Fundamentals of Investing, 11e (Gitman/Joehnk/Smart)
Chapter 4 Return and Risk
1) Investors can be confidently predict future returns on an investment by studying its past
performance.
2) The amount an investor is willing to pay for an investment should be determined by the past
performance of the investment.
3) Internal factors such as the quality of management and the level of corporate debt affect the
rate of return on an individual stock.
4) In response to the same external force, the return on one investment may increase while the
return on another investment may decrease.
5) In the short term, stock prices tend to rise as inflation rises.
6) A capital loss is computed by
A) subtracting the original cost of an investment from the proceeds received from the sale of that
investment minus any income from the investment.
B) subtracting the original cost of an investment from the proceeds received from the sale of that
investment plus any income from the investment.
C) subtracting the proceeds received from the sale of an investment from the original cost of the
investment.
D) subtracting the original cost of an investment from the proceeds received from the sale of that
investment.
7) Jessica bought a stock at a price of $11.50. She received a $.75 dividend and sold the stock for
$12.50. What is Jessica‘s capital gain on this investment?
A) $0.25
B) $0.75
C) $1.00
D) $1.75
8) Ashley purchased a stock at a price of $27 a share. She received quarterly dividends of $0.75
per share. After one year, Ashley sold the stock at a price of $29.25 a share. What is her
percentage total return on this investment?
A) 10.3%
B) 11.1%
C) 17.9%
D) 19.4%
9) Inflation tends to have a particularly negative impact on the price of
A) real estate.
B) bonds.
C) gold.
D) crude oil.
10) Inflation tends to have a favorable impact on
A) real estate.
B) common stock.
C) preferred stock.
D) bonds.
11) Which one of the following is an internal characteristic that can affect the value of an
investment?
A) Federal Reserve actions
B) inflation
C) war
D) use of debt financing
12) Stocks in which of the following industries may be impacted by government actions?
A) Health Care
B) Housing
C) Defense
D) All of the above
13) Over the long term, which one of the following has historically had the lowest average
annual rate of return?
A) small-company stocks
B) long-term government bonds
C) large-company stocks
D) long-term corporate bonds
1) The financial concept of time value of money is dependent upon the opportunity to earn
interest over time.
2) Compound interest is interest paid not only on the initial investment but also on any interest
accumulated in prior periods.
3) An interest rate of 6.18% compounded daily is equivalent to 6% compounded annually.
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4) For a given stated rate of interest, daily compounding results in a higher true rate of interest
than monthly compounding.
5) An ordinary annuity is defined as an annuity for which the cash flows occur at the beginning
of each year or payment period.
6) To calculate the interest rate or growth rate using a spreadsheet or financial calculator, the
present value and the future value most have opposite signs.
7) The future value is equal to the present value multiplied by the 1 plus the interest rate.
8) If the discount rate is appropriate for the level of risk, a satisfactory investment will have a
present value of benefits equal to or greater than than the present value of costs.
9) The adage “the sooner one receives a return on a given investment, the better,” reflects the
financial concept known as the
A) time value of money.
B) total return concept.
C) historical dividend theory.
D) expected yield factor.
10) Justin invests $4,000 in a savings account for two years. The account pays 2% interest
compounded annually. How much interest income will Justin earn on this investment?
A) $80.00
B) $81.60
C) $160.00
D) $161.60
11) The value of an investment paying 4% compounded quarterly will have a value at the end of
one year equal to
A) An investment paying 16% compounded annually at the end of 1 year.
B) An investment paying 2% compounded semi-annually at the end of 1 year.
C) An investment paying 4% compounded annually at the end of 4 years.
D) An investment paying 1% compounded annually at the end of 4 years.
12) The present value of $10,000 discounted at 5% per year and received at the end of 5 years is
A) $10,000/1.25
B) $10,000(1.05)5
C) $10,000/(1.05)5
D) $10,000 (1.05)1/5
13) The stated rate of interest is equal to the true rate of interest when
A) interest is compounded annually and the period in questions is exactly 1 year.
B) interest is compounded continuously over one or more years.
C) interest is compounded annually over a period of several years.
D) interest is discounted rather than compounded.
14) Which one of the following statements is correct concerning the time value of money?
A) The future value of $1 at the end of a year is equal to $1 times 1 plus the annual interest rate.
B) As the interest rate increases for any given year, the future value interest factor will decrease.
C) The future value of $1 decreases with the passage of time.
D) The future value interest factor is equal to zero if the interest rate is zero.
15) Which one of the following is an example of an annuity?
A) the receipt of $50 in January, March, April, June, August, September and December
B) the payment of $259 a month for three consecutive years
C) the payment of $389 in January, $200 in February, and $200 in March
D) the receipt of $100 a month for three months and then $150 a month for two months
16) Christopher invests $400 today at a 4% rate of return which is compounded annually. What
is the future value of this investment after four years?
A) $342
B) $416
C) $464
D) $468
17) The maximum rate of return that can be earned for a given rate of interest occurs when
interest is compounded
A) annually.
B) daily.
C) monthly.
D) continuously.
18) If you invest $2,000 at the end of each year for five years and you earn 7% interest
compounded annually, how much will you have accumulated at the end of the fifth year?
A) $10,700
B) $11,501
C) $12,307
D) $14,026
19) Roy is going to receive a payment of $5,000 one year from today. He earns an average of 6%
on his investments. What is the present value of this payment?
A) $4,717
B) $4,821
C) $5,000
D) $5,300
20) Which of the following statements are correct concerning present value?
I. The present value interest factor for a single sum is always equal to or less than 1.
II. The lower the discount rate for a given year, the smaller the present value interest factor.
III. The further in time, the smaller the present value interest factor.
IV. The present value is equal to the future value only when the stated interest rate is 1%.
A) I and II only
B) I and III only
C) II and III only
D) I, III and IV only
21) An ordinary annuity has cash flows that occur at the ________ of each time period and are
________ in amount.
A) beginning; constant
B) beginning; variable
C) end; constant
D) end; variable
22) When calculating the present value of either a future single sum or a future annuity, the
applicable interest rate is usually called the
A) yield to maturity.
B) compound interest rate.
C) internal rate of return.
D) discount rate.
23) When the rate of return is equal to the discount rate
A) the present value of an investment’s benefits must be greater than its cost.
B) the cost of an investment equals the sum of its benefits.
C) the cost of an investment equals the future value of its benefits.
D) the cost of an investment equals the present value of its benefits.
24) Assume that $100 is deposited at the end of each year for five years at 10% compound
interest and that no withdrawals are made over the five-year period. Based on this data, which
one of the following statements is correct?
A) The future value will be $550.
B) The present value can be determined by computing the present value of $500 in five years at
10%.
C) The present value can be determined by computing the present value of a $100 ordinary
annuity for five years at 10%.
D) The present value will be $500.
25) If the present value of an investment’s benefits equals the present value of the investment’s
costs, then the investor would earn a
A) return equal to the discount rate.
B) negative rate of return.
C) 0% rate of return.
D) return greater than the discount rate.
26) David has purchased an investment that he expects to produce an annual cash flow of $3,000
for five years. He requires an 8% rate of return compounded annually. What is the maximum
amount that David can pay and still earn the required rate of return?
A) $19,008
B) $15,000
C) $14,764
D) $12,936
27) To compute the present value of $1,000 discounted at the rate of 5% per year, to be received
at the end of 3 years, you should enter the following variables into a financial calculator
A) N=3, i=5, PV=1000
B) N=3, i=5, FV=1000
C) N=3, i=5, PMT=1000
D) N=3, i=.05, PV=1000
28) To compute the present value of $1,000 discounted at the rate of 5% per year, to be received
at the end of 3 years, you should use the following EXCEL command.
A) DISC
B) TVM
C) PV
D) RATE
29) To compute the present value of $1,000 annuity received at the end of each of the next three
years and discounted at the rate of 5% per year, you should enter the following variables into a
financial calculator
A) N=3, i=5, PMT=1000
B) N=3, i=5, FV=3000
C) N=3, i=15, PMT=1000
D) N=1, i=5, PMT=3000
30) To compute the present value of $1,000 annuity received at the end of each of the next three
years and discounted at the rate of 5% per year, you should use he following EXCEL command.
A) ANN
B) TVM
C) RATE
D) PV
31) David has purchased an investment that he expects to produce an annual cash flow of $3,000
for five years. He requires an 8% rate of return compounded annually. What is the maximum
amount that David can pay and still earn the required rate of return?
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4.3 Learning Goal 3
1) The return that fully compensates for the risk of an investment is called the risk-free rate of
return.
2) The required return on a risky investment includes a real rate of return, an inflation premium
and a risk premium.
3) If the risk-free rate of return is less than the inflation rate, the real rate of return is negative.
4) The holding period return is an excellent method for comparing a short-term investment to a
long-term investment.
5) One reason that the holding period return should not be used to compare long-term
investments is that it does not consider the time value of money.
6) The holding period return should not be used when analyzing investments with unequal
holding periods.
7) Historically, the real rate of return in the United States has tended to be
A) between -1% and 0%.
B) between 0.5 and 2%.
C) between 2 and 3%.
D) between 3%. and 5%
8) The risk-free rate is equal to the real rate of return plus
A) an expected inflation premium.
B) a risk premium.
C) both an inflation and a risk premium.
D) the prevailing prime rate.
9) The markets in general are paying a 2% real rate of return. Inflation is expected to be 3%.
ABC stock commands a 6% risk premium. What is the expected rate of return on ABC stock?
A) 2%
B) 5%
C) 8%
D) 11%
10) The required rate of return on the Daisy Corporation’s common stock is 11%, the current real
rate of return in the market is 1%, and the market’s risk-free rate of return is 4%. In this case, the
risk premium associated with Daisy’s stock is
A) 5%.
B) 6%.
C) 7%.
D) 8%.
11) Which one following will lower required rates of return?
A) Higher rates of inflation.
B) Higher risk premiums.
C) Lower rates of inflation .
D) Lower dividend yields.
12) The required return on Beta stock is 14%. The risk-free rate of return is 4% and the real rate
of return is 2%. How much are investors requiring as compensation for risk?
A) 8%
B) 10%
C) 12%
D) 14%
13) Which of the following is(are) issue characteristics of an investment?
I. type of investment such as stocks or bonds
II. state of the economy
III. coupon or dividend payments
IV. time to maturity
A) I and II only
B) III only
C) I, III and IV only
D) I, II, III and IV
14) A holding period return is calculated by adding the current income to the capital gains and
dividing this sum by the
A) average investment value.
B) beginning investment value.
C) total income received.
D) selling price of the investment.
15) Brittany purchased a stock for $14 a share and sold it six months later for $15.50. While she
owned the stock, Britanny received two quarterly dividends of $0.16 per share. Brittany’s
holding period return on this stock is
A) 13.0%.
B) 15.0%.
C) 17.4%.
D) 19.3%.