Chapter 05 Risk and Return: Past and Prologue

5/25/2018 Chapter 05 Risk and Return: Past and Prologue

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Chapter 05 - Risk and Return: Past and Prologue

Chapter 05

Chapter 05 Risk and Return: Past and Prologue Answer Key

Multiple Choice Questions

1. You put up $50 at the eginning o! the year !or an in"est#ent. he "alue o! the in"est#entgrows %& and you earn a di"idend o! $'.50. Your (PR was )))).A.%.00&*.'.50&C.+.00&

D.11.00&

Difficulty: Medium

,. he )))))) #easure o! returns ignores o#pounding.

A.geo#etri a"erageB.arith#eti a"erageC.RR/.dollar weighted

Difficulty: Easy

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Difficulty: Medium

%. hih one o! the !ollowing #easure ti#e weighted returns. 2eo#etri a"erage return. Arith#eti a"erage return. /ollar weighted returnA. only*. onlyC. and only/. and only

Difficulty: Medium

5. Rank the !ollowing !ro# highest a"erage historial return to lowest a"erage historialreturn !ro# 13,4-,00.. 6#all stoks. 7ong ter# onds. 7arge stoks8. -illsA.9 9 9 8

*.9 89 9 C.9 9 9 8/.9 9 9 8

Difficulty: Medium

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4. Rank the !ollowing !ro# highest a"erage historial standard de"iation to lowest a"eragehistorial standard de"iation !ro# 13,4-,00.. 6#all stoks. 7ong ter# onds

. 7arge stoks8. -illsA.9 9 9 8*.9 89 9 C.9 9 9 8/.9 9 9 8

Difficulty: Medium

+. You ha"e alulated the historial dollar weighted return9 annual geo#etri a"erage returnand annual arith#eti a"erage return. ! you desire to !oreast per!or#ane !or net year9 theest !oreast will e gi"en y the )))))))).A.dollar weighted return*.geo#etri a"erage returnC.arith#eti a"erage return/.inde return

Difficulty: Medium

. he o#plete port!olio re!ers to the in"est#ent in ))))))))).A.the risk-!ree asset*.the risky port!olioC.the risk-!ree asset and the risky port!olio o#ined/.the risky port!olio and the inde

Difficulty: Easy

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3. You ha"e alulated the historial dollar weighted return9 annual geo#etri a"erage returnand annual arith#eti a"erage return. You always rein"est your di"idends and interest earnedon the port!olio. hih #ethod pro"ides the est #easure o! the atual a"erage historialper!or#ane o! the in"est#ents you ha"e hosen

A./ollar weighted returnB.2eo#etri a"erage returnC.Arith#eti a"erage return/.nde return

Difficulty: Medium

10. he holding period return on a stok is e;ual to ))))))))).A.the apital gain yield o"er the period plus the in!lation rate

B.the apital gain yield o"er the period plus the di"idend yieldC.the urrent yield plus the di"idend yield/.the di"idend yield plus the risk pre#iu#

Difficulty: Easy

Difficulty: Medium

1,. Pulished data on past returns earned y #utual !unds are re;uired to e )))))).A.dollar weighted returnsB.geo#etri returnsC.eess returns/.inde returns

Difficulty: Medium

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1'. he arith#eti a"erage o! -11&9 15& and ,0& is )))))))).A.15.4+&B..00&C.11.,,&

/.4.%5&

Difficulty: Easy

1%. he geo#etri a"erage o! -1,&9 ,0& and ,5& is ))))))))).

A..%,&*.11.00&C.3.+0&/.1.&

Difficulty: Medium

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14. An in"est#ent earns 10& the !irst year9 15& the seond year and loses 1,& the third year.Your total o#pound return o"er the three years was )))))).A.%1.4&B.11.',&

C.'.4%&/.1'.00&


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13. 6uppose you pay $3900 !or a $109000 par reasury ill #aturing in two #onths. hat isthe annual perentage rate o! return !or this in"est#entA.,.0%&*.1,.00 &

C.1,.,%&/.1,.3&

Difficulty: Medium

,0. 6uppose you pay $39%00 !or a $109000 par reasury ill #aturing in si #onths. hat isthe e!!eti"e annual rate o! return !or this in"est#entA.4.'&*.1,.++&C.1'.1+&/.1%.,5&

Difficulty: Medium

Difficulty: Medium

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Difficulty: Medium

,'. he #arket risk pre#iu# is de!ined as )))))))))).A.the di!!erene etween the return on an inde !und and the return on reasury ills*.the di!!erene etween the return on a s#all !ir# #utual !und and the return on the6tandard and Poors 500 indeC.the di!!erene etween the return on the risky asset with the lowest returns and the returnon reasury ills/.the di!!erene etween the return on the highest yielding asset and the lowest yielding asset

Difficulty: Easy

,%. he eess return is the ))))))))).A.rate o! return that an e earned with ertaintyB.rate o! return in eess o! the reasury ill rateC.rate o! return to risk a"ersion/.inde return

Difficulty: Easy

,5. he rate o! return on ))))) is known at the eginning o! the holding period while the rateo! return on )))) is not known until the end o! the holding period.A.risky assets9 reasury illsB.reasury ills9 risky assetsC.eess returns9 risky assets/.inde assets9 onds

Difficulty: Medium

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,4. he reward@"ariaility ratio is gi"en y ))))))))).A.the slope o! the apital alloation line*.the seond deri"ati"e o! the apital alloation lineC.the point at whih the seond deri"ati"e o! the in"estors indi!!erene ur"e reahes Bero

/.port!olio eess return

Difficulty: Easy

,+. Your in"est#ent has a ,0& hane o! earning a '0& rate o! return9 a 50& hane o!earning a 10& rate o! return and a '0& hane o! losing 4&. hat is your epeted return onthis in"est#entA.1,.&*.11.0&

C..3&D.3.,&


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,3. /uring the 13,4 to ,00 period the geo#etri #ean return on s#all !ir# stoks was)))))).A.5.'1&*.5.54&

C.3.'%&D.11.%'&

Difficulty: Medium

'0. /uring the 13,4 to ,00 period the geo#etri #ean return on reasury ills was))))))))).A.5.'1&*.5.54&

C.3.'%&/.11.%'&

Difficulty: Medium

'1. /uring the 13,4 to ,00 period the 6harpe ratio was greatest !or whih o! the !ollowingasset lassesA.6#all .6. stoksB.7arge .6. stoks

C.7ong-er# .6. reasury *onds/.*ond orld port!olio return in .6. dollars

Difficulty: Medium

',. /uring the 135 to ,00 period the 6harpe ratio was greatest !or whih o! the !ollowingasset lassesA.6#all .6. stoks*.7arge .6. stoks

C.7ong-er# .6. reasury *ondsD.D;uity world port!olio in .6. dollars

Difficulty: Hard

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''. /uring the 13,4 to ,00 period whih one o! the !ollowing asset lasses pro"ided thelowest real returnA.6#all .6. stoks*.7arge .6. stoks

C.7ong-er# .6. reasury *onds/.D;uity world port!olio in .6. dollars

Difficulty: Medium

'%. *oth in"estors and ga#lers take on risk. he di!!erene etween an in"estor and aga#ler is that an in"estor ))))))).A.is nor#ally risk neutralB.re;uires a risk pre#iu# to take on the risk

C.knows he or she will not lose #oney/.knows the outo#es at the eginning o! the holding period

Difficulty: Easy

'5. (istorial returns ha"e generally een )))))))))) !or stoks o! s#all !ir#s as@than !orstoks o! large !ir#s.A.the sa#e*.lower

C.higher/.here is no e"idene o! a syste#ati relationship etween returns on s#all !ir# stoks andreturns on s#all !ir# stoks

Difficulty: Easy

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'4. (istorially s#all !ir# stoks ha"e earned higher returns than large !ir# stoks. hen"iewed in the ontet o! an e!!iient #arket9 this suggests that ))))))))))).A.s#all !ir#s are etter run than large !ir#s*.go"ern#ent susidies a"ailale to s#all !ir#s produe e!!ets that are disernile in stok

#arket statistisC.s#all !ir#s are riskier than large !ir#s/.s#all !ir#s are not eing aurately represented in the data

Difficulty: Medium

'+. hen alulating the "ariane o! a port!olios returns s;uaring the de"iations !ro# the#ean results in )))))))).. pre"enting the su# o! the de"iations !ro# always e;ualing Bero

. eaggerating the e!!ets o! large positi"e and negati"e de"iations. a nu#er in units o! perentage o! returnsA. onlyB. and onlyC. and only/.9 and

Difficulty: Medium

'. ! you are pro#ised a no#inal return o! 1,& on a one year in"est#ent9 and you epet therate o! in!lation to e '&9 what real rate do you epet to earnA.5.%&B..+%&C.3.00&/.1,.00&

Difficulty: Medium

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'3. ! you re;uire a real growth in the purhasing power o! your in"est#ent o! &9 and youepet the rate o! in!lation o"er the net year to e '&9 what is the lowest no#inal return thatyou would e satis!ied withA.'.00&

*..00&C.11.00&D.11.,%&

Difficulty: Medium

%0. Ene #ethod to !oreast the risk pre#iu# is to use the ))))))).A.oe!!iient o! "ariation o! analysts earnings !oreasts*."ariations in the risk !ree rate o"er ti#eC.a"erage historial eess returns !or the asset under onsideration/.a"erage anor#al return on the inde port!olio

Difficulty: Medium

%1. reasury ills are paying a %& rate o! return. A risk a"erse in"estor with a risk a"ersion o!

A > ' should in"est in a risky port!olio with a standard de"iation o! ,%& only i! the riskyport!olios epeted return is at least )))))).A..4+&*.3.%&C.1,.4%&/.1%.4&

Difficulty: Hard

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%,. n the #ean-standard de"iation graph9 the line that onnets the risk-!ree rate and theopti#al risky port!olio9 P9 is alled ))))))))).A.the apital alloation line*.the indi!!erene ur"e

C.the in"estors utility line/.the seurity #arket line

Difficulty: Medium

%'. Fost studies indiate that in"estors risk a"ersion is in the range ))))).A.1-'B.,-%C.'-5

/.%-4

Difficulty: Medium

%%. wo assets ha"e the !ollowing epeted returns and standard de"iations when the risk-!reerate is 5&:

An in"estor with a risk a"ersion o! A > ' would !ind that ))))))))))))))))) on a riskreturn asis.A.only Asset A is aeptale*.only Asset * is aeptaleC.neither Asset A nor Asset * is aeptale/.oth Asset A and Asset * are aeptale

Difficulty: Hard

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%5. (istorially the est asset !or the long ter# in"estor wanting to !end o!! the threats o!in!lation and taes while #aking his #oney grow has een )))).A.stoks*.onds

C.#oney #arket !unds/.reasury ills

Difficulty: Easy

%4. he !or#ula is used to alulate the ))))))))))))).A.6harpe #easure

*.reynor #easureC.Coe!!iient o! "ariation/.Real rate o! return

Difficulty: Easy

%+. A port!olio with a ,5& standard de"iation generated a return o! 15& last year when -ills were paying %.5&. his port!olio had a 6harpe #easure o! )))).A.0.,,

*.0.40C.0.%,/.0.,5

Difficulty: Medium

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%. Consider a treasury ill with a rate o! return o! 5& and the !ollowing risky seurities:6eurity A: D .15G "ariane > .0%006eurity *: D .10G "ariane > .0,,56eurity C: D .1,G "ariane > .1000

6eurity /: D .1'G "ariane > .04,5he in"estor #ust de"elop a o#plete port!olio y o#ining the risk-!ree asset with one o!the seurities #entioned ao"e. he seurity the in"estor should hoose as part o! hiso#plete port!olio to ahie"e the est CA7 would e ))))))))).A.seurity A*.seurity *C.seurity C/.seurity /

A has the steepest slopeG !ound as:

Difficulty: Medium

%3. You purhased a share o! stok !or $,3. Ene year later you reei"ed $,.,5 as di"idend andsold the share !or $,. Your holding-period return was ))))))))).A.-'.5+&*.- '.%5&C.%.'1&

/..0'&

Difficulty: Medium

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50. 6eurity A has a higher standard de"iation o! returns than 6eurity *. e would epetthat )))))).. 6eurity A would ha"e a higher risk pre#iu# than 6eurity *. the likely range o! returns !or 6eurity A in any gi"en year would e higher than the likely

range o! returns !or 6eurity *. the 6harpe #easure o! A will e higher than the 6harpe #easure o! *.A. onlyB. and onlyC. and only/.9 and

Difficulty: Medium

51. he holding period return on a stok was ,5&. ts ending prie was $1 and its eginningprie was $14. ts ash di"idend #ust ha"e een ))))))))).A.$0.,5*.$1.00C.$,.00/.$%.00

Difficulty: Medium

5,. An in"estor in"ests +0& o! her wealth in a risky asset with an epeted rate o! return o!15& and a "ariane o! 5& and she puts '0& in a reasury ill that pays 5&. (er port!oliosepeted rate o! return and standard de"iation are )))))))))) and )))))))))) respeti"ely.A.10.0&9 4.+&*.1,.0&9 ,,.%&C.1,.0&9 15.+&/.10.0&9 '5.0&

Difficulty: Medium

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5'. he holding period return on a stok was ',&. ts eginning prie was $,5 and its ashdi"idend was $1.50. ts ending prie #ust ha"e een ))))))))).A.$,.50*.$''.,0

C.$'1.50/.$,3.+5

Difficulty: Medium

5%. Consider the !ollowing two in"est#ent alternati"es. Hirst9 a risky port!olio that pays 15&rate o! return with a proaility o! %0& or 5& with a proaility o! 40&. 6eond9 a treasuryill that pays 4&. he risk pre#iu# on the risky in"est#ent is ))))))))).A.1&B.'&C.4&/.3&

Difficulty: Medium

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55. Consider the !ollowing two in"est#ent alternati"es. Hirst9 a risky port!olio that pays ,0&rate o! return with a proaility o! 40& or 5& with a proaility o! %0&. 6eond9 a treasuryill that pays 4&. ! you in"est $509000 in the risky port!olio9 your epeted pro!it would e))))))))).

A.$'9000B.$+9000C.$+9500/.$109000

Difficulty: Medium

54. You in"est $109000 in a o#plete port!olio. he o#plete port!olio is o#posed o! a riskyasset with an epeted rate o! return o! 15& and a standard de"iation o! ,1& and a treasuryill with a rate o! return o! 5&. (ow #uh #oney should e in"ested in the risky asset to!or# a port!olio with an epeted return o! 11&A.$49000*.$%9000C.$+9000/.$'9000

15 ? 5 11G > 40&G 0.40 $49000

Difficulty: Hard

You in"est $19000 in a o#plete port!olio. he o#plete port!olio is o#posed o! a riskyasset with an epeted rate o! return o! 14& and a standard de"iation o! ,0& and a treasuryill with a rate o! return o! 4&.

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5+. )))))))))) o! your o#plete port!olio should e in"ested in the risky port!olio i! youwant your o#plete port!olio to ha"e a standard de"iation o! 3&.A.100&*.30&

C.%5&/.10&

Difficulty: Easy

5. A port!olio that has an epeted "alue in one year o! $19100 ould e !or#ed i! you

))))))))).A.Plae %0& o! your #oney in the risky port!olio and the rest in the risk !ree asset*.Plae 55& o! your #oney in the risky port!olio and the rest in the risk !ree assetC.Plae 40& o! your #oney in the risky port!olio and the rest in the risk !ree asset/.Plae +5& o! your #oney in the risky port!olio and the rest in the risk !ree asset

$1100 >


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40. You ha"e $5009000 a"ailale to in"est. he risk-!ree rate as well as your orrowing rate is&. he return on the risky port!olio is 14&. ! you wish to earn a ,,& return9 you should))))))))).A.in"est $1,59000 in the risk-!ree asset

*.in"est $'+59000 in the risk-!ree assetC.orrow $1,59000D.orrow $'+59000

Difficulty: Hard

41. he return on the risky port!olio is 15&. he risk-!ree rate as well as the in"estorsorrowing rate is 10&. he standard de"iation o! return on the risky port!olio is ,0&. ! thestandard de"iation on the o#plete port!olio is ,5&9 the epeted return on the o#pleteport!olio is ))))))))).A.4.00&*..+5 &C.10.00&D.14.,5&

Difficulty: Hard

You are onsidering in"esting $19000 in a o#plete port!olio. he o#plete port!olio iso#posed o! treasury ills that pay 5& and a risky port!olio9 P9 onstruted with , riskyseurities I and Y. he opti#al weights o! I and Y in P are 40& and %0& respeti"ely. Ihas an epeted rate o! return o! 1%& and Y has an epeted rate o! return o! 10&.

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4,. o !or# a o#plete port!olio with an epeted rate o! return o! 11&9 you should in"est)))))))))) o! your o#plete port!olio in treasury ills.A.13&*.,5&

C.'4&/.50&

Difficulty: Hard

4'. o !or# a o#plete port!olio with an epeted rate o! return o! &9 you should in"estapproi#ately )))))))))) in the risky port!olio. his will #ean you will also in"estapproi#ately )))))))))) and )))))))))) o! your o#plete port!olio in seurity I and Yrespeti"ely.A.0&9 40&9 %0&*.,5&9 %5&9 '0&C.%0&9 ,%&9 14&/.50&9 '0&9 ,0&

Difficulty: Hard

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Difficulty: Hard

You ha"e the !ollowing rates o! return !or a risky port!olio !or se"eral reent years:

44. ! you in"ested $19000 at the eginning o! ,005 your in"est#ent at the end o! ,00 woulde worth ))))))))))).A.$,91+4.40B.$19+5.54C.$194%5.5'/.$19,%+.+

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4. A seurity with nor#ally distriuted returns has an annual epeted return o! 1& andstandard de"iation o! ,'&. he proaility o! getting a return etween -,& and 4%& in anyone year isA.4.,4&B.35.%%&

C.33.+%&/.100.00&

Difficulty: Medium

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43. he Fanhawkin Hund has an epeted return o! 14& and a standard de"iation o! ,0&.he risk !ree rate is %&. hat is the reward-to-"olatility ratio !or the Fanhawkin HundA.0.B.0.4

C.3.0/.1.0

Difficulty: Medium

+0. Hro# 13,4 to ,00 the world stok port!olio o!!ered ))))) return and ))))) "olatilitythan the port!olio o! large .6. stoks.A.lowerG higherB.lowerG lowerC.higherG lower/.higherG higher

Difficulty: Medium

+1. he prie o! a stok is $55 at the eginning o! the year and $50 at the end o! the year. !the stok paid a $' di"idend and in!lation was '&9 what is the real holding period return !orthe yearA.-'.4%&*.-4.'4&C.-4.%%&/.-11.+%&

Jo#inal return on stok:

Real return

Difficulty: Hard

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+,. he prie o! a stok is $' at the eginning o! the year and $%1 at the end o! the year. !the stok paid a $,.50 di"idend what is the holding period return !or the yearA.4.5&*..4&

C.1%.%+&/.1.44&

(PR > 0.1%%+

Difficulty: Easy

+'. You in"est all o! your #oney in one year -ills. hih o! the !ollowing state#ents is@areorret

. Your no#inal return on the -ills is riskless.. Your real return on the -ills is riskless.. Your no#inal 6harpe #easure is Bero.A. onlyB. and onlyC. only/.9 and

Difficulty: Medium

+%. hih one o! the !ollowing would e onsidered a risk-!ree asset in real ter#s as opposedto no#inalA.Foney #arket !und*..6. -illC.6hort ter# orporate ondsD..6. -ill whose return was indeed to in!lation

Difficulty: Medium

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+5. hat is the geo#etri a"erage return o! the !ollowing ;uarterly returns: '&9 5&9 %&9 and+&9 respeti"elyA.'.+,&*.%.,'&

C.%.+%&/.%.30&

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+. Aording to historial data9 o"er the long run whih o! the !ollowing assets has the esthane to pro"ide the est a!ter in!lation9 a!ter ta rate o! returnA.7ong ter# reasury onds*.Corporate onds

C.Co##on stoks/.Pre!erred stoks

Difficulty: Easy

Difficulty: Hard

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1. he CA7 pro"ided y o#inations o! one #onth -ills and a road inde o! o##onstoks is alled the )))))).A.6F7*.CAPF

C.CF7/.otal Return 7ine

Difficulty: Easy

,. hih o! the !ollowing are orret argu#ents supporting passi"e in"est#ent strategies. Ati"e trading strategies #ay not guarantee higher returns ut guarantee higher osts. Passi"e in"estors an !ree ride on the ati"ity o! knowledge in"estors whose trades !orepries to re!let urrently a"ailale in!or#ation

. Passi"e in"estors are guaranteed to earn higher rates o! return than ati"e in"estors o"ersu!!iiently long ti#e horiBonsA. onlyB. and onlyC. and only/.9 and

Difficulty: Medium

You ha"e the !ollowing rates o! return !or a risky port!olio !or se"eral reent years. Assu#ethat the stok pays no di"idends

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'. hat is the geo#etri a"erage return !or the periodA.,.+&*.0.+%&C.,.40&/.,.,1&

Chapter 05 Risk and Return: Past and Prologue

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Transcript of Chapter 05 Risk and Return: Past and Prologue