118
Questions and problems
1) Given a choice between two investments with the
same expected payoff:
A) most people will select the one with the
highest variance.
B) most people will opt for the one with the
higher standard deviation.
C) most people will be indifferent since the
expected payoffs are the same.
D) most people will choose the one with the
lower standard deviation.
2) A risk-averse investor:
A) will always take a risk, while a risk-neutral
investor will not.
B) needs more compensation for the same
risk than would a risk neutral investor.
C) will always accept the same risk as a risk-
neutral investor if the expected returns are
equal.
D) None of the above.
3) The risk premium for an investment:
A) increases with risk.
B) is a fixed amount added to the risk-free
return, regardless of the amount of risk.
C) is negative for U.S. Treasury Securities.
D) is negative for risk-averse investors.
4) When many industries perform poorly due
to a recession, this is an example of:
A) idiosyncratic risk
B) systematic risk.
C) risk premium.
D) unique risk.
119
5) Diversification is the principle of:
A) Holding more than one risk at a time.
B) reducing the risks we carry to just two.
C) creating risk to increase returns.
D) eliminating all investments from our portfolio
that have idiosyncratic
6) If two risky securities provide a payoff with the
same expected value in 1 year, risk is higher for the
security for which the:
A) variance is higher.
B) standard deviation is higher.
C) Both of the above are correct.
D) None of the above is correct.
7) Suppose that an investment has a 50%
probability of a payoff of $1,030 and a 50%
probability of a payoff of $990. Which of the
following represents the standard deviation of the
payoff?
A) 20 dollars
B) 40 dollars
C) 200 dollars
D) 400 dollars
8) Suppose that two investments have an expected
payoff of $1,200, but one has a standard deviation
of 30 while the other has a standard deviation of
40. A risk-averse individual will prefer the
investment that:
A) has a standard deviation of 40 because more is
preferred to less.
B) has a standard deviation of 30 because this
investment is less risky.
C) has a standard deviation of 40 because this
investment is less risky.
D) None of the above is correct.
120
9) Risk of two securities with different expected
return can be compared with:
A) Coefficient of variation
b) Standard deviation of securities
c) Variance of Securities
d) None of the above
10) Which of the following best expresses the
equation for a one-year holding period return?
A) current yield - coupon rate
B) yield to maturity + current yield
C) coupon rate + capital gain
D) current yield + capital gain
11) Suppose that a long-term coupon bond with a
coupon rate of 5% is purchased today at a price of
$1,000 and
resold a year later for a price of $1,020. The
holding period return for this bond is equal to:
A) 2%.
B) 3%.
C) 5%
D)7%
Answe
r (1020-
1000+5
0)/
1000=
7%
12) Suppose that a long-term coupon bond with a
coupon rate of 5% is purchased at its face value of
$1,000 and resold a year later for a price of $950.
The holding period return for this bond is equal to:
A) 0%.
B) 2%.
C) 3%.
D) 5%.
Answer:
(950- 1000+50)/1000 = 0%
13) A chartered analyst purchased a treasury bill for $960
and then sold it for $995 three months later. Calculate the
holding period return.
A. 35%
B. 35
Solution
P0 = 960
P1 = 995
D = 0 in this case
HPR=995–960960=35960=3.6%
14) When an investment advisor attempts to
determine an investor's risk tolerance, which factor
would they be least likely to assess?
A) the investor's prior investing experience
B) the investor's degree of financial security
C) the investor's tendency to make risky or
conservative choices
D) the level of return the investor prefers
15) Ema is a risk-averse investor. Doaa is a less
risk- averse investor than Ema. Therefore,
A) for the same risk, Doaa requires a higher rate of
return than Ema.
B) for the same return, Ema tolerates higher risk
than Doaa.
C) for the same risk, Ema requires a lower rate of
return than Doaa.
D) for the same return, Doaa tolerates higher risk
than Ema.
16) Security Analysis is a process of
estimating for individual securities.
(A) Return and risk
(B) Risk and correlation
(C) Correlation and coefficient
(D) Return and coefficient
17) Standard deviation determine - …………..
(A) Systematic risk of a security
(B) Unsystematic risk of security
(C) Total risk of security
(D) Premium of security
18) Investment with lower standard deviation carries
(A) High risk
(B) Less risk
(C) Infinite risk
(D) Avoidable risk
19) Standard deviation is 18% and expected return
is 15.5% then coefficient of variation
would be ?
A. 0.86%
B. 1.16%
C. 2.50%
D. −2.5%
Coefficient of variation = σ / R
= 18%/15.5% = 1.16
Problems
20) Joe bought some gold coins for $1000 and sold
those 4 months later for $1200. Jane on the other
hand bought 100 shares of a stock for $10 and sold
those 2 years later for $12 per share after
receiving $0.50 per share as dividends for the
year. Calculate the dollar profit and percent
return earned by each investor over their
respective holding periods.
Answer
Gold Coins Dollar Profit = Ending value – Original
cost = $1200 – $1000 = $200 Joe‘s
HPR = Dollar profit/Original cost = $200/$1000 =
20% Stock‘s Dollar Profit
= Ending value + Distributions – Orig. Cost
= $12*100 + $0.50*100 – $10*100 = $1200 +
$50 – $1000 =$250
HPR = $250/$1000 = 25%
21) There are 4 investments
X Y Z U
σ 37,947 44,497 42,163 41,997
Expected 90,000 1,06,000 1,00,000 90,000
Return
Which investment has the highest risk?
(A) X
(B) Y
(C) X
(D) U
Answer:
Coefficient of variation of
X=37947/90000=0.422 Coefficient of
variation of Y=44497/106000=0.420
Coefficient of variation of Z=
42163/100000=0.422 Coefficient of variation
of U= 41997/90000=0.467
U has highest risk as it has highest coefficient of
variation