Risk and Return Midterm

Risk and Return
 Nico bought 100 shares of Cisco Systems stock for $30.00 per share on January 1, 2021. He
received a dividend of $2.00 per share at the end of 2021, and at that time the stock was selling
for $34. What return did Nico earn in 2021 on the stock?
A) +13%
B) +20%
C) +7%
D) Nico did not earn a return because he did not sell the shares in 2020.
Answer: B
Diff: 1
Topic: Return Defined
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking
 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
Answer: D
Diff: 1
 Tim purchased a bounce house one year ago for $6,500. During the year it generated $4,000 in
cash flow. If Tim sells the bounce house today, he could receive $6,100 for it. What would be his
total rate of return under these conditions?
Answer: Realized return = = 55.38%
Asset A was purchased six months ago for $25,000 and has generated $1,500 cash flow during that
period. What is the asset's total rate of return if it can be sold for $26,750 today?
Answer: Realized return = = 13%

Annual rate of return = 13% × 2 = 26%
Diff: 1
 ) A certain investment has a 50% chance of paying $100 and 50% chance of paying -$100. A risk-
averse investor ________.
A) would not be willing to buy this investment at any price greater than or equal to $0
B) would be willing to buy this investment as long as the price is above $0
C) would be willing to buy this investment at a price between $1 and $5
D) would be willing to accept this investment as a gift
Answer: A
Diff: 1
Topic: Risk Preferences
 Perry purchased 100 shares of Ferro, Inc. common stock for $25 per share one year ago. During
the year, Ferro, Inc. paid cash dividends of $2 per share. The stock is currently selling for $30 per
share. If Perry sells all of his shares of Ferro, Inc. today, what rate of return would he earn?
Answer: Realized return = = 28%
Diff: 1
 Nico bought 100 shares of a company's stock for $22.00 per share on January 1, 2019. He
received a dividend of $2.00 per share at the end of 2019 and $3.00 per share at the end of
2020. At the end of 2021, Nico collected a dividend of $4.00 per share and sold his stock for
$18.00 per share. What was Nico's total return over the three-year period? What was Nico's
compound annual rate of return? (Hint: calculate an IRR). Explain the difference.
Answer: Realized return = = 22.7%
Which asset would the risk-averse financial manager prefer? (See below.)
A) Asset A
B) Asset B
C) Asset C
D) Asset D
Answer: D
Diff: 1
Topic: Risk Measurement
AACSB: Reflective Thinking
 The expected value and the standard deviation of returns for asset A is ________. (See below.)
Asset A
A) 12 percent and 4 percent

B) 12.7 percent and 2.3 percent
C) 12.7 percent and 4 percent
D) 12 percent and 2.3 percent
Answer: B
Diff: 1
 The ________ the coefficient of variation, the ________ the risk.

A) lower; lower
B) higher; lower
C) lower; higher
D) more stable; higher
Answer: A
Diff: 1
 Given the following expected returns and standard deviations of assets B, M, Q, and D, which
asset has the most favorable coefficient of variation?
A) Asset B
B) Asset M
C) Asset Q
D) Asset D
Answer: A
Diff: 1
 The expected value, standard deviation of returns, and coefficient of variation for asset A are
________. (See below.)
Asset A
A) 10 percent, 8 percent, and 1.25, respectively

B) 9.33 percent, 8 percent, and 2.15, respectively
C) 9.35 percent, 4.68 percent, and 2.00, respectively
D) 9.35 percent, 2.76 percent, and 0.295, respectively
Answer: D
Diff: 3
Given the following limited information about the two assets A and B, which asset seems preferable?
Answer: Asset A is preferred because it has a lower range for the same expected return.
Diff: 1
Topic: Risk Assessment
34) Using five years of historical data below, calculate the average return and standard deviation of
returns for Asset A.
Answer: Average return = (20 + 30 - 15 + 2 + 3) / 5 = 8%
Std deviation = = 17.4%
Diff: 2
 Champion Breweries must choose between two asset purchases. The annual rate of return and
related probabilities given below summarize the firm's analysis.
For each asset, compute

(a) the expected rate of return.
(b) the standard deviation of the expected return.
(c) the coefficient of variation of the return.
(d) Which asset should Champion select?
Answer:
(a)
Expected Return = 15% Expected Return = 15%

(b) Asset A
× 0.30 = 7.5%
× 0.40 = 0%
× 0.30 = 7.5%
15%
Variance = 15
Standard Deviation of A = 3.87%
Asset B
× 0.40 = 40%
× 0.20 = 0%
× 0.40 = 40%
80%
 Standard Deviation of B = 8.94%
(c) CVA = 3.87/15 = 0.26 CVB = 8.94/15 = 0.60
(d) Asset A; for 15% rate of return and lesser risk.
Diff: 2
 The College Copy Shop is in the process of purchasing a high-tech copier. In its search, it has
gathered the following information about two possible copiers A and B.
(a) Compute expected rate of return for each copier.

(b) Compute variance and standard deviation of rate of return for each copier.
(c) Which copier should they purchase?
Answer:
a and b.
Expected value = 16.9% Expected value = 17.05%

Variance A = 17.48 Variance = 35.65
SD = 4.18% SD = 5.97%
(c) CV = SD / r
Copier A: CV = 4.18/16.90 = 0.25
Copier B: CV = 5.97/17.05 = 0.35
The College Copy Shop should buy copier A.
Diff: 2
Given the following probability distribution for assets X and Y, compute the expected rate of return,
variance, standard deviation, and coefficient of variation for the two assets. Which asset seems to be a
better investment?
Answer:
Expected value = 10.7% Expected value = 11.15%

Variance = 2.01 Variance = 0.63
SD = 1.42% SD = 0.79%
CV = SD/r
Asset X: CV = 1.42/10.70 = 0.13
Asset Y: CV = 0.79/11.15 = 0.07
Asset Y is preferred.
Diff: 2
8.3 Risk of a portfolio
 An efficient portfolio is a portfolio that maximizes return for a given level of risk.
Answer: TRUE
Diff: 1
Topic: Risk of a Portfolio
 Two assets whose returns move in the same direction and have a correlation coefficient of +1
are very risky assets.
Answer: FALSE
Diff: 1
Topic: Correlation
 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.
Answer: FALSE
Diff: 1
Topic: Correlation
 A(n) ________ portfolio maximizes return for a given level of risk.

A) efficient
B) risk-free
C) risk-neutral
D) risk-indifferent
Answer: A
Diff: 1
 Two assets have a correlation coefficient of -1.0. If you combine these two assets in a portfolio
________.
A) the portfolio return will be 0% because the returns on one assets exactly offset the returns on the
other asset
B) there will be some combination of the two assets that produces a portfolio with no risk at all
C) all combinations of the two assets will result in portfolios that are completely free of risk
D) the benefits of diversification are minimal Answer: B
 Asset #1 has a standard deviation of 20%, and Asset #2 has a standard deviation of 30%. The
correlation between the two assets is less than 1.0. The standard deviation of a portfolio that
invests 50% in Asset #1 and 50% in Asset #2 is ________.
A) 25%
B) less than 25%
C) more than 25%
D) it is impossible to say without knowing the value of the correlation coefficient
Answer: B
Diff: 2
 An investment advisor has recommended a $50,000 portfolio containing assets R, J, and K;

$25,000 will be invested in asset R, with an expected annual return of 12 percent; $10,000 will
be invested in asset J, with an expected annual return of 18 percent; and $15,000 will be
invested in asset K, with an expected annual return of 8 percent. The expected annual return of
this portfolio is ________.
A) 12.67%
B) 12.00%
C) 10.00%
D) 11.78%
Answer: B
Diff: 2
Topic: Portfolio Return and Standard Deviation
 Given the returns of two stocks J and K in the table below over the next 4 years. Find the
expected return and standard deviation of holding a portfolio of 40% of stock J and 60% in stock
K over the next 4 years:
Stock J Stock K
2020 10% 9%
2021 12% 8%
2022 13% 10%
2023 15% 11%
A) 10.7% and 1.34%

B) 10.6% and 1.79%
C) 10.6% and 1.16%
D) 14.3% and 2.02%
Answer: A
Diff: 2
 ________ is a statistical measure of the relationship between any two series of numbers.
A) Coefficient of variation
B) Standard deviation
C) Correlation
D) Probability
Answer: C
Diff: 1
Topic: Correlation
 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
Answer: D
Diff: 1
Topic: Correlation
 Two assets have a correlation coefficient less than 1.0, and they have the same expected return.
Combining these assets results in a portfolio with ________ expected return and ________ risk.
A) a higher; less
B) the same; more
C) the same; less
D) a lower; more
Answer: C
Diff: 1
Topic: Correlation
Table 8.1
 The correlation of returns between Asset A and Asset B can be characterized as ________. (See
Table 8.1)
A) perfectly positively correlated
B) perfectly negatively correlated
C) uncorrelated
D) partially correlated
Answer: B
Diff: 2
 If you were to create a portfolio designed to reduce risk by investing equal proportions in each of
two different assets, which portfolio would you recommend? (See Table 8.1)
A) Assets A and B
B) Assets A and C
C) none of the available combinations
D) cannot be determined
Answer: A
Diff: 2
Topic: Correlation
 The portfolio with a standard deviation of zero ________. (See Table 8.1)
A) is comprised of Assets A and B
B) is comprised of Assets A and C
C) is not possible
D) cannot be determined
Answer: A
Diff: 2
 Akai has a portfolio of three assets. Find the expected rate of return for the portfolio assuming
he invests 50 percent of its money in asset A with 10 percent rate of return, 30 percent in asset
B with a rate of return of 20 percent, and the rest in asset C with 30 percent rate of return.
Answer:
Expected rate of return = 17 percent.

Diff: 2
 Combining assets that are not perfectly positively correlated with each other can reduce the
overall variability of returns.
Answer: TRUE
Diff: 1
Topic: Diversification
 Even if assets are not negatively correlated, the lower the correlation between them, the lower
the resulting standard deviation of the portfolio.
Answer: TRUE
Diff: 1
 In general, the lower the correlation between asset returns, the greater the benefit of
diversification.
Answer: TRUE
Diff: 1
 One stock has a standard deviation of 20%, and another has a standard deviation of 40%. The
correlation coefficient is 0.3. The standard deviation of a portfolio that invests 50% in each of
the two stocks equals ________.
A) 30.0%
B) 26.5%
C) 6.2%
D) 24.9%
Answer: D
Diff: 1
 Asset A has an expected return of 10% and a standard deviation of 25%. Asset B has an
expected return of 18% and a standard deviation of 50%. The correlation between the two
assets is -1.0. If a risk-averse investor can hold either of these two assets or any combination of
them, it is irrational for the investor to hold all of their money in Asset A.
Answer: FALSE
Diff: 1
Topic: International Diversification
 Asset 1 has an expected return of 10% and a standard deviation of 20%. Asset 2 has an
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) between 20% and 30%
D) above 15%
Answer: B
Diff: 1
Topic: Portfolio Effects
assets is -1.0. Portfolios of these two assets will have a standard deviation ________.
C) below 10%
D) between 20% and 30%
Answer: B
Diff: 1
assets is -1.0. Portfolios of these two assets will have an expected return ________.
C) between 0% and 30%
D) above 15%
Answer: B
Diff: 1
8.4 Risk and return: The Capital Asset Pricing Model (CAPM)
 The difference between the expected return on the market portfolio of assets and the risk-free
rate of return represents the premium the investor demands for taking the average amount of
risk associated with holding the market portfolio of assets.
Answer: TRUE
Diff: 1
Topic: The Model: CAPM
Total risk is the sum of a security's nondiversifiable and diversifiable risk.

Answer: TRUE
Diff: 1
Topic: Types of Risk
Unsystematic risk can be eliminated through diversification.

Answer: TRUE
Diff: 1
AACSB: Analytical ThinkingLearning Objective: LG 5
Table 8.2
You are going to invest $20,000 in a portfolio consisting of assets X, Y, and Z, as follows:
 Given the information in Table 8.2, what is the expected return of this portfolio?
A) 11.40%
B) 10.00%
C) 11.33%
D) 11.70%
Answer: C
Diff: 1
 The beta of the portfolio in Table 8.2, containing assets X, Y, and Z is ________.
A) 1.5
B) 2.4
C) 1.6
D) 2.0
Answer: C
Diff: 1
 The beta of the portfolio in Table 8.2 indicates this portfolio ________.
A) has more risk than the market
B) has less risk than the market
C) has an unrelated amount of risk compared to the market
D) has the same risk as the market
Answer: A
Diff: 2
 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
Answer: C
Diff: 1
 Nicole holds three stocks in her portfolio: A, B, and C. The portfolio beta is 1.40. Stock A
comprises 15 percent of the dollar value of her holdings and has a beta of 1.0. If Nicole sells all
of her investment in A and invests the proceeds in the risk-free asset, her new portfolio beta will
be ________.
A) 0.60
B) 0.88
C) 1.00
D) 1.25
Answer: D
Diff: 1
 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
Answer: A
Diff: 1
 Nico owns 100 shares of Stock X which has a price of $12 per share and 200 shares of Stock Y
which has a price of $3 per share. What is the proportion of Nico's portfolio invested in stock X?
A) 77%
B) 67%
C) 50%
D) 33%
Answer: B
Diff: 1
 Nico wants to invest all of his money in just two assets: the risk-free asset and the market
portfolio. What is Nico's portfolio beta if he invests a quarter of his money in the market
portfolio and the rest in the risk free asset?
A) 0.00
B) 0.25
C) 0.75
D) 1.00
Answer: B
Diff: 1
 What is the expected market return if the expected return on Asset X is 20 percent, its beta is
1.5, and the risk free rate is 5 percent?
A) 5.0%
B) 7.5%
C) 15.0%
D) 22.5%
Answer: C
Diff: 1
 What is Nico's portfolio beta if he invests an equal amount in Asset X with a beta of 0.60, Asset Y
with a beta of 1.60, and the risk-free asset?
A) 1.24
B) 1.00
C) 0.73
D) 0.66
Answer: C
Diff: 1
Table 8.3
Consider the following two securities X and Y.
 Which security (X or Y) in Table 8.3 has the least total risk? Which has the least systematic risk?
A) X; X
B) X; Y
C) Y; X
D) Y; Y
Answer: B
Diff: 2
 Using the data from Table 8.3, what is the beta for a portfolio with two-thirds of the funds
invested in X and one-third invested in Y?
A) 0.88
B) 1.17
C) 1.33
D) 1.67
Answer: C
Diff: 2
 Using the data from Table 8.3, what is the portfolio expected return and the portfolio beta if you
invest 35 percent in X, 45 percent in Y, and 20 percent in the risk-free asset?
A) 9.875%, 0.975
B) 10.125, 1.025
C) 8.875%, 0.975
D) 20.5%, 1.250
Answer: A
Diff: 2
 ) Using the data from Table 8.3, what is the portfolio expected return if you invest 100 percent
of your money in X, borrow an amount equal to half of your own investment at the risk-free rate
and invest your borrowings in asset X?
A) 18.75%
B) 22.50%
C) 12.50%
D) 16.25%
Answer: D
Diff: 2
 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
Answer: C
Diff: 1
 Tangshan Antiques has a beta of 1.40, the annual risk-free rate of interest is currently 10
percent, and the required return on the market portfolio is 16 percent. The firm estimates that
its future dividends will continue to increase at an annual compound rate consistent with that
experienced over the 2018-2021 period.
(a) Estimate the value of Tangshan Antiques stock.

(a) rs = 0.10 + 1.4(0.16 - 0.10) = 0.184
 Research on the CAPM as shown that while high-beta stock may earn slightly higher returns
compared with low-beta stocks, the difference in returns is not as great as the CAPM would
predict.
Answer: TRUE
Diff: 1
 A stock with a beta of 1.0 will have returns that are just as volatile as returns on the market
portfolio.
Answer: FALSE
Diff: 1
 Asset Z has a beta of 1.2. The risk-free rate of return is 6 percent, while the return on the market
portfolio of assets is 10 percent. The market risk premium is ________.
A) 10.8 percent
B) 4.0 percent
C) 18.0 percent
D) 4.8 percent
Answer: B
Diff: 1
 Asset P has a beta of 1.25. The risk-free rate of return is 2 percent, while the return on the
market portfolio of assets is 10 percent. The asset's required rate of return is ________.
A) 12.0 percent
B) 14.5 percent
C) 10.0 percent
D) 17.0 percent
Answer: A
Diff: 1
 ) As risk aversion decreases ________.

A) a firm's beta will remain neutral
B) investors' required rate of return will decrease
C) a firm's beta will decrease
D) investors' required rate of return will remain unchanged
Answer: B
Diff: 1
 what is the risk-free rate of return if Asset X, with a beta of 1.5, has an expected return of 20
percent, and the expected market return is 15 percent?
A) 5.0%
B) 7.5%
C) 15.0%
D) 22.5%
Answer: A
Diff: 1
 What is the expected return for Asset X if it has a beta of 1.5, the expected market return is 15
percent, and the risk-free rate is 5 percent?
A) 5.0%
B) 7.5%
C) 15.0%
D) 20.0%
Answer: D
Diff: 1
 Adam wants to determine the required return on a stock portfolio with a beta coefficient of 0.5.
Assuming the risk-free rate of 6 percent and the market return of 12 percent, compute the
required rate of return.
Answer: r = RF + b(rm - RF)
= 0.06 + 0.5(0.12 - 0.06) = 0.09 = 9%
 The company should expect at least 9 percent return on the stock portfolio.
Diff: 1
 Assuming a risk-free rate of 8 percent and a market return of 12 percent, would a wise investor
acquire a security with a beta of 1.5 if its expected return were 14 percent?
= 0.08 + 1.5(0.12 - 0.08) = 0.14 = 14%
Yes, a security with a beta of 1.5 should yield 14 percent rate of return.
Diff: 1
 Suppose the CAPM is true. Asset X has a standard deviation of 25%, which happens to equal the
standard deviation of returns on the market portfolio. This means that Asset X has a beta of 1.0.
Answer: FALSE
Diff: 2
 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.
Answer: FALSE
Diff: 2
 Dr. Dan is considering investing in a project with beta coefficient of 1.75. What would you
recommend him to do if this investment has an 11.5 percent rate of return, the risk-free rate is
5.5 percent, and the rate of return on the market portfolio of assets is 8.5 percent?
= 0.055 + 1.75(0.085 - 0.055) = 0.108 = 10.75%
 Dr. Dan should invest in the project because the project's actual rate of return (11.5 percent) is
greater than the project's required rate of return (10.8 percent).
Diff: 1
 Asset Y has a beta of 1.2. The risk-free rate of return is 6 percent, while the return on the
market portfolio of assets is 12 percent. The market risk premium is ________.
A) 7.2 percent
B) 6.0 percent
C) 13.2 percent
D) 10 percent
Answer: B
Diff: 1
 Asset P has a beta of 0.9. The risk-free rate of return is 8 percent, while the return on the market
portfolio of assets is 14 percent. The asset's required rate of return is ________.
A) 13.4 percent
B) 22.0 percent
C) 15.4 percent
D) 6.0 percent
Answer: A
Diff: 1
 What is the risk-free rate of return if Asset X, with a beta of 1.5, has an expected return of 20
percent, and the expected market return is 15 percent?
A) 5.0%
B) 7.5%
C) 15.0%
D) 22.5%
Answer: A
Diff: 1
 What is the expected return for Asset X if it has a beta of 2.0, the expected market return is 10
percent, and the risk-free rate is 2 percent?
A) 10.0%
B) 16.0%
C) 22.0%
D) 18.0%
Answer: D
Diff: 1

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Risk and Return

Answer: Realized return = = 13%

A) 12 percent and 4 percent

 The ________ the coefficient of variation, the ________ the risk.

A) 10 percent, 8 percent, and 1.25, respectively

For each asset, compute

Expected Return = 15% Expected Return = 15%

(a) Compute expected rate of return for each copier.

Expected value = 16.9% Expected value = 17.05%

Expected value = 10.7% Expected value = 11.15%

 A(n) ________ portfolio maximizes return for a given level of risk.

 An investment advisor has recommended a $50,000 portfolio containing assets R, J, and K;

A) 10.7% and 1.34%

Expected rate of return = 17 percent.

Total risk is the sum of a security's nondiversifiable and diversifiable risk.

Unsystematic risk can be eliminated through diversification.

Consider the following two securities X and Y.

(a) Estimate the value of Tangshan Antiques stock.

 ) As risk aversion decreases ________.

AACSB: Analytical Thinking

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 The the coefficient of variation, the the risk.