# Expert Answers

1. The risk-free rate is equal to the real rate of return plus:

a. an expected inflation premium.

b. a risk premium.

c. both an inflation and a risk premium.

d. the prevailing prime rate.

2. The required rate of return on the Cosmos Corporationâ€™s common stock is 10%, the current real rate of return in the market is 1%, and the inflation rate is 3%. In this case, the risk premium associated with Cosmos stock is:

a. 5%

b. 6%

c. 7%

d. 8%

3. ____________ will lower required rates of return.

a. Higher rates of inflation

b. Higher risk premiums

c. Lower rates of inflation

d. Lower dividend yields

4. The required return on Beta stock is 14%. The risk-free rate of return is 4% and the real rate of return is 2%. Investors are requiring _________ as compensation for risk.

a. 8%

b. 10%

c. 12%

d. 14%

5. A holding period return is calculated by adding the current income to the capital gains and dividing this sum by the:

a. average investment value.

b. beginning investment value.

c. total income received.

d. selling price of the investment.

6. To determine the compounded annual rate of return on investments held for more than a year, investors typically use the pre send-value-based measure known as yield or _________ return.

a. holding period

b. internal rate of

c. inflation-adjusted

d. simple

7. 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. The internal rate of return on this investment is:

a. 8.1%

b. 9.33%

c. 14.6%

d. 16.2%

8. Ryan purchased a bond for $980 at the beginning of 2007. He received annual interest payments of $55 at the end of each year through 2012 when the bond was redeemed at its faced value of $1,000. The yield (internal rate of return) Ryan earned on his bond purchase was:

a. 5.50%

b. 5.61%

c. 5.91%

d. .34%

9. A petroleum refinery in the Gulf region is forced to shut down for several months because of hurricane damage. This is an example of:

a. market risk.

b speculation.

c. event risk.

d. business risk

10. 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 ________ risk.

a. business

b. financial

c. market

d. liquidity

11. Congress considers a bill that would eliminate the mortgage interest deduction for individuals. For the housing industry, this is an example of _________ risk.

a. tax

b. interest rate

c. business

d. event

12. An investment produced annual rates of return of 5%, 12%, 8% and 11% respectively over the past four years. The standard deviation of these returns is:

a. 2.7%

b. 3.2%

c. 3.6%

d. 3.8%

13. 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%

The clearly least desirable stock is:

a. ABC

b. CDE

c. FGH

d. IJK

14. Most investors are risk-averse, which means they:

a. refuse to accept and 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.

15. Assume that $100 is deposited at the end of each year for five years at 10% compound interest and that no withdrawals are made over the five-year period. Based on this data, which of the following would be a correct statement?

a. The future value will be $550.

b. The present value can be determined by computing the present value of $500 in five years at 10%.

c. The present value can be determined by computing the present value of a $100 ordinary annuity for five years at 10%.

d. The present value will be $500.

16. To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, the variables that should be entered into a financial calculator are:

a. N=3, i=5, PMT=1000.

b. N=3, i=5, FV=3000.

c. N=3, i=15, PMT=1000.

d. N=1, i=5, PMT=3000.

17. Marco owns the following portfolio of stocks. What is the expected return on his portfolio?

Stock__Amount Invested __Return on Stock

L_______$2,400__________-6.0%_______

M_______$10,000_________7.5%_______

N_______$3,600__________12.6%______

a. 4.7%

b. 6.6%

c. 8.4%

d. 8.7%

18. The stock of a technology company has an expected return of 15% and a standard deviation of 20%. The stock of a pharmaceutical company has an expected return of 13% and a standard deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected return of 14% and a standard deviation which will be:

a. less than the average of 20% and 18%.

b. the average of 20% and 18%

c. greater than the average of 20% and 18%

d. The answer cannot be determined with the information given.

19. The risk of a portfolio consisting of two uncorrelated assets will be:

a. equal to zero.

b. greater than the risk of the least risky asset but less than the risk level of more risky asset.

c. greater than zero but less than the risk of the more risky asset.

d. equal to the average of the risk level of the two assets.

20. American investors have several alternatives available to diversify their portfolios internationally. In terms of transaction cost, __________ is/are least attractive.

a. Mutual funds with an international focus

b. stocks of U.S. based companies with extensive foreign sales and/or operations

c. direct investment in foreign stocks

d. American Depositary Shares.

The law of diminishing returns implies: The more hours you spend studying per day, the more you will learn with each added hour Your understanding will be increased by decreasing your marginal study time Eventually, the more hours you spend studying per day, the less you will learn with each added hour The more hours you spend studying the less you will know

a. an expected inflation premium.

b. a risk premium.

c. both an inflation and a risk premium.

d. the prevailing prime rate.

2. The required rate of return on the Cosmos Corporationâ€™s common stock is 10%, the current real rate of return in the market is 1%, and the inflation rate is 3%. In this case, the risk premium associated with Cosmos stock is:

a. 5%

b. 6%

c. 7%

d. 8%

3. ____________ will lower required rates of return.

a. Higher rates of inflation

b. Higher risk premiums

c. Lower rates of inflation

d. Lower dividend yields

4. The required return on Beta stock is 14%. The risk-free rate of return is 4% and the real rate of return is 2%. Investors are requiring _________ as compensation for risk.

a. 8%

b. 10%

c. 12%

d. 14%

5. A holding period return is calculated by adding the current income to the capital gains and dividing this sum by the:

a. average investment value.

b. beginning investment value.

c. total income received.

d. selling price of the investment.

6. To determine the compounded annual rate of return on investments held for more than a year, investors typically use the pre send-value-based measure known as yield or _________ return.

a. holding period

b. internal rate of

c. inflation-adjusted

d. simple

7. 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. The internal rate of return on this investment is:

a. 8.1%

b. 9.33%

c. 14.6%

d. 16.2%

8. Ryan purchased a bond for $980 at the beginning of 2007. He received annual interest payments of $55 at the end of each year through 2012 when the bond was redeemed at its faced value of $1,000. The yield (internal rate of return) Ryan earned on his bond purchase was:

a. 5.50%

b. 5.61%

c. 5.91%

d. .34%

9. A petroleum refinery in the Gulf region is forced to shut down for several months because of hurricane damage. This is an example of:

a. market risk.

b speculation.

c. event risk.

d. business risk

10. 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 ________ risk.

a. business

b. financial

c. market

d. liquidity

11. Congress considers a bill that would eliminate the mortgage interest deduction for individuals. For the housing industry, this is an example of _________ risk.

a. tax

b. interest rate

c. business

d. event

12. An investment produced annual rates of return of 5%, 12%, 8% and 11% respectively over the past four years. The standard deviation of these returns is:

a. 2.7%

b. 3.2%

c. 3.6%

d. 3.8%

13. 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%

The clearly least desirable stock is:

a. ABC

b. CDE

c. FGH

d. IJK

14. Most investors are risk-averse, which means they:

a. refuse to accept and 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.

15. Assume that $100 is deposited at the end of each year for five years at 10% compound interest and that no withdrawals are made over the five-year period. Based on this data, which of the following would be a correct statement?

a. The future value will be $550.

b. The present value can be determined by computing the present value of $500 in five years at 10%.

c. The present value can be determined by computing the present value of a $100 ordinary annuity for five years at 10%.

d. The present value will be $500.

16. To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, the variables that should be entered into a financial calculator are:

a. N=3, i=5, PMT=1000.

b. N=3, i=5, FV=3000.

c. N=3, i=15, PMT=1000.

d. N=1, i=5, PMT=3000.

17. Marco owns the following portfolio of stocks. What is the expected return on his portfolio?

Stock__Amount Invested __Return on Stock

L_______$2,400__________-6.0%_______

M_______$10,000_________7.5%_______

N_______$3,600__________12.6%______

a. 4.7%

b. 6.6%

c. 8.4%

d. 8.7%

18. The stock of a technology company has an expected return of 15% and a standard deviation of 20%. The stock of a pharmaceutical company has an expected return of 13% and a standard deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected return of 14% and a standard deviation which will be:

a. less than the average of 20% and 18%.

b. the average of 20% and 18%

c. greater than the average of 20% and 18%

d. The answer cannot be determined with the information given.

19. The risk of a portfolio consisting of two uncorrelated assets will be:

a. equal to zero.

b. greater than the risk of the least risky asset but less than the risk level of more risky asset.

c. greater than zero but less than the risk of the more risky asset.

d. equal to the average of the risk level of the two assets.

20. American investors have several alternatives available to diversify their portfolios internationally. In terms of transaction cost, __________ is/are least attractive.

a. Mutual funds with an international focus

b. stocks of U.S. based companies with extensive foreign sales and/or operations

c. direct investment in foreign stocks

d. American Depositary Shares.

The law of diminishing returns implies: The more hours you spend studying per day, the more you will learn with each added hour Your understanding will be increased by decreasing your marginal study time Eventually, the more hours you spend studying per day, the less you will learn with each added hour The more hours you spend studying the less you will know

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