Chapter 05 Flashcards by Matt Mitchell

Over the past year you earned a nominal rate of interest of 10% on your money. The inflation rate was 5% over the same period. The exact actual growth rate of your purchasing power was

4.8%

r = (1+R)/(1+l)-1
r = 1.10/1.05 - 1 = 4.8

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Over the past year you earned a nominal rate of interest of 8% on your money. The inflation rate was 4% over the same period. The exact actual growth rate of your purchasing power was

3.8%

r = (1+R)/(1+l) - 1
r = 1.08/1.04 - 1 = 3.8

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A year ago you invested $1,000 in a savings account that pays an annual interest rate of 9%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year?

9 - 4 = 5

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A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year?

1.5%

5-3.5

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If the annual real rate of interest is 5% and the expected inflation rate is 4%, the nominal rate of interest would be approximately

5 + 4

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If the annual real rate of interest is 2.5% and the expected inflation rate is 3.7%, the nominal rate of interest would be approximately

6.2%

2.5 + 3.7

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You purchased a share of stock for $20. One year later you received $1 as a dividend and sold the share for $29. What was your holding-period return?

50%

(1+29-20)/20

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You purchased a share of stock for $68. One year later you received $3.00 as a dividend and sold the share for $74.50. What was your holding-period return?

14.0%

(3+74.50-68)/68

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Which of the following determine(s) the level of real interest rates?

I) The supply of savings by households and business firms
II) The demand for investment funds
III) The government’s net supply and/or demand for funds

I, II and III

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Which of the following statement(s) is (are) true?

I) The real rate of interest is determined by the supply and demand for funds.
II) The real rate of interest is determined by the expected rate of inflation.
III) The real rate of interest can be affected by actions of the Fed.
IV) The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation.

I and III only

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Which of the following statement(s) is(are) true?

None of the options are true.

Options are: inflation has no effect on the nominal rate of interest, the realised nominal rate of interest is always greater than the real rate of interest, certificates of deposit offer a guaranteed real rate of interest

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Other things equal, an increase in the government budget deficit

drives the interest rate up

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Ceteris paribus, a decrease in the demand for loanable funds

drives the interest rate down

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The holding-period return (HPR) on a share of stock is equal to

the capital gain yield during the period, plus the dividend yield

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Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2012 show that

stocks offered investors greater rates of return than bonds and bills

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If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realised rate of inflation,

neither borrowers nor savers gain nor lose

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You have been given this probability distribution fo the holding-period return for KMP stock:

State of the Economy - Probability - HPR
Boom - 0.30 - 18%
Normal Growth - 0.50 - 12%
Recession - 0.20 - -5%

What is the expected holding-period return for KMP stock?

10.40%

HPR = 0.30(18%) + 0.50(12%) = 0.20(-5%)

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You have been given this probability distribution fo the holding-period return for KMP stock:

State of the Economy - Probability - HPR
Boom - 0.30 - 18%
Normal Growth - 0.50 - 12%
Recession - 0.20 - -5%

What is the expected standard deviation for KMP stock?

8.13%

s = [0.30 (18-10.4)^2 + 0.50 (12-10.4)^2 + 0.20 (-5 - 10.4)^2]^0.5

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You have been given this probability distribution fo the holding-period return for KMP stock:

State of the Economy - Probability - HPR
Boom - 0.30 - 18%
Normal Growth - 0.50 - 12%
Recession - 0.20 - -5%

What is the expected variance for KMP stock?

66.04%

Variance = [0.30 (18-10.4)^2 + 0.50 (12-10.4)^2 + 0.20(-5-10.4)^2]

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If the nominal return is constant, the after-tax real rate of return

declines as the inflation rate increases and increases as the inflation rate decreases

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The risk premium for common stocks

cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in theory

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If a portfolio had a return of 18%, the risk-free asset return was 5%, and the standard deviation of the portfolio’s excess returns was 34%, the risk premium would be

13%

18-5

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You purchase a share of Boeing stock for $90. One year later, after received a dividend of $3, you sell the stock for $92. What was your holding-period return?

5.56%

HPR = (92-90+3)/90

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Toyota stock has the following probability distribution of expected prices on year from now:

State - Probability - Price
1 - 25% - $50
2 - 40% - $60
3 - 35% - $70

If you buy Toyota today for $55 and it will pay a dividend during the year of $4 per share, what is your expected holding-period return on Toyota?

18.18%

E(P) = 0.25(54/55-1) + 0.40(64/55-1) + 0.35 (74/55-1) = 18.18

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Which of the following factors would not be expected to affect the nominal interest rate?

The coupon rate on previously issued government bonds

If a portfolio had a return of 11%, the risk-free asset return was 6%, and the standard deviation of the portfolio's excess returns was 25%, the risk premium would be

5% 11-6

In words, the real rate of interest is approximately equal to

the nominal rate minus the inflation rate

If the Federal Reserve lowers the discount rate, ceteris paribus, the equilibrium levels of funds lent will ... and the equilibrium level of real interest rates will ...

increase; decrease

What has been the relationship between T-Bill rates and inflation rates since the 1980s?

The T-bill rate has been higher than the inflation rate almost the entire period

"Bracket Creep" happens when

tax liabilities are based on nominal income and there is a positive inflationrate

The holding-period return (HPR) for a stock is equal to

the dividend yield plus the capital gains yield

You have been given this probability distribution for the holding-period return for Cheese, Inc. stock State of Economy - Probability - HPR Boom - 0.20 - 24% Normal Growth - 0.45 - 15.% Recession - 0.35 - 8% Assuming that the expected return on Cheese's stock is 14.35%, what is the standard deviation of these returns?

5.74% Variance = 0.20 x (24-14.35)^2 + 0.45 x (15-14.35)^2 + 0.35 x (8-14.35)^2 = 32.9275 Standard Deviation = 32.9275^0.5

An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980. What is the holding-period return on his investment?

1.02% HPR = (15 + 980 - 985) / 985

An investor purchased a bond 63 days ago for $980. He received $17 in interest and sold the bond for $987. What is the holding-period return on his investment?

2.45% HPR = (17+987 - 980)/980

Over the past year you earned a nominal rate of interest of 8% on your money. The inflation rate was 3.5% over the same period. The exact actual growth rate of you repurchasing power was

4.35% r = (1+R)/(1+l)-1 r = 1.08/1.035 - 1

Over the past year you earned a nominal rate of interest of 14% on your money. The inflation rate was 2% over the same period. The exact actual growth rate of your purchasing power was

11.76% r = (1+R)/(1+l)-1 r = 1.14 / 1.02 -1

Over the past year you earned a nominal rate of interest of 12.5% on your money. The inflation rate was 2.6% over the same period. The exact actual growth rate of your purchasing power was

9.65% r = (1+R)/(1+l)-1 r = 1.125 / 1.026 -1

A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 6%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year?

4% 6 - 2

A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 3%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year?

-1% 3-4

A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 3%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year?

-1% \3-4

A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 5.7%. What is your approximate annual real rate of return if the rate of inflation was 1.6% over the year?

4.1% 5.7-1.6

A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 2.5%. What is your approximate annual real rate of return if the rate of inflation was 3.4% over the year?

-0.9% 2.5-3.4

A year ago, you invested $12,000 in an investment that produced a return of 18%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year?

16% 18-2

If the annual real rate of interest is 3.5% and the expected inflation rate is 2.5%, the nominal rate of interest would be approximately

None of the options 3.5+2.5 = 6

If the annual rate of interest is 2.5% and the expected inflation rate is 3.4%, the nominal rate of interest would be approximately

None of the options 2.5 + 3.4 = 5.9%

If the annual real rate of interest is 4% and the expected inflation rate is 3%, the nominal rate of interest would be approximately

None of the options 4 + 3 = 7%

You purchased a share of stocks for $12. One year later you received $0.25 as a dividend and sold the share of $12.92. What was your holding-period return?

9.75% (0.25 + 12.92 - 12)/12

You purchased a share of stock for $120. One year later you received $1.82 as a dividend and sold the share for $136. what was your holding-period return?

None of the options (1.82 + 136 - 120)/120

You purchased a share of stock for $65. One year later you received $2.37 as a dividend and sold the share for $63. What was your holding-period return?

0.57% (2.37 + 63 - 65)/65

You have been given this probability distribution for the holding-period return for a stock: State of the Economy - Probability - HPR Boom - 0.40 - 22% Normal Growth - 0.35 - 11% Recession - 0/25 0 -9% What is the expected holding period return for the stock?

None of the options 0.40(22%) + 0.35(11%) + 0.25(-9%) = 10.4%

None of the options [0.40(22-10.4)^2 + 0.35(11-10.4)^2 + 0.25(-9-10.4)^2]^0.5 = 12.167%

None of the options Variance = [0.40(22-10/4)^2 + 0.35(11-10.4)^2 + 0.25(-9-10.4)^2] = 148.04%

Which of the following measures of risk best highlights the potential loss from extreme negative returns?

Value at Risk (VaR)

Over the past year you earned a nominal rate of interest of 3.6% on your money. The inflation rate was 3.1% over the same period. The exact actual growth rate of your purchasing power was

0.48% r = (1+R)/(1+l)-1 1.036/1.031 - 1 =0.484%

A year ago you invested $1000 in a savings account that pays an annual interest rate of 4.3%. What is your approximate annual real rate of return if the rate of inflation was 3% over the year?

None of the options 4.3-3 = 1.3%

If the annual real rate of interest is 3.5% and the expected inflation rate is 3.5%, the nominal rate of interest would be approximately

7% 3.5 + 3.5

You purchased a share of CSCO stock for $20. One year later you received $2 as a dividend and sold the share for $31. What was your holding-period return?

None of the options (2+31-20)/20 = 65%

You have been given this probability distribution for the holding-period return for GM stock: State of the Economy - Probability - HPR Boom - 0.40 - 30% Normal Growth - 0.40 - 11% Recession - 0.20 - -10% What is the expected holding-period return for GM stock?

14.4% HPR = 0.40(30%) + 0.40(11%) + 20(-10%) = 14.4

14.87% [0.40(30-14.4)^2 + 0.40(11-14.4)^2 + 0.20(-10-14.4)^2]^0.5

221.04% [0.40(30-14.4)^2 + 0.40(11-14.4)^2 + 0.20(-10-14.4)^2]

You purchase a share of CAT stock for $90. One year later, after receiving a dividend of $4, you sell the stock for $97. What was your holding-period return?

12.22% (97-90+4)/90

When comparing investments with different horizons, the ... provides the more accurate comnparison

effective annual rate

Annual percentage rates (APRs) are computed using

simple interest

An investment provides a 2% return semi-annually, its effective annual rate is

4.04% (1.02)^2 - 1

If an investment provides a 1.25% return quarterly, its effective annual rate is

5.09% (1.0125)^4 - 1

If an investment provides a 0.78% return monthly, its effective annual rate is

9.77% (1.0078)^12 - 1

If an investment provides a 3% return semi-annually, its effective annual rate is

6.09% (1.03)^2 - 1

If an investment provides a 2.1% return quarterly, its effective annual rate is

8.67% (1.021)^4 - 1

Skewness is a measure of

the normality of a distribution

Kurtosis is a measure of

how fat the tails of a distribution are and the normality of a distribution

When a distribution is positively skewed,

standard deviation overestimates risk

When a distribution is negatively skewed,

standard deviation underestimates risk

If a distribution has "fat tails," it exhibits

kurtosis

If a portfolio had a return of 8%, the risk-free asset return was 3%, and the standard deviation of the portfolio's excess returns was 20%, the Sharpe measure would be

0.25 (8-3)/20

If a portfolio had a return of 12%, the risk-free asset return was 4$, and the standard deviation of the portfolio's excess returns was 25%, the Sharpe measure would be

0.32 (12-4)/25

If a portfolio had a return of 15%, the risk-free asset return was 5%, and the standard deviation of the portfolio's excess returns was 30%, the Sharpe measure would be

0.33 (15-5)/30

If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio's excess returns was 25%, the risk premium would be

8% 12-4

... is a risk measure that indicates vulnerability to extreme negative returns.

Value at risk and lower partial standard deviation

... is a risk measure that indicates vulnerability to extreme negative returns

All of the options Options include: Value at risk, Lower partial standard deviation, Expected shortfall, None of the options

The most common measure of loss associated with extremely negative returns is

value at risk

Practitioners often use a ...% VaR, meaning that ...% of returns will exceed the VaR, and ...% will be worse

5, 95, 5

When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the

most optimistic as it takes the highest return (smallest lost) of all the cases

When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside exposure would be

expected shortfall and conditional tail expectation