Exam 3: HW #5 - Risk and Return

Question 1

What are the two components of a total holding period return?
The two components are:

Answer 1

Capital appreciation and income

Question 2

Which of the following statements is correct?
a. If two investments have the same expected return, investors prefer the riskiest alternative
b. When choosing between two investments that have the same level of risk, investors prefer the investment with the lower return
c. The greater the risk associated with an investment, the lower the return investors expect from it
d. When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return

Answer 2

d. When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return

Question 3

Gunther earned a 62.5 percent return on a stock that he purchased one year ago. The stock is now worth $12, and he received a dividend of $1 during the year. How much did Gunther originally pay for the stock?

Answer 3

Return = (Current value + Dividend - Original value) / Original value
0.625 = ($12 +$1 - Original value) / original value
= $8.00

Question 4

Moshe purchased a stock for $30 last year. He found out today that he had a -100 percent return on his investment. Which of the following must be true?
a. The stock is worth $30 today
b. The stock is worth $0 today
c. The stock paid no dividends during the year
d. Both B and C must be true

Answer 4

d. Both B and C must be true

Question 5

George Wilson purchased Bright Light industries common stock for $47.50 on January 31, 2020. The firm dividends of $1.10 during the last 12 months. George sold the stock today (January 30, 2021) for $54.00. What is George’s holding period return?

Answer 5

16.00%

Question 6

Use the following table to calculate the expected return from the asset

Return Probability
0.1 0.25
0.2 0.5
0.25 0.25

Answer 6

0.1x0.25 + 0.2x0.5 + 0.25x0.25
= 18.75%

Question 7

Use the following table to calculate the expected return from the asset

Return Probability
0.05 0.1
0.1 0.15
0.15 0.5
0.25 0.25

Answer 7

0.05x0.1 + 0.1x0.15 + 0.15x0.5 + 0.25x0.25
= 15.75%

Question 8

Ahmet purchased a stock for $45 one year ago. The stock is now worth $65. During the year, the stock paid a dividend of $2.50. What is Ahmet’s total return?

Answer 8

(65-45+2.50)/45 = 0.50 or 50%

Question 9

Security Analysts that have evaluated Concordia Corporation, have determined that there is a 15% chance that the firm will generate earnings per share of $2.40; a 60% probability that the firm will generate earnings per share of $3.10; and a 25% probability that the firm will generate earnings per share of $3.80. What are the expected earnings per share for Concordia Corporation? (Round to the nearest $0.01)

Answer 9

Expected Earnings Per Share = (0.15 x $2.40) + (0.60 x $3.10) + (0.25 x $3.80) = $3.17

Question 10

Tommie has made an investment that will generate returns that are based on the state of the economy during the year. Use the following information to calculate the standard deviation of the return distribution for Tommie’s investment. Do not round intermediate computations

State Return Probability
Weak 0.13 0.30
OK 0.20 0.40
Great 0.25 0.30

Answer 10

E(R) = (0.13x0.30) + (0.20x0.40) + (0.25x0.30) = 0.194
Var(R) = (0.13-0.194)^2 x 0.30 + (0.20-0.194)^2 x 0.40 + (0.25-0.194)^2 x 0.30 =0.002184

SD(R) = SQR of 0.002184
= 0.046733285

Answer: 0.0467

Question 11

You have invested 20 percent of your portfolio in Homer, Inc., 40 percent in Marge Co., and 20 percent in Bart Resources. What is the expected return of your portfolio if Homer, Marge, and Bart have expected returns of 2 percent, 18 percent, and 3 percent, respectively?

Answer 11

0.20x0.002 = 0.004
0.40x0.18 = 0.072
0.20x0.03 = 0.006
0.004+0.072+0.006 = 0.082

Answer: 8.2%

Question 12

The beta of Ricci Co.’s stock is 3.2 and the risk-free rate of return is 9 percent. If the expected return on the market is 18 percent, then what should investors expect as a return on Ricci Co.?

Answer 12

CAPM formula
Re = Rf + B(Rm - Rf)

18%-9% = 9%

Re = 9% +3.2(9%)
= 37.8%

Question 13

The risk-free rate of return is currently 3 percent and the market risk premium is 6 percent. If the beta of Lenz, Inc., stock is 1.8, then what is the expected return on Lenz?

Answer 13

Re = Rf +B(Rm - Rf)
= 0.03 +1.8(0.06)
= 0.138 x 100%
= 13.80%

Question 14

When choosing between two investments
a. that have the same expected return, investors prefer to make equal investments in both
b. that have the same level of risk, investors prefer to make equal investments in both
c. that have the same level of risk, investors prefer that investment with the higher return
d. that have the same expected return, investors prefer the riskier alternative

Answer 14

c. that have the same level of risk, investors prefer that investment with the higher return

Question 15

Use the following table to calculate the expected return for the asset

Return Probability
12% 15%
10% 50%
7% 35%

Answer 15

E(R) = (0.12x0.15)+(0.10x0.50)+(0.07x0.35)
= 0.018+0.05+0.0245
=0.0925

= 9.25%

Question 16

The two components of total risk associated with an investment are
a. systematic risk and diversifiable risk
b. short-term risk and long-term risk
c. variance and standard deviation
d. covariance and correlation

Answer 16

a. systematic risk and diversifiable risk

Question 17

The Capital Asset Pricing Model (CAPM) measures
a. the risk-free rate of return
b. the systematic risk level of an asset
c. the expected rate of return of an asset
d. the realized rate of return of an asset

Answer 17

c. the expected rate of return of an asset

Question 18

Which of the following is true of risk and expected returns?
a. the expected return on an investment is independent of the associated risk
b. higher the risk, higher the expected returns on an investment
c. The expected return on an investment is inversely proportional to the associated risk
d. If two investments have the same expected return, investors prefer the riskier alternative

Answer 18

b. higher the risk, higher the expected returns on an investment

Question 19

The total holding period return on an investment
a. consists of a capital appreciation component and an income component
b. stays constant every year
c. is the difference between the selling price and the purchase price
d. is the difference between its selling price and tis income component

Answer 19

a. consists of a capital appreciation component and an income component

Question 20

You purchased a share of Blyton Industries common stock 1 year ago for $37.50. During the year you received dividends totaling $0.60 and today the stock can be sold for $39.28. What total return did you earn on this stock over the past year?

Answer 20

Total Return = (New Price + Dividends - Old Price) / Old Price
= ($39.28 + $0.60 - $37.50) / $37.50
= 0.06346
= 6.3%