978-0136117049 Test Bank Chapter 4 Part 2

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16) Christopher purchased 200 shares of ABC stock at $21.25 per share. After nine months, he

sold all of his shares at a price of $19.88 a share. Jake received a total of $0.55 per share in

dividends during the time he owned the shares. Jake’s holding period return is

A) -6.4%.

B) -3.9%.

C) 2.6%.

D) 9.7%.

17) The holding period return (HPR) can appropriately be used to

A) compare the yield on investments held for any time period.

B) compare returns among investments that are held for one year or less.

C) isolate realized capital gains.

D) determine the required reinvestment rate for long-term investments.

18) The holding period is a useful way to compare investments because it considers

A) the time value of money

B) only capital gains, but not income

C) both income and capital gains or losses

D) the relative size of investments being compared

19) Briefly explain the holding period return (HPR) and give several characteristics of this

measure.

4.4 Learning Goal 4

1) The yield on an investment is the discount rate that produces a present value of benefits

greater than the cost of the investment.

2) The yield is the rate of return that causes a project to have a zero net present value.

3) The net present value of an investment is computed by discounting cash flows at the internal

rate of return.

4) When using a financial calculator or electronic spreadsheet to calculate an investment’s yield,

the amount invested is expressed as a negative number.

5) The internal rate of return is the correct discount rate to use when computing the net present

value of an investment.

6) If you own an investment providing periodic returns, your actual yield on the investment will

depend on the reinvestment rate you are able to obtain.

7) The yield on an investment is equal to its internal rate of return.

8) When computing an investment’s yield using a financial calculator or spreadsheet such as

Excel, which of the following should be entered as a negative number?

A) the number of time periods

B) dividend or interest payments

C) the price at which the investment is sold

D) the initial cost of the investment

9) To determine the compounded annual rate of return on investments held for more than a year,

investors typically use the present-value-based measure known as yield or

A) holding period return.

B) internal rate of return.

C) inflation-adjusted return.

D) simple return.

10) Six years ago, Miguel invested $3,500. Today his investment is worth $5659. The yield on

this investment is

A) 1.4%.

B) 4.2%.

C) 8.3%.

D) 9.7%.

11) Joshua bought a stock for $17 a share two years ago. The stock does not pay any dividends.

Today Izzie sold the stock for $18.50 a share. What was his internal rate of return on this

investment?

A) 4.3%

B) 6.2%

C) 7.1%

D) 8.8%

12) An investment costs $3,500 today. This investment is expected to produce annual cash flows

of $1,200, $1,400, $1,300 and $1,100, respectively, over the next four years. What is the internal

rate of return on this investment?

A) 8.1%

B) 12.4%

C) 14.6%

D) 16.2%

13) The following investment cash flows have been entered into cells B5 through B9 of an

EXCEL spreadsheet. B5 $(5,200 ), B6 $2,100, B7 $1,300, B8 $1,800, B9 $1,200, where $5,200

is the cost of the investment and the following amounts are cash flows at the end of years one

through four. The correct function for computing the yield on this investment is…?

A) =irr(B6:B9)+B5

B) =irr(B6:B9)

C) =rate(4,0,-5200, 1200)

D) =ytm(B5, B6:B9)

14) The Sorka Corp. has paid annual dividends of $0.60, $0.63, $0.65, $0.68 and $0.72,

respectively, over the past five years. What is the dividend growth rate?

A) 4.7%

B) 5.2%

C) 5.4%

D) 5.9%

15) Samantha bought a stock one year ago for $66 a share. She received a total of $2.00 in

dividends. Today she sold the stock for $70 a share. Which one of the following statements is

correct concerning this investment?

A) Samantha has current income of $6.00.

B) Samantha has a capital gain of $2.00.

C) Samantha has a total return of 9.1%.

D) Samantha has unrealized income of $4 a share.

16) Explain the similarities and differences between the holding period return and the internal

rate of return.

1) Risk can be defined as uncertainty concerning the actual return that an investment will

generate.

2) Interest rates change as the result of changes in the supply and demand for money.

3) Lower risk investments are associated with higher expected rates of return.

4) Business risk is the risk associated with the amount of debt financing used by a firm.

5) The possibility that deflation could affect the rate of return on an investment is referred to as

interest rate risk.

6) Investors who limit themselves to risk free and low risk investments can avoid purchasing

power risk.

7) Liquidity risk is defined as the risk of

A) having to trade a security in a broad market.

B) not being able to sell an investment conveniently and at a reasonable price.

C) having inflation erode the purchasing power of your investment.

D) having declining price levels affect the reinvestment rate of your current income stream.

8) The difficulty many investors experienced in selling mortgage based securities during the

financial crisis of 2009 is an example of

A) business risk.

B) credit risk.

C) market risk.

D) liquidity risk.

9) The stock of Plomb Co. falls sharply on news that its CEO has drowned in a boating accident

while on vacation. This is an example of

A) liquidity risk.

B) event risk.

C) accidental risk.

D) flotation risk.

10) The risk associated with a sudden and unforeseen happening that has a significant and

usually immediate effect on a firm’s financial condition is called

A) market risk.

B) speculation.

C) event risk.

D) business risk.

11) The risk that the rate of return on an investment will be less than expected due to factors that

are independent of the investment, such as political, social or economic events, is called

A) business risk.

B) financial risk.

C) market risk.

D) liquidity risk.

12) Which one of the following will tend to decrease the rate of return on an investment?

A) elimination of a tax exemption relevant to the investment

B) reduction in tax rates

C) stabilization of inflation rates at a reasonably low level

D) increased assurance of reinvestment rates at the desired rate of return

13) Which of the following factors will increase the risk level of an investment?

I. a firm’s decision to use a high percentage of debt financing

II. an economic situation in which consumer prices are rising at a rapid rate

III. the ability to trade the investment in a broad market rather than in a thin market

IV. unstable currency values

A) I and II only

B) I, II and IV only

C) II and IV only

D) I, III and IV only

14) Identify and discuss five sources of risk.

15) Which types of risk can not be avoided by carefully researching a company’s business

prospects and financial statements.

1) The standard deviation is computed by dividing the sum of the squared deviations by the

number of observations.

2) Historical returns are of no use in estimating the risk of an investment.

3) The greater the dispersion around an asset’s expected return, the greater the risk.

4) Investments with lower standard deviations can be expected to produce higher rates of return.

5) Between 1926 and 2005, the return on small company stocks on average exceeded the return

on large company stocks.

6) Most investors are risk-seeking.

7) Each of the following investments produces the same rate of return. Which one has the

greatest amount of risk?

A) investment A with a standard deviation of 4%

B) investment B with a standard deviation of 12%

C) investment C with a standard deviation of 8%

D) investment D with a standard deviation of 19%

8) An investment produced annual rates of return of 5%, 12%, 8% and 11% respectively over the

past four years. What is the standard deviation of these returns?

A) 2.7%

B) 3.2%

C) 3.6%

D) 3.8%

9) An investment produced annual rates of return of 4%, 8%, 14% and 6%, respectively, over the

past four years. What is the standard deviation of these returns?

A) 3.7%

B) 4.1%

C) 4.3%

D) 4.6%

10) Which of the following statements about the standard deviation are correct?

I. The standard deviation is a measure of relative dispersion.

II. Standard deviations should be in conjunction with expected returns to compare investments.

III. The standard deviation is calculated by taking the square root of the variance.

IV. The higher the standard deviation of an investment, the lower its risk.

A) I and IV only

B) II and III only

C) I, III and IV only

D) I, II and III only

11) The expected rate of return and standard deviations, respectively for four stocks are given

below:

ABC 9%, 3%

CDE 11%, 9%

FGH 12%, 8%

IJK 14%, 10%

Which stock is clearly least desirable?

A) ABC

B) CDE

C) FGH

D) IJK

12) Most investors are risk-averse, which means they

A) refuse to accept any financial risk.

B) invest only in government insured securities.

C) require an increase in return for any increase in risk.

D) gain satisfaction from the excitement of risk.

13) Which of the following should be considered when deciding among alternative investments?

I. time value of money

II. risks associated with each investment

III. risk free rate of return

IV. personal risk tolerance level

A) I and II only

B) III and IV only

C) I, II and IV only

D) I, II, III and IV

14) Explain the relationship between risk, the expected rate of return and the actual rate of return.