CH8 TB RISK AND RETURN Flashcards by Mae Larazi

Investment A guarantees its holder $100 return. Investment B earns $0 or $200 with equal chances (i.e., an average of $100) over the same period. Both investments have equal risk.

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The return on an asset is the change in its value plus any cash distribution over a given period of time, expressed as a percentage of its ending value.

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The return on an asset is the change in its value plus any cash distribution over a given period of time, expressed as a percentage of its beginning value.

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For a risk-seeking investor, no increase in return would be required for an increase in risk.

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TRUE

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For a risk-averse investor, required return would decrease for an increase in risk.

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FALSE

For a risk-averse investor, required return would increase for an increase in risk.

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For a risk-indifferent investor, no change in return would be required for an increase in risk.

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TRUE

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Most investors are risk-averse, since for a given increase in risk they require an increase in return.

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TRUE

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For a risk-averse investor, the required return increases for an increase in risk.

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TRUE

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Interest rate risk is the chance that changes in interest rates will adversely affect the value of an investment.

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The term “risk” is used interchangeably with “uncertainty” to refer to the unpredictability of returns associated with a given asset.

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In the most basic sense, risk is a measure of the uncertainty surrounding the return that an investment will earn.

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TRUE

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An investment’s total return is the sum of any cash distributions minus the change in the investment’s value, divided by the beginning-of-period value.

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FALSE

plus

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Stocks are less risky than either bonds or bills.

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The interest rate risk associated with Treasury bonds is much higher than with bills.

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TRUE

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Which of the following is true of risk?
A) Risk and return are inversely proportionate to each other.
B) Higher the risk associated with a security the lower is its return.
C) Risk is a measure of the uncertainty surrounding the return that an investment will earn.
D) Riskier investments tend to have lower returns as compared to T-bills which are risk free.

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Nico bought 100 shares of Cisco Systems stock for $30.00 per share on January 1, 2018. He received a dividend of $2.00 per share at the end of 2018 and $3.00 per share at the end of 2019. At the end of 2020, Nico collected a dividend of $4.00 per share and sold his stock for $33.00 per share. What was Nico’s realized holding period return?
A) -40%
B) +40%
C) -36.36%
D) +36.36%

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The total rate of return on an investment over a given period of time is calculated by ________.
A) dividing the asset’s cash distributions during the period, plus change in value, by its beginning-of
period investment value
B) dividing the asset’s cash distributions during the period, plus change in value, by its ending-of period
investment value
C) dividing the asset’s cash distributions during the period, minus change in value, by its ending-of
period investment value
D) dividing the asset’s cash distributions during the period, minus change in value, by its beginning-of
period investment value

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Last year, Mike bought 100 shares of Dallas Corporation common stock for $53 per share. During the
year he received dividends of $1.45 per share. The stock is currently selling for $60 per share. What rate of
return did Mike earn over the year?
A) 11.7 percent
B) 13.2 percent
C) 14.1 percent
D) 15.9 percent

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If an investor prefers a higher return investment regardless of its risk, then he is following a ________ strategy.
A) risk-seeking
B) risk-neutral
C) risk-averse
D) risk-aware

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If an investor prefers investments with greater risk even if they have lower expected returns, then he
is following a ________ strategy.
A) risk-seeking
B) risk-indifferent
C) risk-averse
D) risk-neutral

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Risk aversion is the behavior exhibited by investors who require ________.
A) an increase in return, for a given decrease in risk
B) an increase in return, for a given increase in risk
C) no changes in return, for a given increase in risk
D) decrease in return, for a given increase in risk

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If an investor requires greater return when risk increases, then he is said to be ________.
A) risk-seeking
B) risk-indifferent
C) risk-averse
D) risk-aware

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The range of an asset’s risk is found by subtracting the worst outcome from the best outcome.

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TRUE

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Risk can be assessed by means of scenario analysis and probability distributions.

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TRUE

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An approach for assessing risk that uses a number of possible return estimates to obtain a sense of the variability among outcomes is called scenario analysis.

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TRUE

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The greater the range of an asset's returns, the more the variability the asset is said to possess. | T/F

TRUE

The real utility of the coefficient of variation is in comparing assets that have equal expected returns. | T/F

FALSE

The risk of an asset can be measured by its variance, which is found by subtracting the worst outcome from the best outcome. | T/F

FALSE ## Footnote range

The coefficient of variation is a measure of relative dispersion used in comparing the risks of assets with differing expected return. | T/F

TRUE

The more certain the return from an asset, the less variability and therefore the less risk. | T/F

TRUE

in U.S., during the past 90 years, on average the return on large-company stocks has exceeded the return on small-company stocks. | T/F

FALSE

In U.S., during the past 90 years, on average the return on small-company stocks has equalled the return on large-company stocks. | T/F

FALSE

A normal probability distribution is a symmetrical distribution whose shape resembles a bell-shaped curve. | T/F

TRUE

For normal probability distributions, 95 percent of the possible outcomes will lie between ±1 standard deviation from the expected return. | T/F

FALSE ## Footnote For normal probability distributions, *68* percent of the possible outcomes will lie between ±1 standard deviation from the expected return.

Standard deviation is a measure of relative dispersion that is useful in comparing the risks of assets with different expected returns. | T/F

FALSE ## Footnote Variance

A normal probability distribution is an asymmetrical distribution whose shape resembles a pyramid. | T/F

FALSE ## Footnote A normal probability distribution is a symmetrical distribution whose shape resembles a bell curve.

A lower coefficient of variation indicates that an asset has higher variability relative to its expected return. | T/F

FALSE

If an asset's returns display a higher coefficient of variation, that suggests the asset is riskier. | T/F

TRUE

Standard deviation measures the dispersion of an investment's return around the expected return. | T/F

TRUE

In U.S., during the past 117 years, on average the return on U.S. Treasury bills has exceeded the inflation rate. | T/F

TRUE

On average in the U.S., during the past 117 years, the return on U.S. Treasury bills has exceeded the return on Treasury bonds. | T/F

FALSE

On average in the U.S., during the past 117 years, the return on stocks has exceeded the return on Treasury bonds. | T/F

TRUE

A common approach of estimating the variability of returns involving the forecast of pessimistic, most likely, and optimistic returns associated with an asset is called ________. A) marginal analysis B) scenario analysis C) break-even analysis D) DuPont analysis

________ is one way of assessing an asset's risk. It is found by subtracting the pessimistic outcome from the optimistic outcome. A) Variance B) Standard deviation C) Probability distribution D) Range

The simplest type of probability distribution is a ________. A) bar chart B) normal distribution C) lognormal distribution D) Poisson distribution

The ________ of a given outcome is its chance of occurring. A) dispersion B) standard deviation C) probability D) reliability

A(n) ________ distribution shows all possible outcomes and associated probabilities for a given event. A) discrete B) lognormal C) exponential D) probability

The ________ measures the dispersion around the expected value. A) coefficient of variation B) chi square C) mean D) standard deviation

A ________ is a measure of relative dispersion used in comparing the risk of assets with differing expected returns. A) coefficient of variation B) chi square C) mean D) standard deviation

The ________ the coefficient of variation, the ________ the risk. A) lower; lower B) higher; lower C) lower; higher D) more stable; higher

An efficient portfolio is a portfolio that maximizes return for a given level of risk. | T/F

TRUE

New investments must be considered in light of their impact on the risk and return of the portfolio of assets because the risk of any single proposed asset investment is not independent of other assets. | T/F

TRUE

A financial manager's goal for the firm is to create a portfolio that maximizes return for a given level of risk. | T/F

FALSE

Two assets whose returns move in the same direction and have a correlation coefficient of +1 are very risky assets. | T/F

FALSE

Two assets whose returns move in the opposite directions and have a correlation coefficient of -1 are either risk-free assets or low-risk assets. | T/F

FALSE

The standard deviation of a portfolio is a function of the standard deviations of the individual securities in the portfolio, the proportion of the portfolio invested in those securities, and the correlation between the returns of those securities. | T/F

TRUE

A(n) ________ portfolio maximizes return for a given level of risk. A) efficient B) risk-free C) risk-neutral D) risk-indifferent

An efficient portfolio is defined as ________. A) grouping of assets with same level of risk B) collection of assets with the aim of maximizing the return for a given risk level C) an investment in a single asset D) grouping of assets with the highest possible correlation

An efficient portfolio is one that ________. A) guarantees a predetermined rate of return B) maximizes return for a given level of risk C) consists of a single asset, which gives maximum return D) maximizes return at all risk levels

________ is a statistical measure of the relationship between any two series of numbers. A) Coefficient of variation B) Standard deviation C) Correlation D) Probability

Perfectly ________ correlated series move exactly together and have a correlation coefficient of ________, while perfectly ________ correlated series move exactly in opposite directions and have a correlation coefficient of ________. A) negatively; -1; positively; +1 B) negatively; +1; positively; -1 C) positively; -1; negatively; +1 D) positively; +1; negatively; -1

Combining negatively correlated assets having the same expected return results in a portfolio with ________ level of expected return and ________ level of risk. A) a higher; a lower B) the same; a higher C) the same; a lower D) a lower; a higher

Combining assets that are not perfectly positively correlated with each other can reduce the overall variability of returns. | T/F

TRUE

Even if assets are not negatively correlated, the lower the correlation between them, the lower the resulting risk of the portfolio. | T/F

TRUE

In general, the lower the correlation between asset returns, the greater the benefit of diversification. | T/F

TRUE

A portfolio of two negatively correlated assets may have less risk than either of the individual assets. | T/F

TRUE

Under no circumstance would adding an asset to a portfolio increase the risk of the portfolio above the risk of the most risky asset in the portfolio. | T/F

TRUE

A portfolio that combines two assets having perfectly positively correlated returns cannot reduce the portfolio's overall risk below the risk of the least risky asset. | T/F

TRUE

A portfolio combining two assets with less than perfectly positive correlation can reduce total risk to a level below that of either of the components. | T/F

TRUE

Uncorrelated assets have correlation coefficient close to zero. | T/F

TRUE

Combining uncorrelated assets can reduce risk—not as effectively as combining negatively correlated assets, but more effectively than combining positively correlated assets. | T/F

TRUE

A firm has high sales when the economy is expanding and low sales during a recession. This firm's overall risk will be higher if it invests in another product which is counter cyclical. | T/F

FALSE

A portfolio combining two assets whose returns are less than perfectly positive correlated can increase total risk to a level above that of either of the components. | T/F

FALSE

The risk of a portfolio containing international stocks generally contains less nondiversifiable risk than one that contains only domestic stocks. | T/F

TRUE

The inclusion of assets from countries with business cycles that are not highly correlated with the U.S. business cycle reduces the portfolio's responsiveness to market movements. | T/F

TRUE

Returns (relative to risk) from internationally diversified portfolios tend to be superior to those yielded by purely domestic ones. | T/F

TRUE

When the U.S. currency gains in value, the dollar value of a foreign-currency-denominated portfolio of assets decline. | T/F

TRUE

The risk of a portfolio containing international stocks generally does not contain less nondiversifiable risk than one that contains only domestic stocks. | T/F

FALSE

Combining two less than perfectly positively correlated assets to reduce risk is known as ________. A) diversification B) valuation C) securitization D) risk aversion

If two assets having perfectly negatively correlated returns are combined in a portfolio, then some combination of those two assets will ________. A) have more risk than either asset does on its own B) have no risk at all C) have a higher return than either asset does on its own D) have a lower return than either asset does on its own

Asset 1 has an expected return of 10% and a standard deviation of 20%. Asset 2 has an expected return of 15% and a standard deviation of 30%. The correlation between the two assets is 1.0. Portfolios of these two assets will have an expected return ________. A) between 0% and 15% B) between 10% and 15% C) below 10% D) above 15%

Asset 1 has an expected return of 10% and a standard deviation of 20%. Asset 2 has an expected return of 15% and a standard deviation of 30%. The correlation between the two assets is -1.0. Portfolios of these two assets will have a standard deviation ________. A) between 0% and 20% B) between 0% and 30% C) below 10% D) between 20% and 30%

Asset 1 has an expected return of 10% and a standard deviation of 20%. Asset 2 has an expected return of 15% and a standard deviation of 30%. The correlation between the two assets is -1.0. Portfolios of these two assets will have an expected return ________. A) between 0% and 15% B) between 10% and 15% C) below 10% D) above 15%

Asset 1 has an expected return of 10% and a standard deviation of 20%. Asset 2 has an expected return of 15% and a standard deviation of 30%. The correlation between the two assets is less than 1.0. You form a portfolio by investing half of your money in asset 1 and half in asset 2. Which of the following best describes the expected return and standard deviation of your portfolio? A) The expected return is 12.5% and the standard deviation is less than 25%. B) The expected return is between 10% and 15% and the standard deviation is greater than 30%. C) The expected return is 12.5% and the standard deviation is 25%. D) The expected return is 12.5% and the standard deviation is greater than 25%.

Combining two assets having perfectly positively correlated returns will result in the creation of a portfolio with an overall risk that ________. A) remains unchanged B) decreases to a level below that of either asset C) increases to a level above that of either asset D) lies between the asset with the higher risk and the asset with the lower risk

The difference between the return on the market portfolio of assets and the risk-free rate of return represents the premium the investor must receive for taking the average amount of risk associated with holding the market portfolio of assets. | T/F

TRUE

Total risk is the sum of a security's nondiversifiable and diversifiable risk. | T/F

TRUE

Total risk is attributable to firm-specific events, such as strikes, lawsuits, regulatory actions, or the loss of a key account. | T/F

FALSE

As any investor can create a portfolio of assets that will eliminate all, or virtually all, nondiversifiable risk, the only relevant risk is diversifiable risk. | T/F

FALSE ## Footnote As any investor can create a portfolio of assets that will eliminate all, or virtually all, diversifiable risk, the only relevant risk is nondiversifiable risk.

Diversifiable risk is the relevant portion of risk attributable to market factors that affect all firms. | T/F

FALSE ## Footnote *Non-diversifiable risk* is the relevant portion of risk attributable to market factors that affect all firms.

Diversified investors should be concerned solely with nondiversifiable risk because they can easily create a portfolio of assets that will eliminate all, or virtually all, diversifiable risk. | T/F

TRUE

Diversified investors should be concerned solely with nondiversifiable risk because they can easily create a portfolio of assets that will eliminate all, or virtually all, diversifiable risk. | T/F

TRUE

Systematic risk is that portion of an asset's risk that is attributable to firm-specific, random causes. | T/F

FALSE

Unsystematic risk can be eliminated through diversification. | T/F

TRUE

Unsystematic risk is the relevant portion of an asset's risk attributable to market factors that affect all firms. | T/F

FALSE ## Footnote Systematic risk is the relevant portion of an asset's risk attributable to market factors that affect all firms.

The required return on an asset is an increasing function of its nondiversifiable risk. | T/F

TRUE

The empirical measurement of beta can be approached by using least-squares regression analysis to find the regression coefficient (bj) in the equation for the slope of the "characteristic line." | T/F

TRUE

Investors should recognize that betas are calculated using historical data and that past performance relative to the market average may not accurately predict future performance. | T/F

TRUE

The beta coefficient is an index that measures the degree of movement of an asset's return in response to a change in the market return. | T/F

TRUE

The beta coefficient is an index of the degree of movement of an asset's return in response to a change in the risk-free asset. | T/F

FALSE

Systematic risk is also referred to as ________. A) business specific risk B) internal risk C) nondiversifiable risk D) maturity risk

Risk that affects all firms is called ________. A) maturity risk B) unsystematic risk C) nondiversifiable risk D) reinvestment risk

The portion of an asset's risk that is attributable to firm-specific, random causes is called ________. A) unsystematic risk B) nondiversifiable risk C) market risk D) political risk

The relevant portion of an asset's risk, attributable to market factors that affect all firms, is called ________. A) credit risk B) diversifiable risk C) systematic risk D) maturity risk

________ risk represents the portion of an asset's risk that can be eliminated by combining assets with less than perfect positive correlation. A) Diversifiable B) Market C) Systematic D) Economic

Unsystematic risk ________. A) does not change B) can be eliminated through diversification C) cannot be estimated D) affects all firms in a market

Strikes, lawsuits, regulatory actions, or the loss of a key account are all examples of ________. A) diversifiable risk B) market risk C) economic risk D) systematic risk

War, inflation, and the condition of the foreign markets are all examples of ________. A) business specific risk B) nondiversifiable risk C) internal risk D) unsystematic risk

A beta coefficient of +1 represents an asset that ________. A) has a higher expected return than the market portfolio B) has the same expected return as the market portfolio C) has a lower expected return than the market portfolio D) is unaffected by market movement

A beta coefficient of -1 represents an asset that ________. A) is more responsive than the market portfolio B) has the same response as the market portfolio but in opposite direction C) is less responsive than the market portfolio D) is unaffected by market movement

The purpose of adding an asset with a negative or low positive beta to a portfolio is to ________. A) reduce profit B) reduce risk C) increase profit D) increase risk

The beta associated with a risk-free asset ________. A) is greater than 1 B) is less than 1 C) is equal to 0 D) is between 0 and 1

The higher an asset's beta, ________. A) the more responsive it is to changing market returns B) the less responsive it is to changing market returns C) the higher the expected return will be in a down market D) the lower the expected return will be in an up market

An increase in nondiversifiable risk would ________. A) cause an increase in the beta and would lower the required return B) have no effect on the beta and would, therefore, cause no change in the required return C) cause an increase in the beta and would increase the required return D) cause a decrease in the beta and would, therefore, lower the required rate of return

An increase in the Treasury Bill rate ________. A) has no effect on the required rate of return of a common stock B) increases the required rate of return of a common stock C) doubles the required rate of return of a common stock D) increases the beta of a common stock

The beta of a portfolio ________. A) is the sum of the betas of all assets in the portfolio B) is the product of the betas of the individual assets in the portfolio C) is the median of the range of beta of the portfolio D) is the weighted average of the betas of the individual assets in the portfolio

As randomly selected securities are combined to create a portfolio, the ________ risk of the portfolio decreases. The portion of the risk eliminated is ________ risk, while that remaining is ________ risk. A) diversifiable; nondiversifiable; total B) relevant; irrelevant; total C) total; diversifiable; nondiversifiable D) total; nondiversifiable; diversifiable

If you expect the market to increase which of the following portfolios should you purchase? A) a portfolio with a beta of 1.9 B) a portfolio with a beta of 1.0 C) a portfolio with a beta of 0 D) a portfolio with a beta of -0.5

A(n) ________ in the beta coefficient normally causes ________ in the required return and therefore ________ in the price of the stock, everything else remaining the same. A) increase; an increase; an increase B) increase; a decrease; an increase C) increase; an increase; a decrease D) decrease; a decrease; a decrease

TRUE

The security market line (SML) reflects the required return in the marketplace for each level of nondiversifiable risk (beta). | T/F

TRUE

The capital asset pricing model (CAPM) links together unsystematic risk and return for all assets. | T/F

FALSE

The correlation coefficient is an index of the degree of movement of an asset's return in response to a change in the risk-free asset return. | T/F

FALSE

The security market line is not stable over time and shifts over time in response to changing inflationary expectations. | T/F

TRUE

The steeper the slope of the security market line, the greater the degree of risk aversion | T/F

TRUE

A change in inflationary expectations resulting from events such as international trade embargoes or major changes in Federal Reserve policy will result in a shift in the SML. | T/F

TRUE

Greater risk aversion results in lower required returns for each level of risk, whereas a reduction in risk aversion would cause the required return for each level of risk to increase as depicted by SML. | T/F

FALSE

A given change in inflationary expectations will be fully reflected in a corresponding change in the returns of all assets and will be reflected graphically in a parallel shift of the SML. | T/F

TRUE

The CAPM uses standard deviation to relate an asset's risk relative to the market to the asset's required return. | T/F

FALSE

Changes in risk aversion, and therefore shifts in the SML, result from changing tastes and preferences of investors, which generally result from various economic, political, and social events. | T/F

TRUE

The widely shared expectations of hard times ahead tend to cause investors to become less risk-averse. | T/F

FALSE ## Footnote more risk averse

The ________ describes the relationship between nondiversifiable risk and the required rate of return. A) EBIT-EPS approach to capital structure B) supply-demand function for assets C) capital asset pricing model D) Gordon model

Which of the following is true of risk aversion? A) Greater risk aversion results in lower required returns for each level of risk. B) A reduction in risk aversion causes the required return for each level of risk to increase. C) In general, widely shared expectations of hard times ahead tend to cause investors to become less risk averse. D) Changes in risk aversion, and therefore shifts in the SML, result from changing preferences of investors.

In the capital asset pricing model, the beta coefficient is a measure of ________. A) unsystematic risk B) non-aggregate risk C) business-specific risk D) nondiversifiable risk

In the capital asset pricing model, the beta coefficient is a measure of ________. A) business-specific risk B) maturity risk C) market risk D) unsystematic risk

As risk aversion increases ________. A) a firm's beta will remain neutral B) investors' required rate of return will increase C) a firm's beta will decrease D) investors' required rate of return will remain unchanged

In the capital asset pricing model, an increase in inflationary expectations will be reflected by ________. A) no effect on security market line B) a decrease in the slope of the security market line C) a parallel shift downward in the security market line D) a parallel shift upward in the security market line

In the capital asset pricing model, the general risk preferences of investors in the marketplace are reflected by ________. A) the risk-free rate B) the level of the security market line C) the slope of the security market line D) the difference between the beta and the risk-free rate

An increase in the beta of a corporation, all else being the same, indicates ________. A) a decrease in risk, a higher required rate of return, and hence a lower share price B) an increase in risk, a higher required rate of return, and hence a lower share price C) a decrease in risk, a lower required rate of return, and hence a higher share price D) an increase in risk, a lower required rate of return, and hence a higher share price

Two central components of the CAPM are the ________. A) risk-free rate and the market risk premium B) risk premium and the inflation rate C) inflation rate and the market rate D) market rate and the inflation premium

Suppose the CAPM is true. Asset X has a standard deviation of 25%. The risk-free asset, by definition, has a standard deviation of 0%. Therefore, the expected return on asset X must exceed the risk-free rate. | T/F

FALSE

Suppose the CAPM is true. Asset X has a standard deviation of 20%, and Asset Y has a standard deviation of 30%. Asset Y's expected return must exceed that of Asset X. | T/F

FALSE

The security market line (SML) reflects the required return in the marketplace for each level of nondiversifiable risk (beta). | T/F

TRUE

The capital asset pricing model (CAPM) links together unsystematic risk and return for all assets. | T/F

FALSE

The correlation coefficient is an index of the degree of movement of an asset's return in response to a change in the risk-free asset return. | T/F

FALSE

The security market line is not stable over time and shifts over time in response to changing inflationary expectations. | T/F

TRUE

The steeper the slope of the security market line, the greater the degree of risk aversion. | T/F

TRUE

A change in inflationary expectations resulting from events such as international trade embargoes or major changes in Federal Reserve policy will result in a shift in the SML | T/F

TRUE

FALSE ## Footnote higher required returns

A given change in inflationary expectations will be fully reflected in a corresponding change in the returns of all assets and will be reflected graphically in a parallel shift of the SML. | T/F

TRUE

The CAPM uses standard deviation to relate an asset's risk relative to the market to the asset's required return. | T/F

FALSE

Changes in risk aversion, and therefore shifts in the SML, result from changing tastes and preferences of investors, which generally result from various economic, political, and social events. | T/F

TRUE

The widely shared expectations of hard times ahead tend to cause investors to become less riskaverse. | T/F

FALSE

In the capital asset pricing model, the beta coefficient is a measure of ________. A) unsystematic risk B) non-aggregate risk C) business-specific risk D) nondiversifiable risk

In the capital asset pricing model, the beta coefficient is a measure of ________. A) business-specific risk B) maturity risk C) market risk D) unsystematic risk

FALSE

Suppose the CAPM is true. Asset X has a standard deviation of 20%, and Asset Y has a standard deviation of 30%. Asset Y's expected return must exceed that of Asset X. | T/F

FALSE