is the expected variance for ABC stock?

A) 72.07%
B) 69.96%
C) 77.04%
D) 66.04%
E) 68.13%

9. Over the past year you earned a nominal rate of interest of 14 percent on your
money. The inflation rate was 2 percent over the same period. The exact
actual growth rate of your purchasing power was
A) 12.00%.
B) 16.00%.
C) 15.02%.
D) 14.32%.
E) 11.76%

10. You purchased a share of stock for $65. One year later you received $2.37 as
dividend and sold the share for $63. What was your holding period return?
A) -4.5%
B) -0.2550%
C) 0.89%
D) 0.57%
E) none of the above

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 EF5052 Homework01: Ch. 5 & 6

Use the following to answer questions 11-12:

Consider the following two investment alternatives. First, a risky portfolio that pays a
15 percent rate of return with a probability of 60% or a 5 percent return with a
probability of 40%, and second, a T-bill that pays 6 percent.

11. The risk premium on the risky investment is

A) 11 percent.
B) 1 percent.
C) 9 percent.
D) 5 percent.
E) none of the above.

12. If you invest $50,000 in the risky portfolio, your expected profit would
be__________.
A) $5,500
B) $7,500
C) $25,000
D) $3,000
E) none of the above

Use the following to answer questions 13-14:

Assume an investor with the following utility function: U = E(r) - 3/2(s2).

13. To maximize her expected utility, she would choose the asset with an expected
rate of return of _______ and a standard deviation of ________, respectively.
A) 12%; 20%
B) 10%; 15%
C) 10%; 10%
D) 8%; 10%
E) none of the above

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 EF5052 Homework01: Ch. 5 & 6

14. To maximize her expected utility, which one of the following investment
alternatives would she choose?
A) A portfolio that pays 10 percent with a 60 percent probability or 5 percent
with 40 percent probability.
B) A portfolio that pays 10 percent with 40 percent probability or 5 percent
with a 60 percent probability.
C) A portfolio that pays 12 percent with 60 percent probability or 5 percent
with 40 percent probability.
D) A portfolio that pays 12 percent with 40 percent probability or 5 percent
with 60 percent probability.
E) none of the above.

15. According to the mean-variance criterion, which one of the following

investments dominates all others?
A) E(r) = 0.15; Variance = 0.20
B) E(r) = 0.10; Variance = 0.20
C) E(r) = 0.10; Variance = 0.25
D) E(r) = 0.15; Variance = 0.25
E) none of these is dominates the other alternatives.

16. Consider a risky portfolio, A, with an expected rate of return of 0.15 and a
standard deviation of 0.15, that lies on a given indifference curve. Which one
of the following portfolios might lie on the same indifference curve?
A) E(r) = 0.15; Standard deviation = 0.20
B) E(r) = 0.15; Standard deviation = 0.10
C) E(r) = 0.10; Standard deviation = 0.10
D) E(r) = 0.20; Standard deviation = 0.15
E) E(r) = 0.10; Standard deviation = 0.20

17. The exact indifference curves of different investors

A) cannot be known with perfect certainty.
B) can be calculated precisely with the use of advanced calculus.
C) although not known with perfect certainty, do allow the advisor to create
more suitable portfolios for the client.
D) A and C.
E) none of the above.

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 EF5052 Homework01: Ch. 5 & 6

18. The standard deviation of a portfolio that has 20% of its value invested in a
risk-free asset and 80% of its value invested in a risky asset with a standard
deviation of 20% is ____%.
A) 18
B) 14
C) 12
D) 20
E) 16

19. If the standard deviation of stock 'X' is 30, the standard deviation of stock 'Y'
is 30, and the correlation between stocks 'X' and 'Y' is 0.8, the covariance
between stocks 'X' and 'Y' is ___.
A) 900
B) 24
C) 720
D) 30
E) 642

20. Assume that a portfolio is invested in three securities. Security 'X' has an
expected return of 8%, security 'Y' has an expected return of 10%, and security
'Z' has an expected return of 14%. If the portfolio weights are 20%, 40%, and
40% respectively, the expected return on the portfolio should be ___%.
A) 11.2
B) 12.4
C) 10.7
D) 9.8
E) none of the above

END