Chapter 01 – The Investment Setting
1. Investors are willing to forgo current consumption in order to increase future consumption for a nominal rate of interest.
a.
True
b.
False
2. The rate of exchange between certain future dollars and certain current dollars is known as the pure rate of interest.
a.
True
b.
False
3. An investment is the current commitment of dollars over time to derive future payments to compensate the investor for
the time funds are committed, the expected rate of inflation, and the uncertainty of future payments.
a.
True
b.
False
4. The holding period return (HPR) is equal to the holding period yield (HPY) stated as a percentage.
a.
True
b.
False
5. The geometric mean of a series of returns is always larger than the arithmetic mean, and the difference increases with
the volatility of the series.
a.
True
b.
False
6. The expected return is the average of all possible returns.
a.
True
b.
False
7. An individual who selects the investment that offers greater certainty when everything else is the same is known as a
risk averse investor.
a.
True
b.
False
Chapter 01 – The Investment Setting
8. Two measures of the risk premium are the standard deviation and the variance.
a.
True
b.
False
9. The variance of expected returns is equal to the square root of the expected returns.
a.
True
b.
False
10. The coefficient of variation is the expected return divided by the standard deviation of the expected return.
a.
True
b.
False
11. The two most common calculations investors use to measure return performance are arithmetic means and geometric
means.
a.
True
b.
False
12. The arithmetic mean is a superior measure of the long-term performance because it indicates the compound annual
rate of return based on the ending value of the investment versus its beginning value.
a.
True
b.
False
13. Nominal rates are averages of all possible real rates.
a.
True
b.
False
14. The risk premium is a function of the volatility of operating earnings, sales volatility, and inflation.
a.
True
b.
False
15. The line that reflects the combination of risk and return available on alternative investments is referred to as the
security market line (SML).
a.
True
b.
False
16. The basic trade-off in the investment process is
a.
between the anticipated rate of return for a given investment instrument and its degree of risk.
b.
between understanding the nature of a particular investment and having the opportunity to purchase it.
c.
between high returns available on single instruments and the diversification of instruments into a portfolio.
d.
between the desired level of investment and possessing the resources necessary to carry it out.
e.
None of these are correct.
17. The rate of exchange between future consumption and current consumption is the
a.
nominal risk-free rate.
b.
coefficient of investment exchange.
c.
pure rate of interest.
d.
consumption/investment paradigm.
e.
expected rate of return.
18. In the phrase “nominal risk-free rate,” nominal means
a.
computed.
b.
historical.
c.
market.
d.
average.
e.
risk adverse.
19. If a significant change is noted in the yield of a T-bill, the change is most likely attributable to a
a.
downturn in the economy.
b.
static economy.
c.
change in the expected rate of inflation.
d.
change in the real rate of interest.
e.
change in risk aversion.
Chapter 01 – The Investment Setting
20. The real risk-free rate is affected by two factors:
a.
the relative ease or tightness in capital markets and the expected rate of inflation.
b.
the expected rate of inflation and the set of investment opportunities available in the economy.
c.
the relative ease or tightness in capital markets and the set of investment opportunities available in the
economy.
d.
time preference for income consumption and the relative ease or tightness in capital markets.
e.
time preference for income consumption and the set of investment opportunities available in the economy.
21. The ____ the variance of returns, everything else remaining constant, the ____ the dispersion of expectations and the
____ the risk.
a.
larger, greater, lower
b.
larger, smaller, higher
c.
larger, greater, higher
d.
smaller, greater, lower
e.
smaller, greater, greater
22. The coefficient of variation is a measure of
Chapter 01 – The Investment Setting
a.
central tendency.
b.
absolute variability.
c.
absolute dispersion.
d.
relative variability.
e.
relative return.
23. The nominal risk-free rate of interest is a function of the
a.
real risk-free rate and the investment’s variance.
b.
prime rate and the rate of inflation.
c.
T-bill rate plus the inflation rate.
d.
tax free rate plus the rate of inflation.
e.
real risk-free rate and the rate of inflation.
24. Refer to Exhibit 1.1. What was your holding period return?
a.
−10%
b.
−0.8
c.
25%
d.
0.8
Chapter 01 – The Investment Setting
e.
−20%
25. Refer to Exhibit 1.1. What was your holding period yield?
a.
−10%
b.
−0.8
c.
25%
d.
0.8
e.
−20%
Exhibit 1.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Suppose you bought a GM corporate bond on January 25, 2001 for $750 and solid it on January 25, 2004 for $650.00.
26. Refer to Exhibit 1.2. What was your annual holding period return?
a.
0.8667
b.
−0.1333
c.
0.0333
d.
0.9534
e.
−0.0466
Chapter 01 – The Investment Setting
27. Refer to Exhibit 1.2. What was your annual holding period yield?
a.
−0.0466
b.
−0.1333
c.
0.0333
d.
0.3534
e.
0.8667
Exhibit 1.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The common stock of XMen Inc. had the following historic prices.
Time
Price of X-Tech
3/01/1999
50.00
3/01/2000
47.00
3/01/2001
76.00
3/01/2002
80.00
3/01/2003
85.00
3/01/2004
90.00
28. Refer to Exhibit 1.3. What was your holding period return for the time period of 3/1/1999 to 3/1/2004?
a.
0.1247
b.
1.8
c.
0.1462
d.
0.40
e.
0.25
29. Refer to Exhibit 1.3. What was your annual holding period yield (Annual HPY)?
a.
0.1462
b.
0.1247
c.
1.8
d.
0.40
e.
0.25
30. Refer to Exhibit 1.3. What was your arithmetic mean annual yield for the investment in XMen Industries?
a.
0.1462
b.
0.1247
c.
1.8
d.
0.40
e.
0.25
31. Refer to Exhibit 1.3. What was your geometric mean annual yield for the investment in XMen?
a.
0.25
b.
0.40
c.
1.8
d.
0.1247
e.
0.1462
Exhibit 1.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
You have concluded that next year the following relationships are possible:
Economic Status
Probability
Rate of Return
Weak Economy
.15
−5%
Static Economy
.60
5%
Strong Economy
.25
15%
32. Refer to Exhibit 1.4. What is your expected rate of return [E(Ri)] for next year?
a.
4.25%
b.
6.00%
c.
6.25%
d.
7.75%
e.
8.00%
33. Refer to Exhibit 1.4. Compute the standard deviation of the rate of return for the one-year period.
Chapter 01 – The Investment Setting
a.
0.65%
b.
1.45%
c.
4.0%
d.
6.25%
e.
6.4%
34. Refer to Exhibit 1.4. Compute the coefficient of variation for your portfolio.
a.
0.043
b.
0.12
c.
1.40
d.
0.69
e.
1.04
Exhibit 1.5
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume that during the past year the consumer price index increased by 1.5 percent and the securities listed below
returned the following nominal rates of return.
U.S. Government T-bills
2.75%
U.S. Long-term bonds
4.75%
35. Refer to Exhibit 1.5. What are the real rates of return for each of these securities?
a.
4.29% and 6.32%
b.
1.23% and 4.29%
c.
3.20% and 6.32%
Chapter 01 – The Investment Setting
d.
1.23% and 3.20%
e.
3.75% and 5.75%
36. Refer to Exhibit 1.5. If next year the real rates all rise by 10 percent while inflation climbs from 1.5 percent to 2.5
percent, what will be the nominal rate of return on each security?
a.
1.24% and 1.52%
b.
1.35% and 3.52%
c.
3.89% and 6.11%
d.
3.52% and 3.89%
e.
1.17% and 6.11%
Exhibit 1.6
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume that you hold a two-stock portfolio. You are provided with the following information on your holdings:
Stock
Shares
Price(t)
Price(t + 1)
1
15
10
12
2
25
15
16
37. Refer to Exhibit 1.6. Calculate the HPY for stock 1.
a.
10%
b.
20%
c.
15%
d.
12%
Chapter 01 – The Investment Setting
e.
7%
38. Refer to Exhibit 1.6. Calculate the HPY for stock 2.
a.
5%
b.
6%
c.
7%
d.
8%
e.
10%
39. Refer to Exhibit 1.6. Calculate the market weights for stock 1 and 2 based on period t values.
a.
39%for stock 1 and 61% for stock 2
b.
50% for stock 1 and 50% for stock 2
c.
71% for stock 1 and 29% for stock 2
d.
29% for stock 1 and 71% for stock 2
e.
30% for stock 1 and 82% for stock 2