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Financial Management: Principles and Applications, 11e (Titman)
Chapter 7 An Introduction to Risk and Return-History of Financial Market Returns
1) You purchased the stock of Sargent Motors at a price of $75.75 one year ago today. If you sell
the stock today for $89.00, what is your holding period return?
A) 35.00%
B) 12.50%
C) 17.50%
D) 25.00%
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
2) You have invested in a project that has the following payoff schedule:
Probability of
Payoff Occurrence
$40 .15
$50 .20
$60 .30
$70 .30
$80 .05
What is the expected value of the investment's payoff? (Round to the nearest $1.)
A) $60
B) $65
C) $58
D) $70
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
40% chance of getting a 12% return, and a 10% chance of getting an 8% return, what is the
expected rate of return?
A) 12%
B) 13%
C) 14%
D) 15%
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
1
Copyright © 2011 Pearson Education, Inc.
Principles: Principle 2: There Is a Risk-Return Tradeoff
4) You are considering investing in a project with the following possible outcomes:
Probability of Investment
States Occurrence Returns
State 1: Economic boom 15% 16%
State 2: Economic growth 45% 12%
State 3: Economic decline 25% 5%
State 4: Depression 15% -5%
Calculate the expected rate of return for this investment.
A) 9.8%
B) 7.0%
C) 8.3%
D) 6.3%
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
5) Spartan Sofas, Inc. is selling for $50.00 per share today. In one year, Spartan will be selling
for $48.00 per share, and the dividend for the year will be $3.00. What is the cash return on
Spartan stock?
A) 0%
B) 2%
C) 6%
D) 10%
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
6) What is the standard deviation of an investment that has the following expected scenario? 18%
17% probability of a strong economy, 14.2% return.
A) 3.68%
B) 1.23%
C) 8.47%
D) 6.66%
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: standard deviation
Principles: Principle 2: There Is a Risk-Return Tradeoff
2
Copyright © 2011 Pearson Education, Inc.
7) You are considering investing in a firm that has the following possible outcomes:
Economic boom: probability of 25%; return of 25%
Economic growth: probability of 60%; return of 15%
Economic decline: probability of 15%; return of -5%
What is the expected rate of return on the investment?
A) 15.0%
B) 11.7%
C) 14.5%
D) 25.0%
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
8) Which of the following best measures the risk of holding an asset in isolation (i.e., stand-alone
risk)?
A) The mean co-variance
B) The standard deviation
C) The coefficient of optimization
D) The standard asset pricing model
E) The correlation
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: standard deviation
Principles: Principle 2: There Is a Risk-Return Tradeoff
9) The holding period return is always positive.
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
10) Because returns are more certain for the least risky investments, the required return on these
investments should be higher than the required returns on more risky investments.
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
3
Copyright © 2011 Pearson Education, Inc.
11) Even though an investor expects a positive rate of return, it is possible that the actual return
will be negative.
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
12) The expected rate of return is the weighted average of the possible returns for an investment.
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
13) The expected rate of return is the sum of each possible return times it likelihood of
occurrence.
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
14) The higher the standard deviation, the less risk the investment has.
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: standard deviation
Principles: Principle 2: There Is a Risk-Return Tradeoff
15) Using the following information for McDonovan, Inc.'s stock, calculate their expected return
and standard deviation.
State Probability Return
Boom 20% 40%
Normal 60% 15%
Recession 20% (20%)
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: standard deviation
Principles: Principle 2: There Is a Risk-Return Tradeoff
4
Copyright © 2011 Pearson Education, Inc.
1) The risk-return tradeoff tells us that expected returns should be higher on investments that
have higher risk.
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk
Principles: Principle 2: There Is a Risk-Return Tradeoff
2) Riskier investments have traditionally had lower returns than less risky investments have had.
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk
Principles: Principle 2: There Is a Risk-Return Tradeoff
3) Less risky investments have lower standard deviations than do more risky investments.
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk, return
Principles: Principle 2: There Is a Risk-Return Tradeoff
4) Investments in emerging markets have higher volatility than do U.S. Stocks.
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: standard deviation
Principles: Principle 2: There Is a Risk-Return Tradeoff
5) Expected return and realized return are the same thing.
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: holding period return
Principles: Principle 2: There Is a Risk-Return Tradeoff
6) Historically, in the United States stocks have had higher returns and greater volatility than
have government bonds.
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk, return
Principles: Principle 2: There Is a Risk-Return Tradeoff
5
Copyright © 2011 Pearson Education, Inc.
7) Treasury Bills have less default risk than do Government Bonds.
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk, return
Principles: Principle 2: There Is a Risk-Return Tradeoff
8) Investors are always rewarded for taking higher risk with higher realized returns.
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk, return
Principles: Principle 2: There Is a Risk-Return Tradeoff
9) Investors make different investment choices partially because individuals do not all have the
same tolerance for risk.
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: investor tolerance
Principles: Principle 2: There Is a Risk-Return Tradeoff
1) Marcus Berger invested $9842.33 in Hawkeyehats, Inc. four years ago. He sold the stock
today for $11,396.22. What is his geometric average return?
A) There is insufficient information to derive an answer.
B) 2.98%
C) 3.73%
D) 3.95%
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: holding period return
Principles: Principle 1: Money Has a Time Value
2) Marcus Berger invested $9842.33 in Hawkeyehats, Inc. four years ago. He sold the stock
today for $11,396.22. What is his arithmetic average return?
A) There is insufficient information to derive an answer.
B) 2.98%
C) 3.73%
D) 3.95%
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: arithmetic average return
Principles: Principle 1: Money Has a Time Value
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Copyright © 2011 Pearson Education, Inc.
