Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Chapter 8: Risk, Return, and Portfolio Theory
Multiple Choice Questions
1. Section: 8.1 Measuring Returns
2. Section: 8.1 Measuring Returns
3. Section: 8.1 Measuring Returns
4. Section: 8.1 Measuring Returns
5. Section: 8.2 Measuring Risk
Learning Objective: 8.3
Difficulty: Basic
6. Section: 8.2 Measuring Risk
Learning Objective: 8.3
Difficulty: Intermediate
7. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
8. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
9. Section: 8.4 The Efficient Frontier
10. Section: 8.5 Diversification
Learning Objective: 8.6
Difficulty: Intermediate
Practice Problems
Basic
11. Section: 8.1 Measuring Returns
Learning Objective: 8.2
Difficulty: Basic
Solution: We use arithmetic mean when we are trying to estimate the typical return for a single
12. Section: 8.4 The Efficient Frontier
Learning Objective: 8.5
Difficulty: Basic
Solution:
13. Section: 8.1 Measuring Returns
Learning Objective: 8.2
Difficulty: Basic
Solution:
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
14. Section: 8.1 Measuring Returns
Learning Objective: 8.1
Level of difficulty: Basic
Solution:
15. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Basic
Solution:
Intermediate
16. Section: 8.1 Measuring Returns
Learning Objective: 8.1
Difficulty: Intermediate
Solution:
17. Section: 8.1 Measuring Returns
Learning Objective: 8.1
Difficulty: Intermediate
Solution:
18. Sections: 8.1 Measuring Returns and 8.2 Measuring Risk
Learning Objective: 8.2 and 8.3
Difficulty: Intermediate
Solution:
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Remember to enter nothing in the Y’s just hit the ↓.
BAII+
Your response
X01
X02
X03
X04
X05
Your entry
Interpretation
Sample size is 5
19. Sections: 8.1 Measuring Returns, 8.2 Measuring Risk, and 8.3 Expected Return and Risk for
Portfolios
Learning Objective: 8.2, 8.3, and 8.4
Difficulty: Intermediate
Solution:
a. i) Five-day cumulative return
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
b.
Using the BAII+ to answer a. (iii and iv) and b.:
BAII+
Your response
X01
Y01
X02
Y02
X03
X04
Y04
Remember, you can always go back and check that you have entered the correct data by using
the up arrow key.
Your
entry
BAII+
response
Interpretation
Additional
action
LIN
N = 5
Sample size is 5
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
20. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution:
Case 1
Case 2
Case 3
Case 4
Case 5
$ invested
in stock 1
$500
.2*2,000 =$400
$0
$200
$150
$ invested
in stock 2
$500
$850
15%
Case 2 $ invested in stock 1: 0.2 x 2,000 = $400
Case 3 $ invested in stock 1: 5,000 – 5,000 = $0
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Case 2 Weight in stock 2: (1,600 / 2,000) x 100 = 80%
Case 3 Weight in stock 2: (5,000 / 5,000) x 100 = 100%
21. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution:
The portfolio standard deviation is 11.81% when the correlation is 0.8.
22. Sections: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution:
Case 1
Case 2
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Case 1: portfolio variance
Case 2: portfolio variance
23. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution:
a.
0%
0% 1% 2% 3% 4% 5% 6%
Daily returns
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
4%
6%
8%
Daily returns
8%
Daily returns
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Correlation
with XYZ
ABC
1
-0.84867
-0.99485
-0.13484
24. Section: 8.1 Measuring Returns
Learning Objective: 8.2
Difficulty: Intermediate
Solution:
25. Section: 8.2 Measuring Risk
Learning Objective: 8.3
Difficulty: Intermediate
Solution:
8%
10%
Daily returns
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
26. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution:
27. Sections: 8.1 Measuring Returns and 8.2 Measuring Risk
Learning Objective: 8.2 and 8.3
Difficulty: Intermediate
Solution:
c. The geometric average quarterly return:
The arithmetic average quarterly return:
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
e. We were expecting a quarterly return of 4.3 percent with a standard deviation of 3.87 percent.
28. Section: 8.1 Measuring Returns
Learning Objective: 8.2
Difficulty: Intermediate
Solution:
January 1: the expected price of GTS in one year is .25 × 150 + .75 × 200 = $187.50
29. Section: 8.1 Measuring Returns
Learning Objective: 8.2
Difficulty: Intermediate
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Solution:
To determine what the recommendation should be, we need to determine the expected price in
30. Section: 8.1 Measuring Returns
Learning Objective: 8.2
Difficulty: Intermediate
Solution:
31. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution:
32. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution:
a. Set w = weight in Peledon
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
33. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution:
YX
34. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution
35. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution:
36. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Intermediate
Solution
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Challenging
37. Section: 8.1 Measuring Returns
Learning Objective: 8.1
Difficulty: Challenging
Solution:
Carraway Corporation Performance
Opening
price
Dividend
Closing price
Income
Yield
Capital Gain
Total daily return
M
$100
$7
$115
7/100
= 7%
115 1
100
15%
−
=
=7%+15%
= 22%
Or
115 7 1
100
22%
+−
=
38. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Level of difficulty: Challenging
Solution:
a.
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Creating a chart in Excel: Mark the two columns you wish to graph (make sure X and Y are next
Click next and follow the instructions.
18.00%
20.00%
Portfolio return
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
b. For every additional 1% invested in DEF we gain .01 × 18% and give up .01 × 6% for a net
c. My boss and I are both correct. For every 1% decline in the investment in DEF, I will be
39. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Challenging
Solution:
40. Section: 8.3 Expected Return and Risk for Portfolios
Learning Objective: 8.4
Difficulty: Challenging
Solution: