ch07

Parrino, 2e Test Bank, Chapter 7

Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy 1.Whenever the outcome of an event has a number of different possibilities that have equal probability of occurrence, then the expected value of the outcome is equal to the simple average of the individual events. A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy 2.The variance of a distribution can be a negative value. A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy 3.The standard deviation of a distribution can be a negative value. A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 4.The capital appreciation component of a stock's return considers the increase in price of a stock divided by the beginning of period price of the stock. A) True B) False Ans: A

A)

Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 5.The capital appreciation component of a stock's return considers the increase in price of a stock divided by the end of period price of the stock. True 7-1

B) Ans:

False B

Format: True/False Learning Objective: LO 6 Level of Difficulty: Medium 6.If the expected return of a bet, which is based on a coin toss, is $15, then that means that the outcome of the bet will be a $15 cash inflow to the person making the bet. A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium 7.The normal distribution is completely described by its mean and standard deviation where 50 percent of the distribution's probability is less than the mean and 50 percent greater than the mean. A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium 8.The variance is denominated in squared units, whereas the standard deviation is denominated in the same units as the expected value. A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 9.If the price of an asset has not increased or decreased since the original purchase of the asset, then the total return of the asset (if no dividends were paid during the period) is equal to the capital appreciation component return. A) True B) False Ans: A

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 10.The income component of return for a common stock comes from the dividend cash flow stream. A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 11.If the capital appreciation return from owning a stock is positive, then the total return from owning the same stock can be negative. A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 12.In order for the total return of a stock to be equal to –100 percent, the income return component for that stock must be zero. A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy 13.The best measure of risk within an investment is its variance. A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 14.Robert paid $100 for a stock one year ago. The total return on the stock was 10 percent. Therefore, the stock must be selling for $110 today. A) True B) False 7-3

Ans:

B

Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 15.You have placed a wager such that you will either receive nothing if you lose the bet or you will receive $10 if you win the bet. If the expected cash receipt of the wager is $9, then there is a 100 percent probability that you will win the wager. A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium 16.The variance is equal to the square root of the standard deviation. A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium 17.If you are calculating the variance and standard deviation of returns for a stock, the variance will always be larger than the standard deviation. A) True B) False Ans: B Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy 18.The appropriate measure of risk for a diversified portfolio is beta. A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy 19.The coefficient of variation divides the variance of the returns of an asset by the 7-4

A) B) Ans:

expected return of that asset. True False B

Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy 20.The coefficient of variation is a good measure of the amount of risk that an asset will contribute to a diversified portfolio of assets. A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium 21.If you are building a portfolio, then you desire assets that have a correlation coefficient of one. A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium 22.If the returns for two assets have a correlation coefficient of one, then there are no benefits of diversification by combining these assets in a two-asset portfolio. A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy 23.Utilizing the fact that two or more asset values do not always move in the same direction at the same time in order to reduce the risk of a portfolio is called diversification. A) True B) False Ans: A

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Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy 24.If you are trying to determine whether to purchase Security A or Security B as the only holding in your portfolio, then you can consider the coefficient of variation in order to understand the risk-return relationship of the individual securities. A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium 25.The coefficient of variation is useful when deciding which individual stocks to add to your diversified portfolio. A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy 26.If two assets with return correlation coefficients less than one make up a portfolio, then the portfolio does not take advantage of any diversification benefits. A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy 27.If the covariance between the returns of two assets is equal to zero, then the correlation coefficient must also be zero. A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy 28.If the distribution of returns for an asset has a variance of zero, then covariance of returns between that asset and the returns any other asset must equal zero. 7-6

A) B) Ans:

True False A

Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 29.The expected return of the market portfolio is equal to the market risk premium. A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium 30.If you were to completely diversify your portfolio by purchasing a portion of every asset in the investment universe, then the expected return of your portfolio is equal to the riskfree rate. A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 31.The market risk-premium is equal to expected return on the market portfolio. A) True B) False Ans: B Format: True/False Learning Objective: LO 7 Level of Difficulty: Medium 32.If you know the risk-free rate, the market risk-premium, and the beta of a stock, then using the CAPM you will be able to calculate the expected rate of return for the stock. A) True B) False Ans: A Format: True/False Learning Objective: LO 6 7-7

Level of Difficulty: Medium 33.The market risk-premium is equal to the expected return on the market less the risk-free rate of return. A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy 34.Given the historical information in the chapter, the beta of a small stock should be greater than the beta of a corporate bond. A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy 35.Complete diversification means that the portfolio is no longer subject to market risk. A) True B) False Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 36.The expected return for a portfolio without borrowing A) should never be less than the expected return of the asset with lowest expected return. B) should never be greater than the expected return of the asset with highest expected return. C) may not be an event with even a positive probability of occurrence. D) All of the above. Ans: D Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 37.In a game of chance, the probability of winning a $50 prize is 40 percent, and the probability of winning a $100 prize is 60 percent. What is the expected value of a prize in the game? 7-8

A) B) C) D) Ans:

$50 $75 $80 $100 C Feedback: $50(0.4) + $100 (0.6) = $80

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 38.In a game of chance, the probability of winning a $50 is 40 percent and the probability of losing a $50 prize is 60 percent. What is the expected value of a prize in the game? A) –$10 B) $0 C) $10 D) $25 Ans: A Feedback: $50(0.4) – $50 (0.6) = -$10 Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy 39.Which of the following is the best measure of the systematic risk in a portfolio? A) variance B) standard deviation C) covariance D) beta Ans: D Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 40.Use the following table to calculate the expected return for the asset.

A) B) C)

Return

Probability

0.1 0.2 0.25 15.00% 17.50% 18.75%

0.25 0.5 0.25

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D) Ans:

20.00% C Feedback: (0.1)(0.25) + (0.2)(0.5) + (0.25)(0.25) = 0.1875 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 41.Use the following table to calculate the expected return for the asset. Return

A) B) C) D) Ans:

Probability

0.05 0.1 0.1 0.15 0.15 0.5 0.25 0.25 12.50% 13.75% 15.75% 16.75% C Feedback: (0.5)(0.1) + (0.1)(0.15) + (0.15)(0.5) + (0.25)(0.25) = 0.1575 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 42.The expected return for the asset below is 18.75 percent. If the return distribution for the asset is described as in the following table, what is the variance for the asset's returns? Return

A) B) C) D) Ans:

Probability

0.1 0.25 0.2 0.5 0.25 0.25 0.002969 0.000613 0.015195 0.054486 A Feedback: (0.1)(0.25 – 0.1875)2 + (0.2)(0.5 – 0.1875) 2 + (0.25)(0.25 – 0.1875) 2 = 0.002969

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 43.The expected return for the asset shown in the following table is 18.75 percent. If the return distribution for the asset is described as below, what is the standard deviation for the asset's returns? Return Probability

A) B) C) D) Ans:

0.1 0.25 0.2 0.5 0.25 0.25 0.002969 0.000613 0.015195 0.054486 D Feedback: { (0.25)(0.10 – 0.1875)2 + (0.5)(0.2 – 0.1875) 2 + (0.25)(0.25 – 0.1875) 2 }1/2 = 0.054486

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 44.If you are dealing with percentage returns, then which of the following is generally true? A) The variance of the return distribution is generally smaller than the standard deviation. B) The variance of the return distribution is generally larger than the standard deviation. C) The variance of the return distribution is measured in the same units as expected return. D) None of the above is generally true. Ans: D Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 45.The return distribution for an asset is as shown in the following table. What are the missing values if the expected return is 10 percent? Return

Probability

0.1 x

0.25 0.5 7-11

x A) B) C) D) Ans:

0.25

0.20 0.15 0.10 None of the above C

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 46.The expected return for Stock Z is 30 percent. If we know the following information about Stock Z, then what return will it produce in the Lukewarm state of the world? Return

A) B) C) D) Ans:

Probability

Poor 0.2 0.25 Lukewarm ? 0.5 Dynamite! 0.4 0.25 20% 30% 40% It is impossible to determine. B Feedback: (0.25)(0.2) + (0.5)(X) + (0.25)(0.4) = 0.3 , X = 0.3 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 47.The expected return for Stock V is 24.5 percent. If we know the following information about Stock Z, then what is the probability of the Dynamite state of the world occurring? Return

A) B) C) D) Ans:

Probability

Poor 0.15 0.2 Lukewarm 0.28 0.7 Dynamite! 0.19 ? 5% 10% 15% 20% B Feedback: 0.2 + 0.7 + X = 1.0 ===> X = 0.1 or 10% 7-12

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 48.Ahmet purchased a stock for $45 one year ago. The stock is now worth $65. During the year, the stock paid a dividend of $2.50. What is the total return to Ahmet from owning the stock? (Round your answer to the nearest whole percent.) A) 5% B) 44% C) 35% D) 50% Ans: D Feedback: $65  $45  $2.50  0.5  50% $45 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 49.Julio purchased a stock one year ago for $27. The stock is now worth $32, and the total return to Julio for owning the stock was 37 percent. What is the dollar amount of dividends that he received for owning the stock during the year? A) $4 B) $5 C) $6 D) $7 Ans: B Feedback: $32  $27  $ X  0.37, $ X  $5 $27 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 50.Francis purchased a stock one year ago for $20, and it is now worth $24. The stock paid a dividend of $3 during the year. What was the stock's rate of return from capital appreciation during the year? (Round your answer to the nearest percent.) A) 17% B) 20% C) 29% D) 35% Ans: B Feedback: 7-13

$24  $20  0.20 $20 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 51.Gwen purchased a stock one year ago for $25, and it is now worth $31. The stock paid a dividend of $1.50 during the year. What was the stock's rate of return income during the year? (Round your answer to the nearest percent.) A) 6% B) 15% C) 24% D) 26% Ans: A Feedback: $1.50  .06 $25 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 52.Gunther earned a 62.5 percent return on a stock that he purchased one year ago. The stock is now worth $12, and he received a dividend of $1 during the year. How much did Gunther originally pay for the stock? A) $7.00 B) $7.50 C) $8.00 D) $8.50 Ans: C Feedback: $12  $ X  $1  0.625, $ X  $8 $X Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 53.Moshe purchased a stock for $30 last year. He found out today that he had a –100 percent return on his investment. Which of the following must be true? A) The stock is worth $30 today. B) The stock is worth $0 today C) The stock paid no dividends during the year. D) Both b and c must be true. 7-14

Ans:

D

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 54.Babs purchased a piece of real estate last year for $85,000. The real estate is now worth $102,000. If Babs needs to have a total return of 25 percent during the year, then what is the dollar amount of income that she needed to have to reach her objective? A) $3,750 B) $4,250 C) $4,750 D) $5,250 Ans: B Feedback: $102, 000  $85, 000  $ X  0.25, $ X  $4, 250 $85, 000

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 55.Genaro needs to capture a return of 40 percent for his one-year investment in a property. He believes that he can sell the property at the end of the year for $150,000 and that the property will provide him with rental income of $25,000. What is the maximum amount that Genaro should be willing to pay for the property? A) $112,500 B) $125,000 C) $137,500 D) $150,000 Ans: B Feedback: $150, 000  $ X  $25, 000  0.4, $ X  $125, 000 $X Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 56.Books Brothers stock was priced at $15 per share two years ago. The stock sold for $13 last year and now it sells for $18. What was the total return for owning Books Brothers stock during the most recent year? Assume that no dividends were paid and round to the nearest percent. A) 17% B) 20% C) 23% 7-15

D) Ans:

38% D Feedback: $18  $13  0.3846 $13

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 57.Serox stock was selling for $20 two years ago. The stock sold for $25 one year ago, and it is currently selling for $28. Serox pays a $1.10 dividend per year. What was the rate of return for owning Serox in the most recent year? (Round to the nearest percent.) A) 12% B) 16% C) 32% D) 40% Ans: B Feedback: $28  $25  $1.1  0.164 $25 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 58.You have observed that the average size of a particular goldfish is 1.5 inches long. The standard deviation of the size of the goldfish is 0.25 inches. What is the size of a goldfish such that 95 percent of the goldfish are smaller? Assume a normal distribution for the size of goldfish. A) 1.01 inches B) 1.09 inches C) 1.91 inches D) 1.99 inches Ans: C Feedback: 1.5 + 1645 (0.25) = 1.91 inches Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 59.You know that the average college student eats 0.75 pounds of food at lunch. If the standard deviation of that eating is 0.2 pounds of food, then what is the total amount of food that a cafeteria should have on hand to be 95percent confident that it will not run out of food when feeding 50 college students. 7-16

A) B) C) D) Ans:

17.90 pounds 21.05 pounds 53.95 pounds 57.10 pounds C Feedback: 50 students * {0.75 pounds per student + 1.645 (0.2 pounds per student)} = 53.95 pounds of food required. Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 60.If a random variable is drawn from a normal distribution, what is the probability that the random variable is larger than 1.96 standard deviations larger than the mean? A) 1.25% B) 2.50% C) 3.75% D) 5.00% Ans: B Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 61.If a random variable is drawn from a normal distribution, what is the probability that the random variable is larger than 1.96 standard deviations below the mean? A) 95.00% B) 96.25% C) 97.50% D) 98.75% Ans: C

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 62.Niles is making an investment with an expected return of 12 percent. If the standard deviation of the return is 4.5 percent, and if Niles is investing $100,000, then what dollar amount is Niles 95 percent sure that he will have at the end of the year? A) $100,000.00 B) $104,597.50 C) $116,500.00 D) $119,402.50 Ans: B Feedback: 7-17

{ 1 + [0.12 – 1.645 (0.045)]} X $100,000 = $104,597.50 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 63.Which of the following investment classes had the greatest average return based on recent historical data? A) Intermediate-Term Government Bonds B) Long-Term Government Bonds C) Large U.S. Stocks D) Small U.S. Stocks Ans: D Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 64.Which of the following investment classes had the greatest variability in returns for recent historical data? A) Intermediate-Term Government Bonds B) Long-Term Government Bonds C) Large U.S. Stocks D) Small U.S. Stocks Ans: D Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 65.If you were to compare the returns of an individual stock to a market index, select the answer below that is most true. A) The returns of the individual stock will show more variability than those of the market index. B) The returns of the individual stock will show less variability than those of the market index. C) The returns of the individual stock will show the same level of variability than those of the market index, if they have the same beta. D) None of the above. Ans: A Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 66.Tommie has made an investment that will generate returns that are subject to the state of 7-18

the economy during the year. Use the following information to calculate the standard deviation of the return distribution for Tommie's investment. State

A) B) C) D) Ans:

Return

Probability

Weak 0.13 0.3 OK 0.2 0.4 Great 0.25 0.3 0.0453 0.0467 0.0481 0.0495 B Feedback: E ( R )  (0.3)(0.13)  (0.4)(0.2)  (0.3)(0.25)  0.194 Var ( R )  0.3(0.13  0.194) 2  0.4(0.2  0.194) 2  0.3(0.25  0.194) 2  0.002184 1

Std ( R )  (0.002184) 2  0.046733

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 67.Elrond has made an investment that will generate returns that are subject to the state of the economy. Use the following information to calculate the variance of the return distribution for Elrond's investment. State

A) B) C) D) Ans:

Weak OK Great 0.0536 0.0543 0.0550 0.0557 D Feedback:

Return

Probability

0.10 0.17 0.28

0.8 0.1 0.1

7-19

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 68.Braniff Ground Services stock has an expected return of 9 percent and a variance of 0.25 percent. What is the coefficient of variation for Braniff? A) 0.0278 B) 0.5556 C) 1.800 D) 36.00 Ans: B Feedback:

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 69.Sayers purchased a stock with a coefficient of variation equal to 0.125. The expected return on the stock is 20 percent. What is the variance of the stock? A) 0.000625 B) 0.025000 C) 0.625000 D) 0.790500 Ans: A Feedback: 1

Coefficient

of

Variation 

 2 2

   0.125,  2  0.000625 E ( R ) 0.20

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 70.You have invested 40 percent of your portfolio in an investment with an expected return of 12 percent and 60 percent of your portfolio in an investment with an expected return of 20 percent. What is the expected return of your portfolio? 7-20

A) B) C) D) Ans:

15.2% 16.0% 16.8% 17.6% C Feedback: E ( R )  0.4(0.12)  0.6(0.20)  0.168

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 71.You have invested 20 percent of your portfolio in Homer, Inc., 40 percent in Marge Co., and 20 percent in Bart Resources. What is the expected return of your portfolio if Homer, Marge, and Bart have expected returns of 2 percent, 18 percent, and 3 percent, respectfully? A) 7.7% B) 8.2% C) 8.7% D) 9.2% Ans: B Feedback: E ( R)  0.2(0.02)  0.4(0.18)  0.2(0.03)  0.082 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 72.You invested $3,000 in a portfolio with an expected return of 10 percent and $2,000 in a portfolio with an expected return of 16 percent. What is the expected return of the combined portfolio? A) 6.2% B) 12.4% C) 13.0% D) 13.6% Ans: B Feedback: 3, 000 2, 000 (0.1)  (0.16)  0.124 5, 000 5, 000

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 73.Given the returns for two stocks with the following information, calculate the covariance of the returns for the two stocks. Assume the expected return is 10.8 percent for Stock 1 7-21

and 9.7 percent for Stock 2. Prob

A) B) C) D) Ans:

0.4 0.5 0.1 0.000094 0.00051600 0.00032100 0.71750786 A Feedback:

Stock 1 Stock 2 0.09 0.11 0.17

0.11 0.08 0.13

Cov(R1,R2) =0.4*(0.09-0.108)*(0.11-0.097)+0.5*(0.11-0.108)*(0.08-0.097)+0.1*(0.17-0.108)*(0.13-0.097) = 0.000094 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 74.Given the returns for two stocks with the following information, calculate the correlation coefficient of the returns for the two stocks. Assume the expected return for Stock 1 is 10.8 percent and 9.7 percent for Stock 2. Prob

A) B) C) D) Ans:

Stock 1 Stock 2

0.4 0.09 0.11 0.5 0.11 0.08 0.1 0.17 0.13 0.230967 –0.00002548 0.00032100 0.17671455 A Feedback: From the solution to Problem 73, we find that the covariance between the stocks is 0.000094. We must now solve for the standard deviation of the returns of each individual stock.

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 12  0.4(0.09  0.108) 2  0.5(0.11  0.108) 2  0.1(0.17  0.108)2  0.000516,  1  0.02271563  22  0.4(0.11  0.097) 2  0.5(0.08  0.097) 2  0.1(0.18  0.097)2  0.000321,  2  0..01791647

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 75.Given the returns for two stocks with the following information, calculate the covariance of the returns for the two stocks. Assume the expected return is 14.4 percent for Stock 1 and 15.9 percent for Stock 2. Prob

A) B) C) D) Ans:

Stock 1 Stock 2

0.5 0.11 0.18 0.3 0.17 0.15 0.2 0.19 0.12 0.001204001 0.000549003 -0.00079 –0.3372012 C Feedback: Cov( R1 , R2 )  PState1 ( RState1,1  E ( R1 )( RState1,2  E ( R2 ))  PState 2) ( RState 2,1  E ( R1 ))( RState 2,2  E ( R2 ))

 PState3 ( RState 3,1  E ( R1 ))( RState 3,2  E ( R2 ))  0.00007192 Cov(R1,R2) = . (0.5*(0.11-0.144)*(0.18-0.159)+0.3*(0.17-0.144)*(0.15-0.159)+0.2*(0.19-0.144)*(0.12-0.159) = -0.00079 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 76.Given the returns for two stocks with the following information, calculate the correlation coefficient of the returns for the two stocks. Assume the expected return is 14.4 percent for Stock 1 and 15.9 percent for Stock 2. Prob Stock 1 Stock 2 7-23

A) B) C) D) Ans:

0.5 0.11 0.18 0.3 0.17 0.15 0.2 0.19 0.12 0.001204001 0.000549003 –0.00271370 -0.971689 D Feedback:  12  0.5(0.11  0.144) 2  0.3(0.17  0.144) 2  0.2(0.10  0.144)2  0.001204

 1  0.03469873  22  0.5(0.18  0.159) 2  0.3(0.15  0.159) 2  0.2(0.12  0.159)2  0.000549,  2  0.02343075 Cov(R1,R2) = -0.00079 so p = - .00079 = -.971689 (.03469873)(.02343075)

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 77.The covariance of the returns between Einstein Stock and Bohr Stock is 0.0087. The standard deviation of Einstein is 0.26, and the standard deviation of Bohr is 0.37. What is the correlation coefficient between the returns of the two stocks? A) 0.090437 B) 0.096200 C) 0.90437 D) 0.96200 Ans: A Feedback: Cov( R1 , R2 ) 0.0087    0.090437  1 2 (0.26)(0.37) Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 7-24

78.The covariance of the returns between Wildcat Stock and Sun Devil Stock is 0.09875. The variance of Wildcat is 0.2116, and the variance of Sun Devil is 0.1369. What is the correlation coefficient between the returns of the two stocks? A) 0.170200 B) 0.293347 C) 0.340823 D) 0.578731 Ans: D Feedback: Cov( R1 , R2 ) 0.09875    0.578731  1 2 (0.2116) 2 (0.1369) 2 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 79.Horse Stock returns have exhibited a standard deviation of 0.57, whereas Mod T Stock returns have a standard deviation of 0.63. The correlation coefficient between the returns is 0.078042. What is the covariance of the returns? A) 0.028025 B) 0.217327 C) 0.359100 D) 0.993094 Ans: A Feedback: Cov( R1 , R2)  12 1 2  (0.078042) X (0.57) X (0.63)  0.028025

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 80.Batman Stock has exhibited a standard deviation in stock returns of 0.5, whereas Superman Stock has exhibited a standard deviation of 0.6. The correlation coefficient between the stock returns is 0.5. What is the variance of a portfolio composed of 70 percent Batman and 30 percent Superman? A) 0.1549 B) 0.2179 C) 0.4668 D) 0.5500 Ans: B Feedback: Var ( port )  x12 12  x22 22  2 x1 x2 1 2 12

 (0.7) 2 (0.5) 2  (0.3) 2 (0.6) 2  2(0.7)(0.3)(0.5)(0.6)(0.5)  0.2179

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 81.Aquaman Stock has exhibited a standard deviation in stock returns of 0.7, whereas Green Lantern Stock has exhibited a standard deviation of 0.8. The correlation coefficient between the stock returns is 0.1. What is the standard deviation of a portfolio composed of 70 percent Aquaman and 30 percent Green Lantern? A) 0.32122 B) 0.54562 C) 0.56676 D) 0.75000 Ans: C Feedback: Var ( port )  x12 12  x22 22  2 x1 x2 1 2 12

 (0.7) 2 (0.7) 2  (0.3) 2 (0.8) 2  2(0.7)(0.3)(0.7)(0.8)(0.1)  0.32122 Std ( port )  Sqrt (Var ( port ))  Sqrt (0.32122)  0.566763

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard 82.Most of the risk-reduction benefits from diversification can be achieved in a portfolio consisting of A) 5 to 10 stocks B) 10 to 15 stocks C) 15 to 20 stocks D) 20 to 25 stocks Ans: C Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard 83.Which of the following investors should be willing to pay the highest price for an asset? A) An investor with a single-asset portfolio. B) An investor with a 50-asset portfolio. C) An investor who is not completely diversified. D) An investor who is so risk-averse that he does not recognize the benefits of diversification. Ans: B Format: Multiple Choice Learning Objective: LO 6 7-26

Level of Difficulty: Hard 84.A portfolio with a level of systematic risk the same as that of the market has a beta that is A) equal to zero. B) equal to one. C) less than the beta of the risk-free asset. D) less than zero. Ans: B Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Hard 85.The beta of Elsenore, Inc., stock is 1.6, whereas the risk-free rate of return is 8 percent. If the expected return on the market is 15 percent, then what is the expected return on Elsenore? A) 11.20% B) 19.20% C) 24.00% D) 32.00% Ans: B Feedback: E ( REls )  Rrf   Els ( E ( RM )  Rrf )  0.08  1.6(0.15  0.08)  0.1920

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Hard 86.The beta of RicciCo.'s stock is 3.2, whereas the risk-free rate of return is 9 percent. If the expected return on the market is 18 percent, then what is the expected return on RicciCo.? A) 28.80% B) 37.80% C) 48.60% D) 57.60% Ans: B Feedback: E ( RRicci )  Rrf   Ricci ( E ( RM )  Rrf )  0.09  3.2(0.18  0.09)  0.378

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Hard 87.The risk-free rate of return is currently 3 percent, whereas the market risk premium is 6 percent. If the beta of Lenz, Inc., stock is 1.8, then what is the expected return on Lenz? A) 8.40% B) 10.80% 7-27

C) D) Ans:

13.80% 19.20% C Feedback: E ( RLenz )  Rrf   Lenz ( E ( RM )  Rrf )  0.09  3.2(0.06)  0.138

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Hard 88.The expected return on Kiwi Computers stock is 16.6 percent. If the risk-free rate is 4 percent and the expected return on the market is 10 percent, then what is Kiwi's beta? A) 1.26 B) 2.10 C) 2.80 D) 3.15 Ans: B Feedback: E ( RKiwi )  0.166  Rrf   Kiwi ( E ( RM )  Rrf )  0.04   Kiwi (0.10  0.04)   Kiwi  2.1

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Hard 89.The expected return on Mike's Seafood stock is 17.9 percent. If the expected return on the market is 13 percent and the beta for Kiwi is 1.7, then what is the risk-free rate? A) 4.5% B) 5.0% C) 5.5% D) 6.0% Ans: D Feedback: E ( RMike )  0.179  Rrf   Mike ( E ( RM )  Rrf )  Rrf  1.7(0.13  Rrf )  Rrf  0.06

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Hard 90.The expected return on KarolCo. stock is 16.5 percent. If the risk-free rate is 5 percent and the beta of KarolCo is 2.3, then what is the risk premium on the market? A) 2.5% B) 5.0% C) 7.5% D) 10.0% Ans: B 7-28

Feedback: E ( RKarole )  0.165  Rrf   Karol ( E ( RM )  Rrf )  0.05  2.3( Risk Pr emium)  Risk Pr emium  0.05

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 91.Which of the following statements is most correct? A) The greater the risk associated with an investment, the lower the return investors expect from it. B) When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return. C) If two investments have the same expected return, investors prefer the riskiest alternative. D) When choosing between two investments that have the same level of risk, investors prefer the investment with the lower return. Ans: B

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 92.Holding Period Return: George Wilson purchased Bright Light Industries common stock for $47.50 on January 31, 2010. The firm paid dividends of $1.10 during the last 12 months. George sold the stock today (January 30, 2011) for $54.00. What is George’s holding period return? Round off the nearest 0.01%. A) 16.00% B) 14.35% C) 11.28% D) 19.60% Ans: A Feedback:

R1 

P1  P 0  CF 1 $54.00  $47.50  $1.10   .1600  16.00% P0 $47.50

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 93.Expected Return: Security Analysts that have evaluated Concordia Corporation have determined that there is a 15% chance that the firm will generate earnings per share of $2.40; a 60% probability that the firm will generate earnings per share of $3.10; and a 25% probability that the firm will generate earnings per share of $3.80. What are the expected earnings per share for Concordia Corporation? (Round off to the nearest $0.01) A) $3.10 B) $3.17 C) $2.75 D) $2.91 Ans: B Feedback:

Probabilit Projected Expected y EPS EPS 15.00%$2.40 $0.36 60.00% 3.10 1.86 25.00% 3.80 0.95 100.00% $3.17

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 94.Standard Deviation: View Point Industries has forecast a rate of return of 20.00% if the economy booms (25.00% probability); a rate of return of 15.00% if the economy in in a growth phase (45.00% probability); a rate of return of 2.50% if the economy in in decline (20.00% probability); and a rate of return of -15.00% if the economy in a depression (10.00% probability). What is View Point’s standard deviation of returns? A) 17.31% B) 9.25% C) 15.00% D) 10.46% Ans: D Feedback: Standard

Deviation

A

B

C

D

E

F

Probability Calc. Of Proj. Ret. State of of Projected Expected Minus Col. E Economy Occurance Return Return Exp. Ret. Squared

G Col. F times Col. B

Boom

25.00%

20.00%

5.00%

9.25%

0.856% 0.214%

Growth

45.00%

15.00%

6.75%

4.25%

0.181% 0.081%

Decline

20.00%

2.50%

0.50%

-8.25%

0.681% 0.136%

Depression

10.00%

-15.00%

100.00%

Total

-1.50% -25.75% 10.75%

6.631% 0.663% Variance

1.09

Standard Deviation 10.46%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 95.Which of the following represents a plot of the relation between expected return and systemic risk? A) The beta coefficient. B) The covariance of returns line. C) The security market line. D) The variance. Ans: C 7-31

Format: Essay Learning Objective: LO 6 96.Explain the difference between systematic and nonsystematic risk. Ans: Systematic risk is risk that cannot be diversified away and describes the risk that is inherent in the general economic world of investing. Nonsystematic risk is risk that can be diversified away and describes risk that is unique to a particular investment. Format: Essay Learning Objective: LO 5 97.If you were to regress the historical returns of a stock on the historical return of a general market index, you would plot the line of best fit through those data points. The slope of that line represents the beta of the stock in question. However, in most instances the date points do not lie exactly on that line. Describe why. Ans: The slope of the line of best fit describes the beta of the stock in question that is capturing the systematic risk inherent in investing in that stock. The vertical distance between each point and the line represents the nonsystematic, or diversifiable, risk in investing in the stock.

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