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Essentials of Investments, 11e (Bodie)
Chapter 5 Risk, Return, and the Historical Record
1) You put up $50 at the beginning of the year for an investment. The value of the investment
grows 4% and you earn a dividend of $3.50. Your HPR was ________.
A) 4%
B) 3.5%
C) 7%
D) 11%
2) The ________ measure of returns ignores compounding.
A) geometric average
B) arithmetic average
C) IRR
D) dollar-weighted
3) If you want to measure the performance of your investment in a fund, including the timing of
your purchases and redemptions, you should calculate the ________.
A) geometric average return
B) arithmetic average return
C) dollar-weighted return
D) index return
4) Which one of the following measures time-weighted returns and allows for compounding?
A) geometric average return
B) arithmetic average return
C) dollar-weighted return
D) historical average return
5) Rank the following from highest average historical return to lowest average historical return
from 1926 to 2017.
I. Small stocks
II. Long-term bonds
III. Large stocks
IV. T-bills
A) I, II, III, IV
B) III, IV, II, I
C) I, III, II, IV
D) III, I, II, IV
6) Rank the following from highest average historical standard deviation to lowest average
historical standard deviation from 1926 to 2017.
I. Small stocks
II. Long-term bonds
III. Large stocks
IV. T-bills
A) I, II, III, IV
B) III, IV, II, I
C) I, III, II, IV
D) III, I, II, IV
7) You have calculated the historical dollar-weighted return, annual geometric average return,
and annual arithmetic average return. If you desire to forecast performance for next year, the best
forecast will be given by the ________.
A) dollar-weighted return
B) geometric average return
C) arithmetic average return
D) index return
8) The complete portfolio refers to the investment in ________.
A) the risk-free asset
B) the risky portfolio
C) the risk-free asset and the risky portfolio combined
D) the risky portfolio and the index
9) You have calculated the historical dollar-weighted return, annual geometric average return,
and annual arithmetic average return. You always reinvest your dividends and interest earned on
the portfolio. Which method provides the best measure of the actual average historical
performance of the investments you have chosen?
A) dollar-weighted return
B) geometric average return
C) arithmetic average return
D) index return
10) The holding period return on a stock is equal to ________.
A) the capital gain yield over the period plus the inflation rate
B) the capital gain yield over the period plus the dividend yield
C) the current yield plus the dividend yield
D) the dividend yield plus the risk premium
11) Your timing was good last year. You invested more in your portfolio right before prices went
up, and you sold right before prices went down. In calculating historical performance measures,
which one of the following will be the largest?
A) dollar-weighted return
B) geometric average return
C) arithmetic average return
D) mean holding-period return
12) Published data on past returns earned by mutual funds are required to be ________.
A) dollar-weighted returns
B) geometric returns
C) excess returns
D) index returns
13) The arithmetic average of -11%, 15%, and 20% is ________.
A) 15.67%
B) 8%
C) 11.22%
D) 6.45%
14) The geometric average of -12%, 20%, and 25% is ________.
A) 8.42%
B) 11%
C) 9.7%
D) 18.88%
15) The dollar-weighted return is the ________.
A) difference between cash inflows and cash outflows
B) arithmetic average return
C) geometric average return
D) internal rate of return
16) An investment earns 10% the first year, earns 15% the second year, and loses 12% the third
year. The total compound return over the 3 years was ________.
A) 41.68%
B) 11.32%
C) 3.64%
D) 13%
17) Annual percentage rates can be converted to effective annual rates by means of the following
formula:
A) [1 + (APR/n)]n - 1
B) (APR)(n)
C) (APR/n)
D) (periodic rate)(n)
18) Suppose you pay $9,700 for a $10,000 par Treasury bill maturing in 3 months. What is the
holding-period return for this investment?
A) 3.01%
B) 3.09%
C) 12.42%
D) 16.71%
19) Suppose you pay $9,800 for a $10,000 par Treasury bill maturing in 2 months. What is the
annual percentage rate of return for this investment?
A) 2.04%
B) 12 %
C) 12.24%
D) 12.89%
20) Suppose you pay $9,400 for a $10,000 par Treasury bill maturing in 6 months. What is the
effective annual rate of return for this investment?
A) 6.38%
B) 12.77%
C) 13.17%
D) 14.25%
21) You have an APR of 7.5% with continuous compounding. The EAR is ________.
A) 7.5%
B) 7.65%
C) 7.79 %
D) 8.25%
22) You have an EAR of 9%. The equivalent APR with continuous compounding is ________.
A) 8.47%
B) 8.62%
C) 8.88%
D) 9.42%
23) The market risk premium is defined as ________.
A) the difference between the return on an index fund and the return on Treasury bills
B) the difference between the return on a small-firm mutual fund and the return on the Standard
& Poor's 500 Index
C) the difference between the return on the risky asset with the lowest returns and the return on
Treasury bills
D) the difference between the return on the highest-yielding asset and the return on the lowest-
yielding asset
24) The excess return is the ________.
A) rate of return that can be earned with certainty
B) rate of return in excess of the Treasury-bill rate
C) rate of return to risk aversion
D) index return
25) The rate of return on ________ is known at the beginning of the holding period, while the
rate of return on ________ is not known until the end of the holding period.
A) risky assets; Treasury bills
B) Treasury bills; risky assets
C) excess returns; risky assets
D) index assets; bonds
26) The reward-to-volatility ratio is given by ________.
A) the slope of the capital allocation line
B) the second derivative of the capital allocation line
C) the point at which the second derivative of the investor's indifference curve reaches zero
D) the portfolio's excess return
27) Your investment has a 20% chance of earning a 30% rate of return, a 50% chance of earning
a 10% rate of return, and a 30% chance of losing 6%. What is your expected return on this
investment?
A) 12.8%
B) 11%
C) 8.9%
D) 9.2%
28) Your investment has a 40% chance of earning a 15% rate of return, a 50% chance of earning
a 10% rate of return, and a 10% chance of losing 3%. What is the standard deviation of this
investment?
A) 5.14%
B) 7.59%
C) 9.29%
D) 8.43%
29) During the 1926-2013 period the geometric mean return on small-firm stocks was ________.
A) 5.31%
B) 5.56%
C) 9.34%
D) 11.82%
30) During the 1926-2013 period the geometric mean return on Treasury bonds was ________.
A) 5.07%
B) 5.56%
C) 9.34%
D) 11.43%
31) During the 1926-2013 period the Sharpe ratio was greatest for which of the following asset
classes?
A) small U.S. stocks
B) large U.S. stocks
C) long-term U.S. Treasury bonds
D) bond world portfolio return in U.S. dollars
32) During the 1986-2013 period, the Sharpe ratio was lowest for which of the following asset
classes?
A) small U.S. stocks
B) large U.S. stocks
C) long-term U.S. Treasury bonds
D) equity world portfolio in U.S. dollars
33) During the 1926-2013 period which one of the following asset classes provided the lowest
real return?
A) Small U.S. stocks
B) Large U.S. stocks
C) Long-term U.S. Treasury bonds
D) Equity world portfolio in U.S. dollars
34) Both investors and gamblers take on risk. The difference between an investor and a gambler
is that an investor ________.
A) is normally risk neutral
B) requires a risk premium to take on the risk
C) knows he or she will not lose money
D) knows the outcomes at the beginning of the holding period
35) Historical returns have generally been ________ for stocks of small firms as (than) for stocks
of large firms.
A) the same
B) lower
C) higher
D) none of these options (There is no evidence of a systematic relationship between returns on
small-firm stocks and returns on large-firm stocks.)
36) Historically, small-firm stocks have earned higher returns than large-firm stocks. When
viewed in the context of an efficient market, this suggests that ________.
A) small firms are better run than large firms
B) government subsidies available to small firms produce effects that are discernible in stock
market statistics
C) small firms are riskier than large firms
D) small firms are not being accurately represented in the data
37) In calculating the variance of a portfolio's returns, squaring the deviations from the mean
results in:
I. Preventing the sum of the deviations from always equaling zero
II. Exaggerating the effects of large positive and negative deviations
III. A number for which the unit is percentage of returns
A) I only
B) I and II only
C) I and III only
D) I, II, and III
38) If you are promised a nominal return of 12% on a 1-year investment, and you expect the rate
of inflation to be 3%, what real rate do you expect to earn?
A) 5.48%
B) 8.74%
C) 9%
D) 12%
39) If you require a real growth in the purchasing power of your investment of 8%, and you
expect the rate of inflation over the next year to be 3%, what is the lowest nominal return that
you would be satisfied with?
A) 3%
B) 8%
C) 11%
D) 11.24%
40) One method of forecasting the risk premium is to use the ________.
A) coefficient of variation of analysts' earnings forecasts
B) variations in the risk-free rate over time
C) average historical excess returns for the asset under consideration
D) average abnormal return on the index portfolio
41) Treasury bills are paying a 4% rate of return. A risk-averse investor with a risk aversion of A
= 3 should invest entirely in a risky portfolio with a standard deviation of 24% only if the risky
portfolio's expected return is at least ________.
A) 8.67%
B) 9.84%
C) 21.28%
D) 14.68%
42) In the mean standard deviation graph, the line that connects the risk-free rate and the optimal
risky portfolio, P, is called the ________.
A) capital allocation line
B) indifference curve
C) investor's utility line
D) security market line
43) Most studies indicate that investors' risk aversion is in the range ________.
A) 1-3
B) 1.5-4
C) 3-5.2
D) 4-6
44) Two assets have the following expected returns and standard deviations when the risk-free
rate is 5%:
Asset A E(rA) = 10% σA = 20%
Asset B E(rB) = 15% σB = 27%
An investor with a risk aversion of A = 3 would find that ________ on a risk-return basis.
A) only asset A is acceptable
B) only asset B is acceptable
C) neither asset A nor asset B is acceptable
D) both asset A and asset B are acceptable
