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Corporate Finance: Core Principles & Apps, 5e (Ross)
Chapter 10 Risk and Return: Lessons from Market History
1) Which one of the following values cannot be negative?
A) Capital gain
B) Total dollar return
C) Holding period return
D) Dividend yield
E) Total return
2) The capital gains yield plus the dividend yield on a security is called the
A) geometric return.
B) total return.
C) average period return.
D) variance of returns.
E) current yield.
3) Winter's just declared an increase in its annual dividend from $.82 a share to $.85 a share. If the
stock price should remain constant, then
A) the capital gains yield would decrease.
B) the capital gains yield would increase.
C) the dividend yield would remain constant.
D) the dividend yield would increase.
E) neither the capital gains yield nor the dividend yield would change.
4) Assume stocks A and B have had identical stock prices every day for the past 3 years. Stock A
pays a dividend but Stock B does not. Which one of these statements applies to these stocks for the
last 3 years?
A) Their annual total rates of return are equal.
B) Stock A's total return has been higher than Stock B's every year.
C) Stock B's capital gain has exceeded Stock A's every year.
D) Stock A's total return had to be positive every year.
E) Stock B's holding period return exceeded that of Stock A.
5) Which one of these statements is correct?
A) Treasury bills outperformed inflation every year during the period 1926–2015.
B) Small-company stocks outperformed large-company stocks every year during the period 1926–
2015.
C) On an annual basis, small-company stocks had more consistent rates of return than did
large-company stocks for the period 1926–2015.
D) The inflation rate has been positive every year during the period 1926–2015.
E) During the 1930s (Great Depression), long-term government bonds produced a relatively stable
rate of return relative to large-company stocks.
6) For our historical comparison purposes, how are large-company stocks defined?
A) Stocks of the lowest 20 percent of the firms listed on the NYSE based on market capitalization
B) Stocks with average annual returns that exceed the average annual return of the U.S. Treasury
bill
C) Any firm that has been listed on the NYSE for 40 years or more
D) Stocks of firms included in the S&P 500 composite index
E) Stocks of firms that employ over 5,000 employees
7) Based on the period 1926 to 2015, which category of securities has outperformed all of the other
categories?
A) Long-term corporate bonds
B) U.S. Treasury bills
C) Small-company stocks
D) Large-company stocks
E) Long-term government bonds
8) Which one of these statements correctly reflects historical history for the period 1926–2015?
A) Large-company stocks have never returned more than 40 percent in a single year.
B) There is a direct relationship between the annual returns on large-company stocks and
long-term government bonds.
C) U.S. Treasury bills have had a positive rate of return every single year.
D) The return on U.S. Treasury bills has exceeded the rate of inflation every single year.
E) The rate of inflation as measured by the consumer price index has been positive every single
year.
9) Which one of these statements correctly reflects historical history for the period 1926–2015?
A) U.S. Treasury bills had a negative rate of return during the Great Depression.
B) The rate of return in any given year is a good estimate of the rate of return for the following
year.
C) For large-company stocks, both the worst and best annual rate of return occurred during the
period 1930–35.
D) The annual rate of return on U.S. Treasury bills never exceeded 8 percent.
E) The maximum annual rate of return on large-company stocks was 33 percent.
10) Assume today is December 31, 2015. Approximately how long has it been since the annual
rate of inflation as measured by the Consumer Price Index has been negative?
A) Less than 40 years
B) Between 40 and 50 years
C) Between 50 and 60 years
D) Between 60 and 70 years
E) More than 70 years
11) During the period 2000 to 2015, which one of the following years had the lowest rate of return
for the S&P 500 Index?
A) 2002
B) 2008
C) 2001
D) 2009
E) 2010
12) The histogram of the returns on large-company stocks for the period 1926 to 2015 shows that
the largest number of years had annual returns of
A) 0 to 10 percent.
B) 10 to 20 percent.
C) 20 to 30 percent.
D) 30 to 40 percent.
E) –10 to 0 percent.
13) The histograms of the returns on large-company and small-company stocks for the period 1926
to 2015 show that
A) large-company stocks never lost more than 20 percent in any one year.
B) 1945 was the best-performing year for both large-company and small-company stocks.
C) small-company stocks most commonly return 30 to 40 percent.
D) small-company stocks are more volatile than large-company stocks.
E) large-company stocks are riskier than small-company stocks.
14) For the period 1926 to 2015, the mean return on large-company stocks is
A) 8.7 percent.
B) 11.9 percent.
C) 13.2 percent.
D) 9.6 percent.
E) 14.1 percent.
15) What conclusion should you draw from the performance of stocks and bonds over the period
1926 to 2015?
A) Bonds have greater volatility than stocks.
B) Stock returns have a lower standard deviation than bond returns.
C) In any year, stocks will outperform bonds.
D) Stock returns have a smaller risk premium than bond returns.
E) Stocks are riskier than bonds.
16) The excess return you earn by moving from a relatively risk-free investment to a risky
investment is called the
A) geometric average return.
B) inflation premium.
C) risk premium.
D) time premium.
E) arithmetic average return.
17) Over the long-term, which one of the following is a correct statement concerning risk
premium?
A) The lower the volatility of returns, the greater the risk premium.
B) Stocks tend to have a higher risk premium than bonds.
C) The lower the rate of return, the greater the risk premium.
D) The risk premium does not affect the rate of return.
E) The risk premium varies by the same percentage rate as the inflation rate.
18) The risk premium is computed by ________ the average rate of return for an investment.
A) subtracting the inflation rate from
B) adding the inflation rate to
C) subtracting the average return on U.S. Treasury bills from
D) adding the average return on U.S. Treasury bills to
E) subtracting the average return on long-term government bonds from
19) Which one of the following types of securities has tended to produce the lowest real rate of
return for the period 1926 to 2015?
A) Long-term corporate bonds
B) Long-term government bonds
C) Small-company stocks
D) Large-company stocks
E) U.S. Treasury bills
20) On average, for the period 1926 to 2015
A) U.S. Treasury bills had a negative risk premium.
B) small-company stocks underperformed large-company stocks.
C) large-company stocks had a higher risk premium than long-term corporate bonds.
D) intermediate-term government bonds produced higher returns than long-term government
bonds.
E) large-company stocks had a higher risk premium than small-company stocks.
21) For the period 1926 to 2015, large-company stocks had a standard deviation of
A) 20 percent.
B) 6 percent.
C) 13 percent.
D) 27 percent.
E) 10 percent.
22) What percentage of the time should you expect to earn an annual rate of return that is within
two standard deviations of the mean?
A) 100%
B) 95%
C) 68%
D) 99%
E) 75%
23) How is the Sharpe ratio defined as it applies to security returns?
A) Average return / Risk premium
B) Standard deviation / Risk premium
C) Average return / Standard deviation
D) Risk premium / Average return
E) Risk premium / Standard deviation
24) Given a set of returns, the wider the distribution of those returns, the
A) higher the number of those returns.
B) lower the average rate of return.
C) lower the variance.
D) higher the standard deviation.
E) lower the volatility.
25) Which set of characteristics should you prefer in a stock if you desire the highest (least
negative) rate of return assuming that you will earn a negative total return for the period?
A) High-dividend, high standard deviation
B) No dividend, high standard deviation
C) High-dividend, low standard deviation
D) Low-dividend, high standard deviation
E) Low-dividend, low standard deviation
26) Given a normal distribution, assume you want to earn a rate of return that plots more than three
standard deviations above the mean. What is your probability of earning such a return in any one
year?
A) .14 percent or less
B) .15 to .25 percent
C) .26 to .50 percent
D) .51 to 1 percent
E) More than 1 percent
27) You are comparing the returns of two portfolios for a 10-year period. Portfolio I has a lower
dispersion of returns and a higher average rate of return than Portfolio II. Given this, what do you
know with certainty?
A) Portfolio I has a lower standard deviation than Portfolio II.
B) Portfolio I is riskier than Portfolio II.
C) Portfolio II has less total risk than Portfolio I.
D) Portfolio I will outperform Portfolio II over the next 10 years.
E) Portfolio II consists of more individual stocks than Portfolio I.
28) The variance of returns for a portfolio of stocks is computed by dividing the sum of the
A) squared deviations by (the number of returns minus one).
B) average returns by (the number of returns minus one).
C) average returns by (the number of returns plus one).
D) squared deviations by the average rate of return.
E) squared deviations by (the number of returns plus one).
29) The higher the Sharpe ratio, the
A) greater the total risk.
B) greater the return per unit of risk.
C) more the security resembles the overall market.
D) greater the risk per unit of return.
E) lower the level of total risk.
30) The average squared difference between the actual return and the average return is called the
A) excess return.
B) variance.
C) standard deviation.
D) risk premium.
E) volatility return.
31) The standard deviation for a set of stock returns can be calculated as the
A) variance squared.
B) positive square root of the variance.
C) positive square root of the average return.
D) average return divided by N minus one, where N is the number of returns.
E) average squared difference between the actual return and the average return.
32) A symmetric, bell-shaped frequency distribution that is completely defined by its mean and
standard deviation is the ________ distribution.
A) gamma
B) Poisson
C) bimodal
D) normal
E) uniform
33) Which one of these countries had the highest average stock market risk premium for the period
1900 to 2010?
A) United States
B) United Kingdom
C) Italy
D) Sweden
E) Denmark
34) As of 2015, the United States represents about ________ percent of the total world stock
market capitalization.
A) 53
B) 67
C) 27
D) 38
E) 19
35) If you examine the U.S. stock market risk premium by extending the 1926 to 2015 time period
backwards in time to 1802 (given the available information), the risk premium
A) decreases to 5.2 percent.
B) increases to 7.6 percent.
C) decreases to 3.9 percent.
D) increases to 7.1 percent.
E) decreases to 6.3 percent.
36) Based on historical performance from 1900–2010, the U.S.equity risk premium was
approximately
A) 6.1 percent.
B) 5.4 percent.
C) 7.2 percent.
D) 9.0 percent.
E) 8.3 percent.
37) Past performance
A) does not guarantee future performance.
B) is totally unrelated to future performance.
C) guarantees future performance.
D) is a perfect representation of future performance for the same length of time.
E) will be duplicated in the near future.
38) A review of annualized equity risk premiums by country for the period 1900 to 2010 shows
that
A) country with the lowest standard deviation had the lowest equity risk premium.
B) the standard deviation of returns was consistent among countries.
C) the sharpe ratio for each country is equal.
D) the United States had the highest risk premium of the countries listed.
E) Sharpe ratios vary significantly among countries.
39) How did long-term U.S. Treasury bonds perform in 2008?
A) Decreased by more than 15 percent
B) Decreased between 5 and 15 percent
C) Changed between –5 and +5 percent
D) Increased between 5 and 15 percent
E) Increased more than 15 percent
40) During the 2008 financial crisis, the Icelandic stock exchange temporarily halted trading. What
was the reaction of that market when trading resumed a few days later?
A) Increase in excess of 50 percent
B) Increase between 25 and 50 percent
C) Change between -25 and +25 percent
D) Decrease between 25 and 50 percent
E) Decrease in excess of 75 percent
41) In 2008, the S&P 500 index had an annual decline of
A) 68 percent.
B) 24 percent.
C) 46 percent.
D) 57 percent.
E) 37 percent.
42) In 2008, the S&P 500 index
A) declined in value every month.
B) declined almost 17 percent in 1 month.
C) increased in value during 2 months.
D) never increased by more than 2 percent in any 1 month.
E) increased in value during the first 3 months.
43) What lesson can be learned from the 2008 market decline?
A) Stocks and bonds react similarly in downward markets.
B) Diversification lowers risk.
C) Market declines cause high inflation rates.
D) Global markets all react exactly the same.
E) Equity risk premiums will decline in the future.
44) Suppose a portfolio had an arithmetic average return of 8 percent for a 4-year period. Which
one of these statements must be true regarding this portfolio for the period?
A) At least one of the 4 years produced an annual rate of return of 8 percent.
B) If the standard deviation of the portfolio is greater than zero, then the geometric average
portfolio return is less than 8 percent.
C) The standard deviation of the portfolio must be lower than the standard deviation of a
comparable portfolio that had an arithmetic average return of 9 percent.
D) If the standard deviation of the portfolio is zero, then the geometric average return must also be
zero.
E) The holding period return must be less than 8 percent.
45) The average compound return earned per year over a multiyear period is called the ________
average return.
A) real
B) standard
C) arithmetic
D) variant
E) geometric
46) The return earned in a typical year over a multiyear period is called the ________ average
return.
A) arithmetic
B) standard
C) variant
D) geometric
E) real
47) The geometric average is probably best applied to ________ performance.
A) past
B) future
C) both past and future
D) neither past nor future
E) estimated
48) This morning, you purchased one share of stock for $26. The stock pays $.32 per share each
quarter as a dividend. What must the stock price be 1 year from now if you want to earn a total
return of 16 percent for the year?
A) $29.84
B) $28.88
C) $25.01
D) $27.12
E) $27.46
49) One year ago, Stacey purchased 200 shares of IXC stock at a price of $42.68 per share. The
