Chapter 5 Risk Return and the Historical Record Exam Prep

Student name:__________

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question.
1) Over the past year, you earned a nominal rate of interest of 12% on your money. The inflation rate was 3% over the same period. The exact actual growth rate of your purchasing power was

A) 15.5%.
B) 10.0%.
C) 5.0%.
D) 8.7%.
E) 15.0%.

2) Over the past year, you earned a nominal rate of interest of 9% on your money. The inflation rate was 3% over the same period. The exact actual growth rate of your purchasing power was

A) 15.5%.
B) 10.0%.
C) 5.8%.
D) 4.8%.
E) 15.0%.

3) 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 2% over the year?

A) 5%
B) 10%
C) 7%
D) 3%

4) 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 1.5% over the year?

A) 3.5%
B) 10%
C) 7%
D) 4%
E) None of the options are correct.

5) If the annual real rate of interest is 6%, and the expected inflation rate is 2%, the nominal rate of interest would be approximately

A) 1%.
B) 8%.
C) 20%.
D) 15%.

6) If the annual real rate of interest is 3.0%, and the expected inflation rate is 4.0%, the nominal rate of interest would be approximately

A) 3.7%.
B) 7.0%.
C) 2.5%.
D) −1.2%.

7) You purchased a share of stock for $25. One year later, you received $1 as a dividend and sold the share for $29. What was your holding-period return?

A) 45%
B) 20%
C) 5%
D) 40%
E) None of the options are correct.

8) You purchased a share of stock for $68. One year later, you received $5.00 as a dividend and sold the share for $74.50. What was your holding-period return?

A) 12.5%
B) 16.9%
C) 13.6%
D) 11.8%

9) Which of the following determine(s) the level of real interest rates?I) The supply of savings by households and business firmsII) The demand for investment fundsIII) The government's net supply and/or demand for funds

A) I only
B) II only
C) I and II only
D) I, II, and III

10) 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.

A) I and II only
B) I and III only
C) III and IV only
D) II and III only
E) I, II, III, and IV only

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

A) Inflation has no effect on the nominal rate of interest.
B) The realized nominal rate of interest is always greater than the real rate of interest.
C) Certificates of deposit offer a guaranteed real rate of interest.
D) None of the options are true.

12) Other things equal, an increase in the government budget deficit

A) drives the interest rate down.
B) drives the interest rate up.
C) might not have any effect on interest rates.
D) increases business prospects.

13) Ceteris paribus, a decrease in the demand for loans

A) drives the interest rate down.
B) drives the interest rate up.
C) might not have any effect on interest rates.
D) results from an increase in business prospects and a decrease in the level of savings.

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

A) the capital gain yield during the period plus the inflation rate.
B) the capital gain yield during the period plus the dividend yield.
C) the current yield plus the dividend yield.
D) the dividend yield plus the risk premium.
E) the change in stock price.

15) Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2018 show that

A) stocks offered investors greater rates of return than bonds and bills.
B) stock returns were less volatile than those of bonds and bills.
C) bonds offered investors greater rates of return than stocks and bills.
D) bills outperformed stocks and bonds.
E) Treasury bills always offered a rate of return greater than inflation.

16) If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of inflation,

A) borrowers gain and savers lose.
B) savers gain and borrowers lose.
C) both borrowers and savers lose.
D) neither borrowers nor savers gain nor lose.
E) both borrowers and savers gain.

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

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

A) 10.40%
B) 9.32%
C) 11.63%
D) 11.54%
E) 10.88%

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

What is the expected standard deviation for KMP stock?

A) 6.91%
B) 8.13%
C) 7.79%
D) 7.25%
E) 8.85%

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

What is the expected variance for KMP stock?

A) 66.04%
B) 69.96%
C) 77.04%
D) 63.72%
E) 78.45%

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

A) declines as the inflation rate increases.
B) increases as the inflation rate increases.
C) declines as the inflation rate declines.
D) increases as the inflation rate decreases.
E) declines as the inflation rate increases and increases as the inflation rate decreases.

21) The risk premium for common stocks

A) cannot be zero, for investors would be unwilling to invest in common stocks.
B) must always be positive, in theory.
C) is negative, as common stocks are risky.
D) cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in theory.
E) cannot be zero, for investors would be unwilling to invest in common stocks and is negative, as common stocks are risky.

22) 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

A) 13%.
B) 18%.
C) 49%.
D) 12%.
E) 29%.

23) You purchase a share of Duke Energy Stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding-period return?

A) 4.44%
B) 2.22%
C) 3.33%
D) 5.56%
E) None of the options are correct.

24) Coca Cola stock has the following probability distribution of expected prices one year from now:

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

A) 17.72%
B) 18.89%
C) 17.91%
D) 18.18%

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

A) The supply of loans
B) The demand for loans
C) The coupon rate on previously issued government bonds
D) The expected rate of inflation
E) Government spending and borrowing

26) 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

A) 14%.
B) 6%.
C) 35%.
D) 21%.
E) 5%.

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

A) the nominal rate minus the inflation rate.
B) the inflation rate minus the nominal rate.
C) the nominal rate times the inflation rate.
D) the inflation rate divided by the nominal rate.
E) the nominal rate plus the inflation rate.

28) If the Federal Reserve lowers the Fed Funds rate, ceteris paribus, the equilibrium levels of funds lent will __________, and the equilibrium level of real interest rates will ___________.

A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
E) reverse direction from their previous trends; reverse direction from their previous trends

29) "Bracket Creep" happens when

A) tax liabilities are based on real income and there is a negative inflation rate.
B) tax liabilities are based on real income and there is a positive inflation rate.
C) tax liabilities are based on nominal income and there is a negative inflation rate.
D) tax liabilities are based on nominal income and there is a positive inflation rate.
E) too many peculiar people make their way into the highest tax bracket.

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

A) the real yield minus the inflation rate.
B) the nominal yield minus the real yield.
C) the capital gains yield minus the tax rate.
D) the capital gains yield minus the dividend yield.
E) the dividend yield plus the capital gains yield.

31) You have been given this probability distribution for the holding-period return for Cheese, Inc. stock:

Assuming that the expected return on Cheese's stock is 14.35%, what is the standard deviation of these returns?

A) 4.72%
B) 6.30%
C) 4.38%
D) 5.74%
E) None of the options are correct.

32) 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?

A) 1.02%
B) 0.50%
C) 1.92%
D) 0.01%

33) 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?

A) 1.52%
B) 2.45%
C) 1.92%
D) 2.68%

34) 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 your purchasing power was

A) 15.55%.
B) 4.35%.
C) 5.02%.
D) 4.81%.
E) 15.04%.

35) 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

A) 11.76%.
B) 16.00%.
C) 15.02%.
D) 14.32%.

36) 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

A) 9.15%.
B) 9.90%.
C) 9.65%.
D) 10.52%.

37) 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?

A) 4%
B) 2%
C) 6%
D) 3%

38) 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?

A) 1%
B) −1%
C) 7%
D) 3%

39) 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?

A) 4.1%
B) 2.5%
C) 2.9%
D) 1.6%

40) A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 3.5%. What is your approximate annual real rate of return if the rate of inflation was 5.5% over the year?

A) 0.9%
B) −2.0%
C) 5.9%
D) 3.4%

41) A year ago, you invested $12,000 in an investment that produced a return of 16%. What is your approximate annual real rate of return if the rate of inflation was 4% over the year?

A) 18%
B) 2%
C) 12%
D) 15%

42) If the annual real rate of interest is 2.5%, and the expected inflation rate is 1.0%, the nominal rate of interest would be approximately

A) 3.5%.
B) 2.5%.
C) 1%.
D) 6.8%.
E) None of the options are correct.

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

A) 5.9%.
B) 0.9%.
C) –0.9%.
D) 7%.
E) None of the options are correct.

44) If the annual real rate of interest is 4%, and the expected inflation rate is 2%, the nominal rate of interest would be approximately

A) 6%.
B) 3%.
C) 1%.
D) 5%.
E) None of the options are correct.

45) You purchased a share of stock for $12. One year later, you received $0.50 as a dividend and sold the share for $13.25. What was your holding-period return?

A) 9.75%
B) 10.65%
C) 11.75%
D) 14.58%
E) None of the options are correct.

46) 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?

A) 15.67%
B) 22.12%
C) 18.85%
D) 13.24%
E) None of the options are correct.

47) 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?

A) 0.57%
B) −0.2550%
C) −0.89%
D) 1.63%
E) None of the options are correct.

48) You have been given this probability distribution for the holding-period return for a stock:

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

A) 11.67%
B) 8.33%
C) 9.56%
D) 12.4%
E) None of the options are correct.

49) You have been given this probability distribution for the holding-period return for a stock:

What is the expected standard deviation for the stock?

A) 2.07%
B) 9.96%
C) 7.04%
D) 1.44%
E) None of the options are correct.

50) You have been given this probability distribution for the holding-period return for a stock:

What is the expected variance for the stock?

A) 142.07%
B) 189.96%
C) 177.04%
D) 128.17%
E) None of the options are correct.

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

A) Standard deviation
B) Variance
C) Upper partial standard deviation
D) Value at risk (VaR)
E) None of the options are correct.

52) 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

A) 3.6%.
B) 3.1%.
C) 0.48%.
D) 6.7%.

53) A year ago, you invested $1,000 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?

A) 4.3%
B) −1.3%
C) 7.3%
D) 3%
E) None of the options.

54) 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

A) 0%.
B) 3.5%.
C) 12.25%.
D) 7%.

55) 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?

A) 45%
B) 50%
C) 60%
D) 40%
E) None of the options are correct.

56) You have been given this probability distribution for the holding-period return for GM stock:

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

A) 10.4%
B) 11.4%
C) 12.4%
D) 13.4%
E) 14.4%

57) You have been given this probability distribution for the holding-period return for GM stock:

What is the expected standard deviation for GM stock?

A) 16.91%
B) 16.13%
C) 13.79%
D) 15.25%
E) 14.87%

58) You have been given this probability distribution for the holding-period return for GM stock:

What is the expected variance for GM stock?

A) 200.00%
B) 221.04%
C) 246.37%
D) 14.87%
E) 16.13%

59) 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?

A) 14.44%
B) 12.22%
C) 13.33%
D) 5.56%

60) When comparing investments with different horizons, the ____________ provides the more accurate comparison.

A) arithmetic average
B) effective annual rate
C) average annual return
D) historical annual average

61) Annual percentage rates (APRs) are computed using

A) simple interest.
B) compound interest.
C) either simple interest or compound interest.
D) best estimates of expected real costs.
E) None of the options are correct.

62) If an investment provides a 2% return semi-annually, its effective annual rate is

A) 2%.
B) 4%.
C) 4.02%.
D) 4.04%.
E) None of the options are correct.

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

A) 5.23%.
B) 5.09%.
C) 4.02%.
D) 4.04%.

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

A) 9.36%.
B) 9.63%.
C) 10.02%.
D) 9.77%.

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

A) 3%.
B) 6%.
C) 6.06%.
D) 6.09%.

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

A) 2.1%.
B) 8.4%.
C) 8.56%.
D) 8.67%.

67) Skewness is a measure of

A) how fat the tails of a distribution are.
B) the downside risk of a distribution.
C) the symmetry of a distribution.
D) the dividend yield of the distribution.
E) None of the options are correct.

68) Kurtosis is a measure of

A) how fat the tails of a distribution are.
B) the downside risk of a distribution.
C) the normality of a distribution.
D) the dividend yield of the distribution.

69) When a distribution is positively skewed,

A) standard deviation overestimates risk.
B) standard deviation correctly estimates risk.
C) standard deviation underestimates risk.
D) the tails are fatter than in a normal distribution.

70) When a distribution is negatively skewed,

A) standard deviation overestimates risk.
B) standard deviation correctly estimates risk.
C) standard deviation underestimates risk.
D) the tails are fatter than in a normal distribution.

71) If a distribution has "fat tails," it exhibits

A) positive skewness.
B) negative skewness.
C) a kurtosis of zero.
D) kurtosis.
E) positive skewness and kurtosis.

72) 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

A) 0.08.
B) 0.03.
C) 0.20.
D) 0.11.
E) 0.25.

73) 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

A) 0.12.
B) 0.04.
C) 0.32.
D) 0.16.
E) 0.25.

74) 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

A) 0.20.
B) 0.35.
C) 0.45.
D) 0.33.
E) 0.25.

75) 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

A) 8%.
B) 16%.
C) 37%.
D) 21%.
E) 29%.

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

A) Value at risk
B) Lower partial standard deviation
C) Standard deviation
D) Value at risk and lower partial standard deviation
E) None of the options are correct.

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

A) Value at risk
B) Lower partial standard deviation
C) Expected shortfall
D) None of the options
E) All of the options are correct.

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

A) lower partial standard deviation.
B) value at risk.
C) expected shortfall.
D) standard deviation.

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

A) 25; 75; 25
B) 75; 25; 75
C) 1; 99; 1
D) 95; 5; 95
E) 80; 80; 20

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

A) most realistic, as it is the most complete measure of risk.
B) most pessimistic, as it is the most complete measure of risk.
C) most optimistic, as it is the most complete measure of risk.
D) most optimistic, as it takes the highest return (smallest loss) of all the cases.

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

A) expected shortfall.
B) value at risk.
C) conditional tail expectation.
D) expected shortfall and value at risk.
E) expected shortfall and conditional tail expectation.

82) A portfolio generates a Sharpe ratio of 0.83. Which of the following benchmark Sharpe ration would be considered show the portfolio over performed?

A) 0.81
B) 0.79
C) 0.65
D) 0.62
E) All of them

83) The best measure of a portfolio’s risk adjusted performance is the _________.

A) return
B) standard deviation
C) Jensen alpha
D) Sharpe measure
E) All of them

84) Which combination of returns and standard deviation provides the highest Sharpe ratio? Assume a 3% risk free rate.

A) return = 12%, standard deviation = 20%
B) return = 15%, standard deviation = 22%
C) return = 21%, standard deviation = 25%
D) return = 25%, standard deviation = 35%

85) A(n) ____________________ can be used to show the possible outcomes from a normal distribution function.

A) bell curve
B) cumulative normal function
C) event tree
D) confidence level

86) In a two tailed normal distribution function, what is the confidence level created at 2 standard deviations?

A) 68.26%
B) 95.44%
C) 99.74%
D) 86.85%
E) 72.50%