Test Bank For Investment Analysis And Portfolio Management, 10th Edition

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.CHAPTER 1—AN OVERVIEW OF THE INVESTMENT PROCESSTRUE/FALSE1.The rate of exchange between certain future dollars and certain current dollars is known as the purerate of interest.ANS:TPTS:12.An investment is the current commitment of dollars over time to derive future payments to compensatethe investor for the time funds are committed, the expected rate of inflation and the uncertainty offuture payments.ANS:TPTS:13.The holding period return (HPR) is equal to the holding period yield (HPY) stated as a percentage.ANS:FPTS:14.The geometric mean of a series of returns is always larger than the arithmetic mean and the differenceincreases with the volatility of the series.ANS:FPTS:15.The expected return is the average of all possible returns.ANS:FPTS:16.Two measures of the risk premium are the standard deviation and the variance.ANS:FPTS:17.The variance of expected returns is equal to the square root of the expected returns.ANS:FPTS:18.The coefficient of variation is the expected return divided by the standard deviation of the expectedreturn.ANS:FPTS:19.Nominal rates are averages of all possible real rates.ANS:FPTS:110.The risk premium is a function of the volatility of operating earnings, sales volatility and inflation.ANS:FPTS:1

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.11.An individual who selects the investment that offers greater certainty when everything else is the sameis known as a risk averse investor.ANS:TPTS:112.Investors are willing to forgo current consumption in order to increase future consumption for anominal rate of interest.ANS:FPTS:113.The two most common calculations investors use to measure return performance are arithmetic meansand geometric means.ANS:TPTS:114.The arithmetic mean is a superior measure of the long-term performance because it indicates thecompound annual rate of return based on the ending value of the investment versus its beginningvalue.ANS:FPTS:1MULTIPLE CHOICE1.The basic trade-off in the investment process isa.between the anticipated rate of return for a given investment instrument and its degree ofrisk.b.between understanding the nature of a particular investment and having the opportunity topurchase it.c.between high returns available on single instruments and the diversification of instrumentsinto a portfolio.d.between the desired level of investment and possessing the resources necessary to carry itout.e.None of the above.ANS:APTS:1OBJ:Multiple Choice2.The rate of exchange between future consumption and current consumption isa.The nominal risk-free rate.b.The coefficient of investment exchange.c.The pure rate of interest.d.The consumption/investment paradigm.e.The expected rate of return.ANS:CPTS:1OBJ:Multiple Choice3.The ____ the variance of returns, everything else remaining constant, the ____ the dispersion ofexpectations and the ____ the risk.a.Larger, greater, lowerb.Larger, smaller, higherc.Larger, greater, higher

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.d.Smaller, greater, lowere.Smaller, greater, greaterANS:CPTS:1OBJ:Multiple Choice4.The coefficient of variation is a measure ofa.Central tendency.b.Absolute variability.c.Absolute dispersion.d.Relative variability.e.Relative return.ANS:DPTS:1OBJ:Multiple Choice5.The nominal risk free rate of interest is a function ofa.The real risk free rate and the investment's variance.b.The prime rate and the rate of inflation.c.The T-bill rate plus the inflation rate.d.The tax free rate plus the rate of inflation.e.The real risk free rate and the rate of inflation.ANS:EPTS:1OBJ:Multiple Choice6.In the phrase "nominal risk free rate," nominal meansa.Computed.b.Historical.c.Market.d.Average.e.Risk adverse.ANS:CPTS:1OBJ:Multiple Choice7.If a significant change is noted in the yield of a T-bill, the change is most likely attributable toa.A downturn in the economy.b.A static economy.c.A change in the expected rate of inflation.d.A change in the real rate of interest.e.A change in risk aversion.ANS:CPTS:1OBJ:Multiple Choice8.The real risk-free rate is affected by a two factors;a.The relative ease or tightness in capital markets and the expected rate of inflation.b.The expected rate of inflation and the set of investment opportunities available in theeconomy.c.The relative ease or tightness in capital markets and the set of investment opportunitiesavailable in the economy.d.Time preference for income consumption and the relative ease or tightness in capitalmarkets.e.Time preference for income consumption and the set of investment opportunities availablein the economy.

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.ANS:EPTS:1OBJ:Multiple Choice9.Which of the following isnota component of the risk premium?a.Business riskb.Financial riskc.Liquidity riskd.Exchange rate riske.Unsystematic market riskANS:EPTS:1OBJ:Multiple Choice10.The ability to sell an asset quickly at a fair price is associated witha.Business risk.b.Liquidity risk.c.Exchange rate risk.d.Financial risk.e.Market risk.ANS:BPTS:1OBJ:Multiple Choice11.The variability of operating earnings is associated witha.Business risk.b.Liquidity risk.c.Exchange rate risk.d.Financial risk.e.Market risk.ANS:APTS:1OBJ:Multiple Choice12.The uncertainty of investment returns associated with how a firm finances its investments is known asa.Business risk.b.Liquidity risk.c.Exchange rate risk.d.Financial risk.e.Market risk.ANS:DPTS:1OBJ:Multiple Choice13.What will happen to the security market line (SML) if the following events occur, other thingsconstant: (1) inflation expectations increase, and (2) investors become more risk averse?a.Shift up and keep the same slopeb.Shiftup and have less slopec.Shift up and have a steeper sloped.Shift down and keep the same slopee.Shift down and have less slopeANS:CPTS:1OBJ:Multiple Choice14.A decrease in the market risk premium, all other things constant, will cause the security market line toa.Shift upb.Shift downc.Have a steeper slope

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.d.Have a flatter slopee.Remain unchangedANS:DPTS:1OBJ:Multiple Choice15.A decrease in the expected real growth in the economy, all other things constant, will cause thesecurity market line toa.Shift upb.Shift downc.Have a steeper sloped.Have a flatter slopee.Remain unchangedANS:BPTS:1OBJ:Multiple Choice16.Unsystematic risk refers to risk that isa.Undiversifiableb.Diversifiablec.Due to fundamental risk factorsd.Due to market riske.None of the aboveANS:BPTS:1OBJ:Multiple Choice17.The security market line (SML) graphs the expected relationship betweena.Business risk and financial riskb.Systematic risk and unsystematic riskc.Risk and returnd.Systematic risk and unsystematic returne.None of the aboveANS:CPTS:1OBJ:Multiple Choice18.Two factors that influence the nominal risk-free rate are;a.The relative ease or tightness in capital markets and the expected rate of inflation.b.The expected rate of inflation and the set of investment opportunities available in theeconomy.c.The relative ease or tightness in capital markets and the set of investment opportunitiesavailable in the economy.d.Time preference for income consumption and the relative ease or tightness in capitalmarkets.e.Time preference for income consumption and the set of investment opportunities availablein the economy.ANS:APTS:1OBJ:Multiple Choice19.Measures of risk for an investment includea.Variance of returns and business riskb.Coefficient of variation of returns and financial riskc.Business risk and financial riskd.Variance of returns and coefficient of variation of returnse.All of the above

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.ANS:DPTS:1OBJ:Multiple Choice20.Sources of risk for an investment includea.Variance of returns and business riskb.Coefficient of variation of returns and financial riskc.Business risk and financial riskd.Variance of returns and coefficient of variation of returnse.All of the aboveANS:CPTS:1OBJ:Multiple Choice21.Modern portfolio theory assumes that most investors area.Risk averseb.Risk neutralc.Risk seekersd.Risk tolerante.None of the aboveANS:APTS:1OBJ:Multiple Choice22.Which of the following is not a component of the required rate of return?a.Expected rate of inflationb.Time value of moneyc.Riskd.Holding period returne.All of the above are components of the required rate of returnANS:DPTS:1OBJ:Multiple Choice23.All of the following are major sources of uncertainty EXCEPTa.Business riskb.Financial riskc.Default riskd.Country riske.Liquidity riskANS:CPTS:1OBJ:Multiple Choice24.The total risk for a security can be measured by itsa.Beta with the market portfoliob.Systematic riskc.Standard deviation of returnsd.Unsystematic riske.Alpha with the market portfolioANS:CPTS:1OBJ:Multiple Choice25.The increase in yield spreads in late 2008 and early 2009 indicated thata.Credit risk premiums decreasedb.Market risk premiums increasedc.Investors are more confident of the future cash flows of bondsd.Non-investment grade bonds are less risky

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.e.Government bonds are no longer a risk free investmentANS:BPTS:1OBJ:Multiple Choice26.Which of the following isleast likelyto move a firm's position to the right on the Security Market Line(SML)?a.An increase in the firm's betab.Adding more financial debt to the firm's balance sheet relative to equityc.Changing the business strategy to include new product lines with more volatile expectedcash flowsd.Investors perceive the stock as being more riskye.An increase in the risk-free required rate of return.ANS:EPTS:1OBJ:Multiple ChoiceExhibit 1.1USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)Assume you bought 100 shares of NewTech common stock on January 15, 2003 at $50.00 per shareand sold it on January 15, 2004 for $40.00 per share.27.Refer to Exhibit 1.1. What was your holding period return?a.−10%b.−0.8c.25%d.0.8e.−20%ANS:DHPR = Ending Value/Beginning Value = 40/50 = 0.8PTS:1OBJ:Multiple Choice Problem28.Refer to Exhibit 1.1. What was your holding period yield?a.−10%b.−0.8c.25%d.0.8e.−20%ANS:EHPY = HPR−1 = (40/50)−1 = 0.8−1 =−0.2 =−20%PTS:1OBJ:Multiple Choice ProblemExhibit 1.2USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)Suppose you bought a GM corporate bond on January 25, 2001 for $750, on January 25, 2004 sold itfor $650.00.

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.29.Refer to Exhibit 1.2. What was your annual holding period return?a.0.8667b.−0.1333c.0.0333d.0.9534e.−0.0466ANS:DHPR = Ending Value/Beginning Value = $650.00/$750 = 0.8667Annual HPR = (HPR)1/n= (0.8667)1/3= 0.9534PTS:1OBJ:Multiple Choice Problem30.Refer to Exhibit 1.2. What was your annual holding period yield?a.−0.0466b.−0.1333c.0.0333d.0.3534e.0.8667ANS:AHPR = Ending Value/Beginning Value = $650.00/$750 = 0.8667Annual HPR = (HPR)1/n= (0.8667)1/3= 0.9534Annual HPY = Annual HPR−1 = 0.9534−1 =−0.0466 =−4.66%PTS:1OBJ:Multiple Choice ProblemExhibit 1.3USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)The common stock of XMen Inc. had the following historic prices.TimePrice of X-Tech3/01/199950.003/01/200047.003/01/200176.003/01/200280.003/01/200385.003/01/200490.0031.Refer to Exhibit 1.3. What was your holding period return for the time period 3/1/1999 to 3/1/2004?a.0.1247b.1.8c.0.1462d.0.40e.0.25ANS:B

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.HPR = Ending Value/Beginning Value = 90/50 = 1.8PTS:1OBJ:Multiple Choice Problem32.Refer to Exhibit 1.3. What was your annual holding period yield (Annual HPY)?a.0.1462b.0.1247c.1.8d.0.40e.0.25ANS:BAnnual HPR = (HPR)1/n= (1.8)1/5= 1.1247Annual HPY = Annual HPR−1 = 1.1247−1 = 0.1247 = 12.47%TimePrice of X-TechReturnHPR3/01/1999503/01/200047−0.06000.94003/01/2001760.61701.61703/01/2002800.05261.05263/01/2003850.06251.06253/01/2004900.05881.0588PTS:1OBJ:Multiple Choice Problem33.Refer to Exhibit 1.3. What was your arithmetic mean annual yield for the investment in XMenIndustries.a.0.1462b.0.1247c.1.8d.0.40e.0.25ANS:AArithmetic Mean =PTS:1OBJ:Multiple Choice Problem34.Refer to Exhibit 1.3. What was your geometric mean annual yield for the investment in XMen?a.0.25b.0.40c.1.8d.0.1247e.0.1462ANS:D

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.PTS:1OBJ:Multiple Choice ProblemExhibit 1.4USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)You have concluded that next year the following relationships are possible:Economic StatusProbabilityRate of ReturnWeak Economy.15−5%Static Economy.605%Strong Economy.2515%35.Refer to Exhibit 1.4. What is your expected rate of return [E(Ri)] for next year?a.4.25%b.6.00%c.6.25%d.7.75%e.8.00%ANS:BE(Ri) = (0.15)(−5) + (0.60)(5) + (0.25)(15) = 6%PTS:1OBJ:Multiple Choice Problem36.Refer to Exhibit 1.4. Compute the standard deviation of the rate of return for the one year period.a.0.65%b.1.45%c.4.0%d.6.25%e.6.4%ANS:D= [(0.15)(−5−6)2+ (0.60)(5−6)2+ (0.25)(15−6)2]1/2= 6.25%PTS:1OBJ:Multiple Choice Problem37.Refer to Exhibit 1.4. Compute the coefficient of variation for your portfolio.a.0.043b.0.12c.1.40d.0.69e.1.04

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.ANS:ECV= Standard Deviation of Returns/Expected Rate of Return= 6.25/6 = 1.04PTS:1OBJ:Multiple Choice ProblemExhibit 1.5USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)Assume that during the past year the consumer price index increased by 1.5 percent and the securitieslisted below returned the following nominal rates of return.U.S. Government T-bills2.75%U.S. Long-term bonds4.75%38.Refer to Exhibit 1.5. What are the real rates of return for each of these securities?a.4.29% and 6.32%b.1.23% and 4.29%c.3.20% and 6.32%d.1.23% and 3.20%e.3.75% and 5.75%ANS:DReal rate on T-bills = (1.0275/1.015)−1 = 0.0123 = 1.23%Real rate on bonds = (1.0475/1.015)−1 = 0.032 = 3.2%PTS:1OBJ:Multiple Choice Problem39.Refer to Exhibit 1.5. If next year the real rates all rise by 10 percent while inflation climbs from 1.5percent to 2.5 percent, what will be the nominal rate of return on each security?a.1.24% and 1.52%b.1.35% and 3.52%c.3.89% and 6.11%d.3.52% and 3.89%e.1.17% and 6.11%ANS:CThe computations for the new real rates are:Real rate on T-bills = 1.231.10 = 1.353%Real rate on bonds = 3.21.10 = 3.52%Nominal rate on T-bills = (1.01353)(1.025)−1 = .03886 = 3.89%Nominal rate on corporate bonds = (1.0352)(1.025)−1 = .06108 = 6.11%PTS:1OBJ:Multiple Choice Problem40.If over the past 20 years the annual returns on the S&P 500 market index averaged 12% with astandard deviation of 18%, what was the coefficient of variation?a.0.6

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.b.0.6%c.1.5d.1.5%e.0.66%ANS:CCoefficient of Variation= Standard Deviation of Returns/Expected Rate of Return= 18%/12% = 1.5PTS:1OBJ:Multiple Choice Problem41.Given investments A and B with the following risk return characteristics, which one would you preferand why?Standard DeviationInvestmentExpected Returnof Expected ReturnsA12.2%7%B8.8%5%a.Investment A because it has the highest expected return.b.Investment A because it has the lowest relative risk.c.Investment B because it has the lowest absolute risk.d.Investment B because it has the lowest coefficient of variation.e.Investment A because it has the highest coefficient of variation.ANS:DCoefficient of Variation = Standard Deviation of Returns/Expected Rate of ReturnCVA= 7%/12.2% = 0.573CVB= 5%/8.8% = 0.568Investment B has the lowest coefficient of variation and would be preferred.PTS:1OBJ:Multiple Choice ProblemExhibit 1.6USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)You are provided with the following information:Nominal return on risk-free asset = 4.5%Expected return for asset i = 12.75%Expected return on the market portfolio = 9.25%42.Refer to Exhibit 1.6. Calculate the risk premium for asset i.a.4.5%b.8.25%c.4.75%d.3.5%e.None of the above

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.ANS:BRisk premium for asset i = 12.75−4.5 = 8.25%PTS:1OBJ:Multiple Choice Problem43.Refer to Exhibit 1.6. Calculate the risk premium for the market portfolio.a.4.5%b.8.25%c.4.75%d.3.5%e.None of the aboveANS:CRisk premium market portfolio = 9.25−4.5 = 4.75%PTS:1OBJ:Multiple Choice ProblemExhibit 1.7USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)Consider the following informationNominal annual return on U.S. government T-bills for year 2009 = 3.5%Nominal annual return on U.S. government long-term bonds for year 2009 = 4.75%Nominal annual return on U.S. large-cap stocks for year 2009= 8.75%Consumer price index January 1, 2009 = 165Consumer price index December 31, 2009 = 16944.Refer to Exhibit 1.7. Compute the rate of inflation for the year 2009.a.2.42%b.4.0%c.1.69%d.1.24%e.None of the aboveANS:ARate of inflation = (169/165)−1 = .0242 = 2.42%PTS:1OBJ:Multiple Choice Problem45.Refer to Exhibit 1.7. Calculate the annual real rate of return for U.S. T-bills.a.2.26%b.1.81%c.−0.5%d.1.05%e.None of the aboveANS:DReal return on U.S. T-bills = (1.035/1.0242)−1 = .0105 = 1.05%PTS:1OBJ:Multiple Choice Problem

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.46.Refer to Exhibit 1.7. Calculate the annual real rate of return for U.S. long-term bonds.a.3.06%b.2.27%c.2.51%d.3.5%e.None of the aboveANS:BReal return on U.S. bonds = (1.0475/1.0242)−1 = .0227 = 2.27%PTS:1OBJ:Multiple Choice Problem47.Refer to Exhibit 1.7. Calculate the annual real rate of return for U.S. large-cap stocks.a.7.06%b.6.18%c.4.75%d.3.75%e.None of the aboveANS:BReal return on U.S. stocks = (1.0875/1.0242)−1 = .0618 = 6.18%PTS:1OBJ:Multiple Choice ProblemExhibit 1.8USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)Assume that you hold a two stock portfolio. You are provided with the following information on yourholdings:StockSharesPrice(t)Price(t + 1)1151012225151648.Refer to Exhibit 1.8. Calculate the HPY for stock 1.a.10%b.20%c.15%d.12%e.7%ANS:BStockSharesPrice(t)MV(t)Price(t+1)MV(t+1)HPRHPYWeightWeightedHPY11510150121801.20.20.290.05822515375164001.070.070.710.0485255800.106HPY for stock 1 = (180/150)−1 = .2 = 20%

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© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of theU.S. only, with content that may be different from the U.S.Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.PTS:1OBJ:Multiple Choice Problem49.Refer to Exhibit 1.8. Calculate the HPY for stock 2.a.5%b.6%c.7%d.8%e.10%ANS:CStockSharesPrice(t)MV(t)Price(t+1)MV(t+1)HPRHPYWeightWeightedHPY11510150121801.20.20.290.05822515375164001.070.070.710.0485255800.106HPY for stock 2 = (400/375)−1 = .07 = 7%PTS:1OBJ:Multiple Choice Problem50.Refer to Exhibit 1.8. Calculate the market weights for stock 1 and 2 based on period t values.a.39% for stock 1 and 61% for stock 2b.50% for stock 1 and 50% for stock 2c.71% for stock 1 and 29% for stock 2d.29% for stock 1 and 71% for stock 2e.None of the aboveANS:DStockSharesPrice(t)MV(t)Price(t+1)MV(t+1)HPRHPYWeightWeightedHPY11510150121801.20.20.290.05822515375164001.070.070.710.0485255800.106Market weight for stock 1 = 150/525 = .29 = 29%Market weight for stock 2 = 375/525 = .71 = 71%PTS:1OBJ:Multiple Choice Problem51.Refer to Exhibit 1.8. Calculatethe HPY for the portfolio.a.10.6%b.6.95%c.13.5%d.10%e.15.7%ANS:A

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