KBU International College FIN 1234 Chapter10

Chapter 10
Risk and Return Lessons from Market
History

Multiple Choice Questions

1. The excess return required from a risky asset over
that required from a risk-free asset is called the:
A. risk premium.
B. geometric premium.
C. excess return.
D. average return.
E. variance.

2. The average squared difference between the actual
return and the average return is called the:
A. excess return.
B. risk premium.
C. standard deviation.
D. variance.
E. volatility return

3. The standard deviation for a set of stock returns
can be calculated as the:
A. positive square root of the variance.
B. variance squared.
C. positive square root of the average return.
D. average return divided by N minus one, where N is the number of
returns.
E. average squared difference between the actual return and the average
return.

4. A symmetric, bell-shaped frequency distribution
that is completely defined by its mean and standard deviation is the _____
distribution.
A. gamma
B. Poisson
C. bi-modal
D. normal
E. uniform

5. The average compound return earned per year over a
multi-year period is called the _____ average return.
A. real
B. standard
C. geometric
D. variant
E. arithmetic

6. The return earned in an average year over a
multi-year period is called the _____ average return.
A. arithmetic
B. standard
C. variant
D. geometric
E. real

7. The excess return you earn by moving from a
relatively risk-free investment to a risky investment is called the:
A. geometric average return.
B. inflation premium.
C. risk premium.
D. time premium.
E. arithmetic average return.

8. The capital gains yield plus the dividend yield on
a security is called the:
A. geometric return.
B. variance of returns
C. average period return.
D. total return.
E. current yield.

9. A portfolio of large company stocks would contain
which one of the following types of securities?
A. Stock of the firms which represent the smallest 20% of the companies
listed on the NYSE
B. U.S. Treasury bills
C. Long-term corporate bonds
D. Stocks of firms included in the S&P 500 index
E. Long-term government bonds

10. Based on the period of 1926 through 2009, _____
have tended to outperform other securities over the long-term.
A. long-term corporate bonds
B. small company stocks
C. U.S. Treasury bills
D. large company stocks
E. long-term government bonds

11. Which one of the following types of securities has
tended to produce the lowest real rate of return for the period 1926 through
2009?
A. U.S. Treasury bills
B. Long-term government bonds
C. Small company stocks
D. Large company stocks
E. Long-term corporate bonds

12. On average, for the period 1926 through
2009:
A. the real rate of return on U.S. Treasury bills has been negative.
B. small company stocks have underperformed large company stocks.
C. the risk premium on long-term corporate bonds has exceeded the risk
premium on long-term government bonds.
D. long-term government bonds have produced higher returns than long-term
corporate bonds.
E. the risk premium on large company stocks has exceeded the risk premium
on small company stocks.

13. Over the period of 1926 through 2009, the annual
rate of return on _____ has been more volatile than the annual rate of return
on _____.
A. large company stocks; small company stocks
B. U.S. Treasury bills; long-term government bonds
C. long-term corporate bonds; small company stocks
D. large company stocks; long-term corporate bonds
E. U.S. Treasury bills; small company stocks

14. Which one of the following is a correct ranking of
securities based on their volatility over the period of 1926 to 2009? Rank from
highest to lowest.
A. Small company stocks, long-term corporate bonds, large company stocks
B. Large company stocks, U.S. Treasury bills, long-term government bonds
C. Small company stocks, long-term government bonds, long-term corporate
bonds
D. Long-term corporate bonds, large company stocks, U.S. Treasury bills
E. Small company stocks, large company stocks, long-term government bonds

15. Over the period of 1926 to 2009, small company
stocks had an average return of ____%.
A. 8.9
B. 12.2
C. 16.6
D. 19.6
E. 21.3

16. Over the period of 1926 to 2009, the average rate
of inflation was _______%.
A. 2.0
B. 3.1
C. 3.5
D. 3.8
E. 4.3

17. The average annual return on long-term corporate
bonds for the period of 1926 to 2009 was _______%.
A. 3.8
B. 5.8
C. 6.2
D. 7.5
E. 8.4

18. The average annual return on small company stocks
was about _______% points greater than the average annual return on
large-company stocks over the period of 1926 to 2009.
A. 2
B. 4
C. 5
D. 6
E. 9

19. The average risk premium on U.S. Treasury bills
over the period of 1926 to 2009 was _______%.
A. 0.0
B. 1.5
C. 2.6
D. 3.2
E. 3.5

20. Which one of the following is a correct statement
concerning risk premium?
A. The greater the volatility of returns, the greater the risk premium.
B. The lower the volatility of returns, the greater the risk premium.
C. The lower the average rate of return, the greater the risk premium.
D. The risk premium is not correlated to the average rate of return.
E. The risk premium is not affected by the volatility of returns.

21. The risk premium is computed by ______ the average
return for the investment.
A. subtracting the inflation rate from
B. adding the inflation rate to
C. subtracting the average return on U.S. Treasury bills from
D. adding the average return on U.S. Treasury bills to
E. subtracting the average return on long-term government bonds from

22. The Zolo Company just declared that it is
increasing its annual dividend from $1.00 per share to $1.25 per share. If the
stock price remains constant, then:
A. the capital gains yield will decrease.
B. the capital gains yield will increase.
C. the dividend yield will increase.
D. the dividend yield will also remain constant.
E. neither the capital gains yield nor the dividend yield will change.

23. Which of the following statements are correct
concerning the variance of the annual returns on an investment?
I. The larger the variance, the more the actual returns tend to differ from the
average return.
II. The larger the variance, the larger the standard deviation.
III. The larger the variance, the greater the risk of the investment.
IV. The larger the variance, the higher the expected return.
A. I and III only
B. II, III, and IV only
C. I, III, and IV only
D. I, II, and III only
E. I, II, III, and IV

24. The variance of returns is computed by dividing
the sum of the:
A. squared deviations by the number of returns minus one.
B. average returns by the number of returns minus one.
C. average returns by the number of returns plus one.
D. squared deviations by the average rate of return.
E. squared deviations by the number of returns plus one.

25. Which of the following statements concerning the
standard deviation are correct?
I. The greater the standard deviation, the lower the risk.
II. The standard deviation is a measure of volatility.
III. The higher the standard deviation, the less certain the rate of return in
any one given year.
IV. The higher the standard deviation, the higher the expected return.
A. I and III only
B. II, III, and IV only
C. I, III, and IV only
D. I, II, and III only
E. I, II, III, and IV

26. The standard deviation on small company stocks:
I. is greater than the standard deviation on large company stocks.
II. is less than the standard deviation on large company stocks.
III. had an average value of about 33% for the period 1926 to 2004.
IV. had an average value of about 20% for the period 1926 to 2004.
A. I and III only
B. I and II only
C. II and III only
D. II and IV only
E. I and IV only

27. Estimates using the arithmetic average will
probably tend to _____ values over the long-term while estimates using the
geometric average will probably tend to _____ values over the short-term.
A. overestimate; overestimate
B. overestimate; underestimate
C. underestimate; overestimate
D. underestimate; underestimate
E. none of the above are correct

28. A capital gain occurs when
A. the selling price is less than the purchase price.
B. the purchase price is less than the selling price.
C. there is no dividend paid.
D. there is no income component of return.
E. never, as they can not exist.

29. Capital market history shows us that the average
return relationship from lowest to highest between securities is:
A. inflation, corporate bonds, Treasuries, small company stocks, large
company stocks.
B. inflation, Treasury Bills, large company stocks, small company stocks.
C. Treasury bills, government bonds, large common stocks, corporate bonds,
small company stocks.
D. Treasury bills, government bonds, large common stocks, corporate bonds,
large company stocks.
E. There is no ordering.

30. One year ago, you purchased a stock at a price of
$32.50. The stock pays quarterly dividends of $.40 per share. Today, the stock
is worth $34.60 per share. What is the total amount of your dividend income to
date from this investment?
A. $.40
B. $1.60
C. $2.10
D. $2.50
E. $3.70

31. Six months ago, you purchased 100 shares of stock
in ABC Co. at a price of $44.89 a share. ABC stock pays a quarterly dividend of
$.15 a share. Today, you sold all of your shares for $46.23 per share. What is
the total amount of your capital gains on this investment?
A. $1.24
B. $1.64
C. $40.00
D. $134.00
E. $154.00

32. A year ago, you purchased 300 shares of IXC
Technologies, Inc. stock at a price of $9.05 per share. The stock pays an
annual dividend of $.12 per share. Today, you sold all of your shares for
$29.14 per share. What is your total dollar return on this investment?
A. $5,703
B. $6,063
C. $6,453
D. $6,563
E. $6,603

33. You purchased 100 shares of stock at a price of
$35.72 per share. Over the last year, you have received total dividend income
of $312. What is the dividend yield?
A. 3.2%
B. 4.4%
C. 8.7%
D. 9.2%
E. 11.4%

34. Winslow, Inc. stock is currently selling for $40 a
share. The stock has a dividend yield of 2.8%. How much dividend income will
you receive per year if you purchase 600 shares of this stock?
A. $152
B. $390
C. $672
D. $760
E. $1,053

35. One year ago, you purchased a stock at a price of
$32 a share. Today, you sold the stock and realized a total return of 25%. Your
capital gain was $6 a share. What was your dividend yield on this stock?
A. 1.25%
B. 3.75%
C. 6.25%
D. 18.75%
E. 21.25%

36. You just sold 200 shares of Langley, Inc. stock at
a price of $38.75 a share. Last year you paid $41.50 a share to buy this stock.
Over the course of the year, you received dividends totaling $1.64 per share.
What is your capital gain on this investment?
A. -$550
B. -$222
C. -$3
D. $550
E. $878

37. You purchased 250 shares of Deltona, Inc. stock
for $44.40 a share. You have received a total of $630 in dividends and $12,040
in proceeds from selling the shares. What is your capital gains yield on this
stock?
A. 4.06%
B. 4.23%
C. 4.68%
D. 8.47%
E. 8.91%

38. Today, you sold 200 shares of SLG, Inc. stock.
Your total return on these shares is 12.5%. You purchased the shares one year
ago at a price of $28.50 a share. You have received a total of $280 in
dividends over the course of the year. What is your capital gains yield on this
investment?
A. 4.80%
B. 5.00%
C. 6.67%
D. 7.59%
E. 11.67%

39. Six months ago, you purchased 1,200 shares of ABC
stock for $21.20 a share. You have received dividend payments equal to $.60 a
share. Today, you sold all of your shares for $22.20 a share. What is your
total dollar return on this investment?
A. $720
B. $1,200
C. $1,440
D. $1,920
E. $3,840

40. Eight months ago, you purchased 400 shares of
Winston, Inc. stock at a price of $56.90 a share. To date the company has paid
quarterly dividends of $.55 a share twice. Today, you sold all of your shares
for $49.40 a share. What is your total percentage return on this
investment?
A. -11.2%
B. -9.3%
C. -8.4%
D. 12.0%
E. 13.4%

41. A stock had returns of 8%, -2%, 4%, and 16% over
the past four years. What is the standard deviation of this stock for the past
four years?
A. 6.3%
B. 6.6%
C. 7.1%
D. 7.5%
E. 7.9%

42. A stock has an expected rate of return of 7.3% and
a standard deviation of 5.4%. Which one of the following best describes the
probability that this stock will lose 9% or more in any one given year?
A. Less than 0.5%
B. Less than 1.0%
C. Less than 1.5%
D. Less than 2.5%
E. Less than 5%

43. A stock has returns of 3%, 18%, -24%, and 16% for
the past four years. Based on this information, what is the 95% probability
range for any one given year?
A. -8.4 to 11.7%
B. -16.1 to 22.6%
C. -24.5 to 34.3%
D. -35.4 to 41.9%
E. -54.8 to 61.3%

44. A stock had returns of 8%, 14%, and 2% for the
past three years. Based on these returns, what is the probability that this
stock will earn at least 20% in any one given year?
A. 0.5%
B. 1.0%
C. 2.5%
D. 5.0%
E. 16.0%

45. A stock had returns of 11%, 1%, 9%, 15%, and -6%
for the past five years. Based on these returns, what is the approximate
probability that this stock will earn at least 23% in any one given year?
A. 0.5%
B. 1.0%
C. 2.5%
D. 5.0%
E. 16.0%

46. A stock had returns of 8%, 39%, 11%, and -24% for
the past four years. Which one of the following best describes the probability
that this stock will NOT lose more than 43% in any one given year?
A. 84.0%
B. 95.0%
C. 97.5%
D. 99.0%
E. 99.5%

47. Over the past five years, a stock produced returns
of 14%, 22%, -16%, 2%, and 10%. What is the probability that an investor in
this stock will NOT lose more than 8% nor earn more than 21% in any one given
year?
A. 34%
B. 68%
C. 95%
D. 99%
E. 100%

48. What are the arithmetic and geometric average
returns for a stock with annual returns of 4%, 10%, -6%, and 19%?
A. 5.89%; 6.25%
B. 6.25%; 5.89%
C. 6.75%; 6.35%
D. 8.3%; 5.89%
E. 8.3%; 6.25%

49. What are the arithmetic and geometric average
returns for a stock with annual returns of 21%, 8%, -32%, 41%, and 5%?
A. 5.6%; 8.6%
B. 5.6%; 6.3%
C. 8.6%; 5.6%
D. 8.8%; 6.1%
E. 8.6%; 6.3%

50. A stock had returns of 8%, 12%, -11%, and 17% over
the past four years. What is the geometric average return for this time
period?
A. 4.5%
B. 5.7%
C. 5.9%
D. 7.3%
E. 8.2%

51. A stock had the following prices and dividends.
What is the geometric average return on this stock?
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A. 3.2%
B. 3.4%
C. 3.6%
D. 3.8%
E. 4.0%

52. You bought 100 shares of stock at $25 each. At the
end of the year, you received a total of $500 in dividends, and your stock was
worth $2,500 total. What was your total return?
A. zero
B. 20%
C. 50%
D. 90%
E. None of the above.

53. You bought 100 shares of stock at $25 each. At the
end of the year, you received a total of $500 in dividends, and your stock was
worth $2,500 total. What was total dollar capital gain and total dollar
return?
A. $0; $500
B. $400; $900
C. $500; $900
D. $900; $2,500
E. None of the above.

54. Excelsior shares are currently selling for $25.75
each. You bought 200 shares one year ago at $24 and received dividend payments
of $1.60 per share. What was your percentage capital gain this year?
A. 4.17%
B. 6.80%
C. 10.42%
D. 104.17%
E. 110.42%

55. Excelsior shares are currently selling for $25
each. You bought 200 shares one year ago at $24 and received dividend payments
of $1.50 per share. What was your total rate of return?
A. 4.17%
B. 6.25%
C. 10.42%
D. 104.67%
E. 110.42%

56. The returns for IMB over the last 3 years are
given below. Assuming no dividends were paid, what was the 3-year holding
period return? Given the following information: Year 1 return = 10%, Year 2
return = 15%, Year 3 return = 12%.
A. 12.3%
B. 13.9%
C. 15.8%
D. 41.7%
E. 46.5%

57. Kids Toy Co. has had total returns over the past
five years of -4%, 7%, -2%, 19%, and 12%. What was the arithmetic average
return on this stock?
A. 5.40%
B. 5.50%
C. 6.15%
D. 6.40%
E. 6.75%

58. The return on your portfolio over the last 5 years
were -5%, 20%, 0%, 10% and 5%. What is the arithmetic average return?
A. 5.0%
B. 6.0%
C. 7.5%
D. 8.0%
E. 10.0%

59. If the expected return on the market is 11.5%,
then using the historical risk premium on large stocks of 8.6%, the current
risk-free rate is:
A. 2.9%
B. 7.4%
C. 8.4%
D. 10.6%
E. 12.6%

60. The total annual returns on large company common
stocks averaged 11.8% from 1926 to 2009 small company stocks averaged 16.6%,
long-term government bonds averaged 5.8%, while Treasury Bills averaged 3.7%.
What was the average risk premium earned by long-term government bonds and
small company stocks, respectively?
A. 1.8%; 11.9%
B. 2.1%; 12.9%
C. 4.4%; 13.9%
D. 9.5%; 1.8%
E. None of the above.

61. The return on your portfolio over the last 5 years
were -5%, 20%, 0%, 10% and 5%. What is the standard deviation of your
return?
A. 2.74%
B. 5.21%
C. 9.62%
D. 10.12%
E. 12.70%

62. Suppose you own a risky asset with an expected
return of 12% and a standard deviation of 20%. If the returns are normally
distributed, the approximate probability of receiving a return greater than 32%
is approximately:
A. 2%
B. 5%
C. 16%
D. 33%
E. 67%

63. The return pattern on your favorite stock has been
5%, 8%, -12%, 15%, 21% over the last five years. What was your average return
and holding period return over the last 5 years?
A. 4.5%; 6.5%
B. 7.4%; 38.9%
C. 7.4%; 7.76%
D. 7.4%; 76.73%
E. None of the above.

64. The long term inflation rate average was 3.1% and
you invested in long term corporate bonds over the same period which earned
6.2%. What was the average risk premium you earned?
A. 2.9%
B. 3.1%
C. 9.3%
D. 9.4%
E. None of the above.

65. The market portfolio of common stocks earned 14.2%
in one year. Treasury bills earned 5.5%. What was the real risk premium on
equities?
A. 5.0%
B. 8.7%
C. 9.0%
D. 12.2%
E. 19.7%

66. You have a sample of returns observations for the
Malta Stock Fund. The 4 returns are 0.0725, 0.056, 0.125, 0.010. What is the
average return and variance of these returns?
A. 6.50%; .00169
B. 6.60%; .00225
C. 6.60%; .000475
D. 26.35%; .00676
E. None of the above.

67. The return pattern on your favorite stock has been
7%, 10%, -14%, 10%, 16% over the last five years. What has your average return
and holding period return over the last 5 years?
A. 5.8%; 5.8%
B. 5.8%; 29.2%
C. 9.4%; 7.2%
D. 9.4%; 35.8%
E. None of the above.

68. The long term inflation rate average was 2.7% and
you invested in long term corporate bonds over the same period which earned
5.8%. What was the average risk premium you earned?
A. 3.1%
B. 3.7%
C. 9.5%
D. 9.9%
E. None of the above.

69. The market portfolio of common stocks earned 11.3%
in one year. Treasury bills earned 3.1%. What was the real risk premium on
equities?
A. 2.90%
B. 3.25%
C. 3.57%
D. 8.20%
E. 14.40%

70. You have a sample of returns observations for the
Malta Stock Fund. The 4 returns are 0.06, 0.05, 0.12, 0.01. What is the average
return and variance of these returns?
A. 6.0%; .000454
B. 6.0%; .002067
C. 6.5%; .000675
D. 24.0%; .000712
E. None of the above.

Essay Questions

71. What securities have offered the highest average
annual returns over the last several decades? Can we conclude that return and
risk are related in real life?

72. What are the lessons learned from capital market
history? What evidence is there to suggest these lessons are correct?

73. Suppose you have $30,000 invested in the stock
market and your banker comes to you and tries to get you to move that money
into the bank’s certificates of deposit (CDs). He explains that the CDs are
100% government insured and that you are taking unnecessary risks by being in
the stock market. How would you respond?

74. Little John Industries sold for $1.90 on January 1
and ended the year at a price of $2.50. In addition, the stock paid dividends
of $0.20 per share. Calculate Little John’s dividend yield, capital gain yield,
and total rate of return for the year.

75. You earned a total return of -5% on NoDotCom this
year, earned -40% last year, and earned 30% two years ago. Calculate both the
three-year holding period return and the average three year return.

76. What is the difference between arithmetic average
and geometric mean? Is one better than the other to use in financial
analysis?