Parrino, 2e Test Bank, Chapter 7

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

1. Whenever the outcome of an event has a number of different possibilities that have

equal probability of occurrence, then the expected value of the outcome is equal to the

simple average of the individual events.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

2. The variance of a distribution can be a negative value.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

3. The standard deviation of a distribution can be a negative value.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

4. The capital appreciation component of a stock's return considers the increase in price of

a stock divided by the beginning of period price of the stock.

A) True

B)

False

7-1

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

5. The capital appreciation component of a stock's return considers the increase in price of

a stock divided by the end of period price of the stock.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 6

Level of Difficulty: Medium

6. If the expected return of a bet, which is based on a coin toss, is $15, then that means

that the outcome of the bet will be a $15 cash inflow to the person making the bet.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

7. The normal distribution is completely described by its mean and standard deviation

where 50 percent of the distribution's probability is less than the mean and 50 percent

greater than the mean.

A) True

B)

False

Ans: A

7-2

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

8. The variance is denominated in squared units, whereas the standard deviation is

denominated in the same units as the expected value.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

9. If the price of an asset has not increased or decreased since the original purchase of the

asset, then the total return of the asset (if no dividends were paid during the period) is

equal to the capital appreciation component return.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

10. The income component of return for a common stock comes from the dividend cash

flow stream.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

11. If the capital appreciation return from owning a stock is positive, then the total return

from owning the same stock can be negative.

A) True

B)

False

7-3

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

12. In order for the total return of a stock to be equal to –100 percent, the income return

component for that stock must be zero.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

13. The best measure of risk within an investment is its variance.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

14. Robert paid $100 for a stock one year ago. The total return on the stock was 10 percent.

Therefore, the stock must be selling for $110 today.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

15. You have placed a wager such that you will either receive nothing if you lose the bet or

you will receive $10 if you win the bet. If the expected cash receipt of the wager is $9,

then there is a 100 percent probability that you will win the wager.

A) True

7-4

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

16. The variance is equal to the square root of the standard deviation.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

17. If you are calculating the variance and standard deviation of returns for a stock, the

variance will always be larger than the standard deviation.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 6

Level of Difficulty: Easy

18. The appropriate measure of risk for a diversified portfolio is beta.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

19. The coefficient of variation divides the variance of the returns of an asset by the

expected return of that asset.

A) True

7-5

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

20. The coefficient of variation is a good measure of the amount of risk that an asset will

contribute to a diversified portfolio of assets.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

21. If you are building a portfolio, then you desire assets that have a correlation coefficient

of one.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

22. If the returns for two assets have a correlation coefficient of one, then there are no

benefits of diversification by combining these assets in a two-asset portfolio.

A) True

B)

False

Ans: A

7-6

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

23. Utilizing the fact that two or more asset values do not always move in the same

direction at the same time in order to reduce the risk of a portfolio is called

diversification.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

24. If you are trying to determine whether to purchase Security A or Security B as the only

holding in your portfolio, then you can consider the coefficient of variation in order to

understand the risk-return relationship of the individual securities.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

25. The coefficient of variation is useful when deciding which individual stocks to add to

your diversified portfolio.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

26. If two assets with return correlation coefficients less than one make up a portfolio, then

the portfolio does not take advantage of any diversification benefits.

A) True

B)

False

7-7

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

27. If the covariance between the returns of two assets is equal to zero, then the correlation

coefficient must also be zero.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

28. If the distribution of returns for an asset has a variance of zero, then covariance of

returns between that asset and the returns any other asset must equal zero.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

29. The expected return of the market portfolio is equal to the market risk premium.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

30. If you were to completely diversify your portfolio by purchasing a portion of every

asset in the investment universe, then the expected return of your portfolio is equal to

the risk-free rate.

A) True

7-8

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

31. The market risk-premium is equal to expected return on the market portfolio.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 7

Level of Difficulty: Medium

32. If you know the risk-free rate, the market risk-premium, and the beta of a stock, then

using the CAPM you will be able to calculate the expected rate of return for the stock.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 6

Level of Difficulty: Medium

33. The market risk-premium is equal to the expected return on the market less the risk-free

rate of return.

A) True

B)

False

Ans: A

7-9

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

34. Given the historical information in the chapter, the beta of a small stock should be

greater than the beta of a corporate bond.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

35. Complete diversification means that the portfolio is no longer subject to market risk.

A) True

B)

False

Ans: B

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

36. The expected return for a portfolio without borrowing

A) should never be less than the expected return of the asset with lowest expected

return.

B) should never be greater than the expected return of the asset with highest

expected return.

C) may not be an event with even a positive probability of occurrence.

D)

All of the above.

Ans: D

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

37. In a game of chance, the probability of winning a $50 prize is 40 percent, and the

probability of winning a $100 prize is 60 percent. What is the expected value of a prize

in the game?

A) $50

7-10

B)

$75

C)

$80

D)

$100

Ans: C

Feedback:

$50(0.4) + $100 (0.6) = $80

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

38. In a game of chance, the probability of winning a $50 is 40 percent and the probability

of losing a $50 prize is 60 percent. What is the expected value of a prize in the game?

A) –$10

B)

$0

C)

$10

D)

$25

Ans: A

Feedback:

$50(0.4) – $50 (0.6) = -$10

Format: Multiple Choice

Learning Objective: LO 6

Level of Difficulty: Easy

39. Which of the following is the best measure of the systematic risk in a portfolio?

A) variance

B)

standard deviation

C)

covariance

D)

beta

Ans: D

7-11

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

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

Return

Probability

0.25

0.5

0.25

A)

0.1

0.2

0.25

15.00%

B)

17.50%

C)

18.75%

D)

20.00%

Ans: C

Feedback:

(0.1)(0.25) + (0.2)(0.5) + (0.25)(0.25) = 0.1875

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

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

Return

Probability

0.1

0.15

0.5

0.25

A)

0.05

0.1

0.15

0.25

12.50%

B)

13.75%

C)

15.75%

D)

16.75%

Ans: C

Feedback:

(0.5)(0.1) + (0.1)(0.15) + (0.15)(0.5) + (0.25)(0.25) = 0.1575

7-12

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Easy

42. The expected return for the asset below is 18.75 percent. If the return distribution for

the asset is described as in the following table, what is the variance for the asset's

returns?

Return

A)

0.1

0.2

0.25

0.002969

B)

0.000613

C)

0.015195

D)

0.054486

Probability

0.25

0.5

0.25

Ans: A

Feedback:

(0.1)(0.25 – 0.1875)2 + (0.2)(0.5 – 0.1875) 2 + (0.25)(0.25 – 0.1875) 2 = 0.002969

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Easy

43. The expected return for the asset shown in the following table is 18.75 percent. If the

return distribution for the asset is described as below, what is the standard deviation for

the asset's returns?

Return Probability

A)

0.1

0.2

0.25

0.002969

B)

0.000613

C)

0.015195

D)

0.054486

0.25

0.5

0.25

Ans: D

7-13

Feedback:

{ (0.25)(0.10 – 0.1875)2 + (0.5)(0.2 – 0.1875) 2 + (0.25)(0.25 – 0.1875) 2 }1/2 = 0.054486

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

44. If you are dealing with percentage returns, then which of the following is generally

true?

A) The variance of the return distribution is generally smaller than the standard

deviation.

B) The variance of the return distribution is generally larger than the standard

deviation.

C) The variance of the return distribution is measured in the same units as expected

return.

D) None of the above is generally true.

Ans: D

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Easy

45. The return distribution for an asset is as shown in the following table. What are the

missing values if the expected return is 10 percent?

Return

Probability

A)

0.1

x

x

0.20

0.25

0.5

0.25

B)

0.15

C)

0.10

D)

None of the above

Ans: C

7-14

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

46. The expected return for Stock Z is 30 percent. If we know the following information

about Stock Z, then what return will it produce in the Lukewarm state of the world?

Return

Probability

0.2

?

0.4

0.25

0.5

0.25

A)

Poor

Lukewarm

Dynamite!

20%

B)

30%

C)

40%

D)

It is impossible to determine.

Ans: B

Feedback:

(0.25)(0.2) + (0.5)(X) + (0.25)(0.4) = 0.3 , X = 0.3

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

47. The expected return for Stock V is 24.5 percent. If we know the following information

about Stock Z, then what is the probability of the Dynamite state of the world

occurring?

A)

Poor

Lukewarm

Dynamite!

5%

B)

10%

C)

15%

D)

20%

Return

Probability

0.15

0.28

0.19

0.2

0.7

?

Ans: B

7-15

Feedback:

0.2 + 0.7 + X = 1.0 ===> X = 0.1 or 10%

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

48. 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 the total return to Ahmet from owning

the stock? (Round your answer to the nearest whole percent.)

A) 5%

B)

44%

C)

35%

D)

50%

Ans: D

Feedback:

$65 $45 $2.50

0.5 50%

$45

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

49. Julio purchased a stock one year ago for $27. The stock is now worth $32, and the total

return to Julio for owning the stock was 37 percent. What is the dollar amount of

dividends that he received for owning the stock during the year?

A) $4

B)

$5

C)

$6

D)

$7

Ans: B

Feedback:

$32 $27 $ X

0.37, $ X $5

$27

7-16

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

50. Francis purchased a stock one year ago for $20, and it is now worth $24. The stock paid

a dividend of $3 during the year. What was the stock's rate of return from capital

appreciation during the year? (Round your answer to the nearest percent.)

A) 17%

B)

20%

C)

29%

D)

35%

Ans: B

Feedback:

$24 $20

0.20

$20

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

51. Gwen purchased a stock one year ago for $25, and it is now worth $31. The stock paid

a dividend of $1.50 during the year. What was the stock's rate of return income during

the year? (Round your answer to the nearest percent.)

A) 6%

B)

15%

C)

24%

D)

26%

Ans: A

Feedback:

$1.50

.06

$25

7-17

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

52. 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?

A) $7.00

B)

$7.50

C)

$8.00

D)

$8.50

Ans: C

Feedback:

$12 $ X $1

0.625, $ X $8

$X

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

53. 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.

Ans: D

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

54. Babs purchased a piece of real estate last year for $85,000. The real estate is now worth

$102,000. If Babs needs to have a total return of 25 percent during the year, then what

is the dollar amount of income that she needed to have to reach her objective?

A) $3,750

B)

$4,250

C)

$4,750

7-18

D)

$5,250

Ans: B

Feedback:

$102, 000 $85, 000 $ X

0.25, $ X $4, 250

$85, 000

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

55. Genaro needs to capture a return of 40 percent for his one-year investment in a

property. He believes that he can sell the property at the end of the year for $150,000

and that the property will provide him with rental income of $25,000. What is the

maximum amount that Genaro should be willing to pay for the property?

A) $112,500

B)

$125,000

C)

$137,500

D)

$150,000

Ans: B

Feedback:

$150, 000 $ X $25, 000

0.4, $ X $125, 000

$X

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

56. Books Brothers stock was priced at $15 per share two years ago. The stock sold for $13

last year and now it sells for $18. What was the total return for owning Books Brothers

stock during the most recent year? Assume that no dividends were paid and round to the

nearest percent.

A) 17%

B)

20%

C)

23%

D)

38%

Ans: D

7-19

Feedback:

$18 $13

0.3846

$13

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

57. Serox stock was selling for $20 two years ago. The stock sold for $25 one year ago, and

it is currently selling for $28. Serox pays a $1.10 dividend per year. What was the rate

of return for owning Serox in the most recent year? (Round to the nearest percent.)

A) 12%

B)

16%

C)

32%

D)

40%

Ans: B

Feedback:

$28 $25 $1.1

0.164

$25

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

58. You have observed that the average size of a particular goldfish is 1.5 inches long. The

standard deviation of the size of the goldfish is 0.25 inches. What is the size of a

goldfish such that 95 percent of the goldfish are smaller? Assume a normal distribution

for the size of goldfish.

A) 1.01 inches

B)

1.09 inches

C)

1.91 inches

D)

1.99 inches

Ans: C

Feedback:

1.5 + 1645 (0.25) = 1.91 inches

7-20

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

59. You know that the average college student eats 0.75 pounds of food at lunch. If the

standard deviation of that eating is 0.2 pounds of food, then what is the total amount of

food that a cafeteria should have on hand to be 95percent confident that it will not run

out of food when feeding 50 college students.

A) 17.90 pounds

B)

21.05 pounds

C)

53.95 pounds

D)

57.10 pounds

Ans: C

Feedback:

50 students * {0.75 pounds per student + 1.645 (0.2 pounds per student)} = 53.95

pounds of food required.

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

60. If a random variable is drawn from a normal distribution, what is the probability that

the random variable is larger than 1.96 standard deviations larger than the mean?

A) 1.25%

B)

2.50%

C)

3.75%

D)

5.00%

Ans: B

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

61. If a random variable is drawn from a normal distribution, what is the probability that

the random variable is larger than 1.96 standard deviations below the mean?

A) 95.00%

B)

96.25%

C)

97.50%

7-21

D)

98.75%

Ans: C

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

62. Niles is making an investment with an expected return of 12 percent. If the standard

deviation of the return is 4.5 percent, and if Niles is investing $100,000, then what

dollar amount is Niles 95 percent sure that he will have at the end of the year?

A) $100,000.00

B)

$104,597.50

C)

$116,500.00

D)

$119,402.50

Ans: B

Feedback:

{ 1 + [0.12 – 1.645 (0.045)]} X $100,000 = $104,597.50

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

63. Which of the following investment classes had the greatest average return based on

recent historical data?

A) Intermediate-Term Government Bonds

B)

Long-Term Government Bonds

C)

Large U.S. Stocks

D)

Small U.S. Stocks

Ans: D

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

64. Which of the following investment classes had the greatest variability in returns for

recent historical data?

A) Intermediate-Term Government Bonds

7-22

B)

Long-Term Government Bonds

C)

Large U.S. Stocks

D)

Small U.S. Stocks

Ans: D

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

65. If you were to compare the returns of an individual stock to a market index, select the

answer below that is most true.

A) The returns of the individual stock will show more variability than those of the

market index.

B) The returns of the individual stock will show less variability than those of the

market index.

C) The returns of the individual stock will show the same level of variability than

those of the market index, if they have the same beta.

D) None of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

66. Tommie has made an investment that will generate returns that are subject to 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.

State

Weak

OK

Great

A) 0.0453

B)

0.0467

C)

0.0481

D)

0.0495

Return

Probability

0.13

0.2

0.25

0.3

0.4

0.3

Ans: B

7-23

Feedback:

E ( R ) (0.3)(0.13) (0.4)(0.2) (0.3)(0.25) 0.194

Var ( R ) 0.3(0.13 0.194)2 0.4(0.2 0.194)2 0.3(0.25 0.194) 2 0.002184

1

Std ( R ) (0.002184) 2 0.046733

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

67. Elrond has made an investment that will generate returns that are subject to the state of

the economy. Use the following information to calculate the variance of the return

distribution for Elrond's investment.

State

Weak

OK

Great

A) 0.0536

B)

0.0543

C)

0.0550

D)

0.0557

Return

Probability

0.10

0.17

0.28

0.8

0.1

0.1

Ans: D

Feedback:

7-24

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

68. Braniff Ground Services stock has an expected return of 9 percent and a variance of

0.25 percent. What is the coefficient of variation for Braniff?

A) 0.0278

B)

0.5556

C)

1.800

D)

36.00

Ans: B

Feedback:

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

69. Sayers purchased a stock with a coefficient of variation equal to 0.125. The expected

return on the stock is 20 percent. What is the variance of the stock?

A) 0.000625

B)

0.025000

C)

0.625000

D)

0.790500

Ans: A

Feedback:

Coefficient

of

Variation

E (R)

1

2 2

0.20

7-25

0.125, 2 0.000625

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

1. Whenever the outcome of an event has a number of different possibilities that have

equal probability of occurrence, then the expected value of the outcome is equal to the

simple average of the individual events.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

2. The variance of a distribution can be a negative value.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

3. The standard deviation of a distribution can be a negative value.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

4. The capital appreciation component of a stock's return considers the increase in price of

a stock divided by the beginning of period price of the stock.

A) True

B)

False

7-1

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

5. The capital appreciation component of a stock's return considers the increase in price of

a stock divided by the end of period price of the stock.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 6

Level of Difficulty: Medium

6. If the expected return of a bet, which is based on a coin toss, is $15, then that means

that the outcome of the bet will be a $15 cash inflow to the person making the bet.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

7. The normal distribution is completely described by its mean and standard deviation

where 50 percent of the distribution's probability is less than the mean and 50 percent

greater than the mean.

A) True

B)

False

Ans: A

7-2

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

8. The variance is denominated in squared units, whereas the standard deviation is

denominated in the same units as the expected value.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

9. If the price of an asset has not increased or decreased since the original purchase of the

asset, then the total return of the asset (if no dividends were paid during the period) is

equal to the capital appreciation component return.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

10. The income component of return for a common stock comes from the dividend cash

flow stream.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

11. If the capital appreciation return from owning a stock is positive, then the total return

from owning the same stock can be negative.

A) True

B)

False

7-3

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

12. In order for the total return of a stock to be equal to –100 percent, the income return

component for that stock must be zero.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

13. The best measure of risk within an investment is its variance.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

14. Robert paid $100 for a stock one year ago. The total return on the stock was 10 percent.

Therefore, the stock must be selling for $110 today.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

15. You have placed a wager such that you will either receive nothing if you lose the bet or

you will receive $10 if you win the bet. If the expected cash receipt of the wager is $9,

then there is a 100 percent probability that you will win the wager.

A) True

7-4

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

16. The variance is equal to the square root of the standard deviation.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

17. If you are calculating the variance and standard deviation of returns for a stock, the

variance will always be larger than the standard deviation.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 6

Level of Difficulty: Easy

18. The appropriate measure of risk for a diversified portfolio is beta.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

19. The coefficient of variation divides the variance of the returns of an asset by the

expected return of that asset.

A) True

7-5

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

20. The coefficient of variation is a good measure of the amount of risk that an asset will

contribute to a diversified portfolio of assets.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

21. If you are building a portfolio, then you desire assets that have a correlation coefficient

of one.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

22. If the returns for two assets have a correlation coefficient of one, then there are no

benefits of diversification by combining these assets in a two-asset portfolio.

A) True

B)

False

Ans: A

7-6

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

23. Utilizing the fact that two or more asset values do not always move in the same

direction at the same time in order to reduce the risk of a portfolio is called

diversification.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

24. If you are trying to determine whether to purchase Security A or Security B as the only

holding in your portfolio, then you can consider the coefficient of variation in order to

understand the risk-return relationship of the individual securities.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

25. The coefficient of variation is useful when deciding which individual stocks to add to

your diversified portfolio.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

26. If two assets with return correlation coefficients less than one make up a portfolio, then

the portfolio does not take advantage of any diversification benefits.

A) True

B)

False

7-7

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

27. If the covariance between the returns of two assets is equal to zero, then the correlation

coefficient must also be zero.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

28. If the distribution of returns for an asset has a variance of zero, then covariance of

returns between that asset and the returns any other asset must equal zero.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

29. The expected return of the market portfolio is equal to the market risk premium.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

30. If you were to completely diversify your portfolio by purchasing a portion of every

asset in the investment universe, then the expected return of your portfolio is equal to

the risk-free rate.

A) True

7-8

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

31. The market risk-premium is equal to expected return on the market portfolio.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 7

Level of Difficulty: Medium

32. If you know the risk-free rate, the market risk-premium, and the beta of a stock, then

using the CAPM you will be able to calculate the expected rate of return for the stock.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 6

Level of Difficulty: Medium

33. The market risk-premium is equal to the expected return on the market less the risk-free

rate of return.

A) True

B)

False

Ans: A

7-9

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

34. Given the historical information in the chapter, the beta of a small stock should be

greater than the beta of a corporate bond.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

35. Complete diversification means that the portfolio is no longer subject to market risk.

A) True

B)

False

Ans: B

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

36. The expected return for a portfolio without borrowing

A) should never be less than the expected return of the asset with lowest expected

return.

B) should never be greater than the expected return of the asset with highest

expected return.

C) may not be an event with even a positive probability of occurrence.

D)

All of the above.

Ans: D

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

37. In a game of chance, the probability of winning a $50 prize is 40 percent, and the

probability of winning a $100 prize is 60 percent. What is the expected value of a prize

in the game?

A) $50

7-10

B)

$75

C)

$80

D)

$100

Ans: C

Feedback:

$50(0.4) + $100 (0.6) = $80

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

38. In a game of chance, the probability of winning a $50 is 40 percent and the probability

of losing a $50 prize is 60 percent. What is the expected value of a prize in the game?

A) –$10

B)

$0

C)

$10

D)

$25

Ans: A

Feedback:

$50(0.4) – $50 (0.6) = -$10

Format: Multiple Choice

Learning Objective: LO 6

Level of Difficulty: Easy

39. Which of the following is the best measure of the systematic risk in a portfolio?

A) variance

B)

standard deviation

C)

covariance

D)

beta

Ans: D

7-11

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

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

Return

Probability

0.25

0.5

0.25

A)

0.1

0.2

0.25

15.00%

B)

17.50%

C)

18.75%

D)

20.00%

Ans: C

Feedback:

(0.1)(0.25) + (0.2)(0.5) + (0.25)(0.25) = 0.1875

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

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

Return

Probability

0.1

0.15

0.5

0.25

A)

0.05

0.1

0.15

0.25

12.50%

B)

13.75%

C)

15.75%

D)

16.75%

Ans: C

Feedback:

(0.5)(0.1) + (0.1)(0.15) + (0.15)(0.5) + (0.25)(0.25) = 0.1575

7-12

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Easy

42. The expected return for the asset below is 18.75 percent. If the return distribution for

the asset is described as in the following table, what is the variance for the asset's

returns?

Return

A)

0.1

0.2

0.25

0.002969

B)

0.000613

C)

0.015195

D)

0.054486

Probability

0.25

0.5

0.25

Ans: A

Feedback:

(0.1)(0.25 – 0.1875)2 + (0.2)(0.5 – 0.1875) 2 + (0.25)(0.25 – 0.1875) 2 = 0.002969

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Easy

43. The expected return for the asset shown in the following table is 18.75 percent. If the

return distribution for the asset is described as below, what is the standard deviation for

the asset's returns?

Return Probability

A)

0.1

0.2

0.25

0.002969

B)

0.000613

C)

0.015195

D)

0.054486

0.25

0.5

0.25

Ans: D

7-13

Feedback:

{ (0.25)(0.10 – 0.1875)2 + (0.5)(0.2 – 0.1875) 2 + (0.25)(0.25 – 0.1875) 2 }1/2 = 0.054486

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

44. If you are dealing with percentage returns, then which of the following is generally

true?

A) The variance of the return distribution is generally smaller than the standard

deviation.

B) The variance of the return distribution is generally larger than the standard

deviation.

C) The variance of the return distribution is measured in the same units as expected

return.

D) None of the above is generally true.

Ans: D

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Easy

45. The return distribution for an asset is as shown in the following table. What are the

missing values if the expected return is 10 percent?

Return

Probability

A)

0.1

x

x

0.20

0.25

0.5

0.25

B)

0.15

C)

0.10

D)

None of the above

Ans: C

7-14

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

46. The expected return for Stock Z is 30 percent. If we know the following information

about Stock Z, then what return will it produce in the Lukewarm state of the world?

Return

Probability

0.2

?

0.4

0.25

0.5

0.25

A)

Poor

Lukewarm

Dynamite!

20%

B)

30%

C)

40%

D)

It is impossible to determine.

Ans: B

Feedback:

(0.25)(0.2) + (0.5)(X) + (0.25)(0.4) = 0.3 , X = 0.3

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

47. The expected return for Stock V is 24.5 percent. If we know the following information

about Stock Z, then what is the probability of the Dynamite state of the world

occurring?

A)

Poor

Lukewarm

Dynamite!

5%

B)

10%

C)

15%

D)

20%

Return

Probability

0.15

0.28

0.19

0.2

0.7

?

Ans: B

7-15

Feedback:

0.2 + 0.7 + X = 1.0 ===> X = 0.1 or 10%

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

48. 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 the total return to Ahmet from owning

the stock? (Round your answer to the nearest whole percent.)

A) 5%

B)

44%

C)

35%

D)

50%

Ans: D

Feedback:

$65 $45 $2.50

0.5 50%

$45

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

49. Julio purchased a stock one year ago for $27. The stock is now worth $32, and the total

return to Julio for owning the stock was 37 percent. What is the dollar amount of

dividends that he received for owning the stock during the year?

A) $4

B)

$5

C)

$6

D)

$7

Ans: B

Feedback:

$32 $27 $ X

0.37, $ X $5

$27

7-16

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

50. Francis purchased a stock one year ago for $20, and it is now worth $24. The stock paid

a dividend of $3 during the year. What was the stock's rate of return from capital

appreciation during the year? (Round your answer to the nearest percent.)

A) 17%

B)

20%

C)

29%

D)

35%

Ans: B

Feedback:

$24 $20

0.20

$20

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

51. Gwen purchased a stock one year ago for $25, and it is now worth $31. The stock paid

a dividend of $1.50 during the year. What was the stock's rate of return income during

the year? (Round your answer to the nearest percent.)

A) 6%

B)

15%

C)

24%

D)

26%

Ans: A

Feedback:

$1.50

.06

$25

7-17

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

52. 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?

A) $7.00

B)

$7.50

C)

$8.00

D)

$8.50

Ans: C

Feedback:

$12 $ X $1

0.625, $ X $8

$X

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

53. 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.

Ans: D

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

54. Babs purchased a piece of real estate last year for $85,000. The real estate is now worth

$102,000. If Babs needs to have a total return of 25 percent during the year, then what

is the dollar amount of income that she needed to have to reach her objective?

A) $3,750

B)

$4,250

C)

$4,750

7-18

D)

$5,250

Ans: B

Feedback:

$102, 000 $85, 000 $ X

0.25, $ X $4, 250

$85, 000

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

55. Genaro needs to capture a return of 40 percent for his one-year investment in a

property. He believes that he can sell the property at the end of the year for $150,000

and that the property will provide him with rental income of $25,000. What is the

maximum amount that Genaro should be willing to pay for the property?

A) $112,500

B)

$125,000

C)

$137,500

D)

$150,000

Ans: B

Feedback:

$150, 000 $ X $25, 000

0.4, $ X $125, 000

$X

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

56. Books Brothers stock was priced at $15 per share two years ago. The stock sold for $13

last year and now it sells for $18. What was the total return for owning Books Brothers

stock during the most recent year? Assume that no dividends were paid and round to the

nearest percent.

A) 17%

B)

20%

C)

23%

D)

38%

Ans: D

7-19

Feedback:

$18 $13

0.3846

$13

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

57. Serox stock was selling for $20 two years ago. The stock sold for $25 one year ago, and

it is currently selling for $28. Serox pays a $1.10 dividend per year. What was the rate

of return for owning Serox in the most recent year? (Round to the nearest percent.)

A) 12%

B)

16%

C)

32%

D)

40%

Ans: B

Feedback:

$28 $25 $1.1

0.164

$25

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

58. You have observed that the average size of a particular goldfish is 1.5 inches long. The

standard deviation of the size of the goldfish is 0.25 inches. What is the size of a

goldfish such that 95 percent of the goldfish are smaller? Assume a normal distribution

for the size of goldfish.

A) 1.01 inches

B)

1.09 inches

C)

1.91 inches

D)

1.99 inches

Ans: C

Feedback:

1.5 + 1645 (0.25) = 1.91 inches

7-20

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

59. You know that the average college student eats 0.75 pounds of food at lunch. If the

standard deviation of that eating is 0.2 pounds of food, then what is the total amount of

food that a cafeteria should have on hand to be 95percent confident that it will not run

out of food when feeding 50 college students.

A) 17.90 pounds

B)

21.05 pounds

C)

53.95 pounds

D)

57.10 pounds

Ans: C

Feedback:

50 students * {0.75 pounds per student + 1.645 (0.2 pounds per student)} = 53.95

pounds of food required.

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

60. If a random variable is drawn from a normal distribution, what is the probability that

the random variable is larger than 1.96 standard deviations larger than the mean?

A) 1.25%

B)

2.50%

C)

3.75%

D)

5.00%

Ans: B

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

61. If a random variable is drawn from a normal distribution, what is the probability that

the random variable is larger than 1.96 standard deviations below the mean?

A) 95.00%

B)

96.25%

C)

97.50%

7-21

D)

98.75%

Ans: C

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

62. Niles is making an investment with an expected return of 12 percent. If the standard

deviation of the return is 4.5 percent, and if Niles is investing $100,000, then what

dollar amount is Niles 95 percent sure that he will have at the end of the year?

A) $100,000.00

B)

$104,597.50

C)

$116,500.00

D)

$119,402.50

Ans: B

Feedback:

{ 1 + [0.12 – 1.645 (0.045)]} X $100,000 = $104,597.50

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

63. Which of the following investment classes had the greatest average return based on

recent historical data?

A) Intermediate-Term Government Bonds

B)

Long-Term Government Bonds

C)

Large U.S. Stocks

D)

Small U.S. Stocks

Ans: D

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

64. Which of the following investment classes had the greatest variability in returns for

recent historical data?

A) Intermediate-Term Government Bonds

7-22

B)

Long-Term Government Bonds

C)

Large U.S. Stocks

D)

Small U.S. Stocks

Ans: D

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

65. If you were to compare the returns of an individual stock to a market index, select the

answer below that is most true.

A) The returns of the individual stock will show more variability than those of the

market index.

B) The returns of the individual stock will show less variability than those of the

market index.

C) The returns of the individual stock will show the same level of variability than

those of the market index, if they have the same beta.

D) None of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

66. Tommie has made an investment that will generate returns that are subject to 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.

State

Weak

OK

Great

A) 0.0453

B)

0.0467

C)

0.0481

D)

0.0495

Return

Probability

0.13

0.2

0.25

0.3

0.4

0.3

Ans: B

7-23

Feedback:

E ( R ) (0.3)(0.13) (0.4)(0.2) (0.3)(0.25) 0.194

Var ( R ) 0.3(0.13 0.194)2 0.4(0.2 0.194)2 0.3(0.25 0.194) 2 0.002184

1

Std ( R ) (0.002184) 2 0.046733

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

67. Elrond has made an investment that will generate returns that are subject to the state of

the economy. Use the following information to calculate the variance of the return

distribution for Elrond's investment.

State

Weak

OK

Great

A) 0.0536

B)

0.0543

C)

0.0550

D)

0.0557

Return

Probability

0.10

0.17

0.28

0.8

0.1

0.1

Ans: D

Feedback:

7-24

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

68. Braniff Ground Services stock has an expected return of 9 percent and a variance of

0.25 percent. What is the coefficient of variation for Braniff?

A) 0.0278

B)

0.5556

C)

1.800

D)

36.00

Ans: B

Feedback:

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

69. Sayers purchased a stock with a coefficient of variation equal to 0.125. The expected

return on the stock is 20 percent. What is the variance of the stock?

A) 0.000625

B)

0.025000

C)

0.625000

D)

0.790500

Ans: A

Feedback:

Coefficient

of

Variation

E (R)

1

2 2

0.20

7-25

0.125, 2 0.000625

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