Risk and returns questions

1) Which of the following is true of risk?

A) Risk and return are inversely proportionate to each other.
B) Higher the risk associated with a security the lower is its return.
C) Risk is a measure of the uncertainty surrounding the return that an investment will earn.
D) Riskier investments tend to have lower returns as compared to T-bills, which are risk free.
Answer: C
Diff: 1
Topic: Risk Defined
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking

2) Nico bought 100 shares of Cisco Systems stock for $30.00 per share on January 1, 2021. He
received a dividend of $2.00 per share at the end of 2021, and at that time the stock was selling
for $34. What return did Nico earn in 2021 on the stock?
A) +13%
B) +20%
C) +7%
D) Nico did not earn a return because he did not sell the shares in 2020.
Answer: B
Diff: 1
Topic: Return Defined
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking

3) Last year, Mike bought 100 shares of Dallas Corporation common stock for $53 per share.
During the year he received dividends of $1.45 per share. The stock is currently selling for $60
per share. What rate of return did Mike earn over the year?
A) 11.7 percent
B) 13.2 percent
C) 14.1 percent
D) 15.9 percent
Answer: D
Diff: 1
Topic: Return Defined
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking

4) If an investor prefers an investment with a higher expected return regardless of its risk, then he
could be called a ________ investor.
A) risk-seeking
B) risk-neutral
C) risk-averse
D) risk-aware
Answer: B
Diff: 1
Topic: Risk Preferences
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking

5) If an investor prefers investments with greater risk even if they have lower expected returns,
then he could be called a ________ investor.
A) risk-seeking
B) risk-indifferent
C) risk-averse
D) risk-neutral
Answer: A
Diff: 1
Topic: Risk Preferences
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking

6) Risk aversion is the behavior exhibited by investors who require ________.

A) an increase in return, for a given decrease in risk
B) an increase in return, for a given increase in risk
C) no changes in return, for a given increase in risk
D) decrease in return, for a given increase in risk
Answer: B
Diff: 1
Topic: Risk Preferences
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking

7) Tim purchased a bounce house one year ago for $6,500. During the year it generated $4,000 in
cash flow. If Tim sells the bounce house today, he could receive $6,100 for it. What would be his
total rate of return under these conditions?

Answer: Realized return = = 55.38%

Diff: 1
Topic: Return Defined
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking
8) Perry purchased 100 shares of Ferro, Inc. common stock for $25 per share one year ago.
During the year, Ferro, Inc. paid cash dividends of $2 per share. The stock is currently selling for
$30 per share. If Perry sells all of his shares of Ferro, Inc. today, what rate of return would he
earn?

Answer: Realized return = = 28%

Diff: 1
Topic: Return Defined
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking

9) Asset A was purchased six months ago for $25,000 and has generated $1,500 cash flow during
that period. What is the asset's total rate of return if it can be sold for $26,750 today?

Answer: Realized return = = 13%

Annual rate of return = 13% × 2 = 26%
Diff: 1
Topic: Return Defined
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking

10) ________ is one way of assessing an asset's risk. It is found by subtracting the pessimistic
outcome from the optimistic outcome.
A) Variance
B) Standard deviation
C) Probability distribution
D) Range
Answer: D
Diff: 1
Topic: Risk Assessment
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Analytical Thinking

11) A certain investment has a 50% chance of paying $100 and 50% chance of paying -$100. A
risk-averse investor ________.
A) would not be willing to buy this investment at any price greater than or equal to $0
B) would be willing to buy this investment as long as the price is above $0
C) would be willing to buy this investment at a price between $1 and $5
D) would be willing to accept this investment as a gift
Answer: A
Diff: 1
Topic: Risk Preferences
Learning Objective: LG 1
Learning Outcome: F-11
AACSB: Analytical Thinking

12) Standard deviation is a measure of relative dispersion that is useful in comparing the risks of
assets with different expected returns.
Answer: FALSE
Diff: 1
Topic: Risk Measurement
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Analytical Thinking

13) The ________ measures the dispersion around the expected value.
A) coefficient of variation
B) chi square
C) mean
D) standard deviation
Answer: D
Diff: 1
Topic: Risk Measurement
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Analytical Thinking

14) Which asset would the risk-averse financial manager prefer? (See below.)

A) Asset A
B) Asset B
C) Asset C
D) Asset D
Answer: D
Diff: 1
Topic: Risk Measurement
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Reflective Thinking

14) The expected value and the standard deviation of returns for asset A is ________. (See
below.)

Asset A

A) 12 percent and 4 percent

B) 12.7 percent and 2.3 percent
C) 12.7 percent and 4 percent
D) 12 percent and 2.3 percent
Answer: B
Diff: 1
Topic: Risk Measurement
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Analytical Thinking

15) The expected value, standard deviation of returns, and coefficient of variation for asset A are
________. (See below.)
Asset A

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

B) 9.33 percent, 8 percent, and 2.15, respectively
C) 9.35 percent, 4.68 percent, and 2.00, respectively
D) 9.35 percent, 2.76 percent, and 0.295, respectively
Answer: D
Diff: 3
Topic: Risk Measurement
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Analytical Thinking

16) Given the following limited information about the two assets A and B, which asset seems
preferable?
Answer: Asset A is preferred because it has a lower range for the same expected return.
Diff: 1
Topic: Risk Assessment
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Reflective Thinking

17) Using five years of historical data below, calculate the average return and standard deviation
of returns for Asset A.

Answer: Average return = (20 + 30 - 15 + 2 + 3) / 5 = 8%

Std deviation = = 17.4%

Diff: 2
Topic: Risk Measurement
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Analytical Thinking

18) Champion Breweries must choose between two asset purchases. The annual rate of return
and related probabilities given below summarize the firm's analysis.

For each asset, compute

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

Expected Return = 15% Expected Return = 15%

(b) Asset A
× 0.30 = 7.5%
× 0.40 = 0%
× 0.30 = 7.5%
15%
Variance = 15
Standard Deviation of A = 3.87%
Asset B
× 0.40 = 40%
× 0.20 = 0%
× 0.40 = 40%
80%
Standard Deviation of B = 8.94%
(c) CVA = 3.87/15 = 0.26 CVB = 8.94/15 = 0.60
(d) Asset A; for 15% rate of return and lesser risk.
Diff: 2
Topic: Risk Measurement
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Reflective Thinking

19) The College Copy Shop is in the process of purchasing a high-tech copier. In its search, it
has gathered the following information about two possible copiers A and B.
(a) Compute expected rate of return for each copier.
(b) Compute variance and standard deviation of rate of return for each copier.
(c) Which copier should they purchase?
Answer:
a and b.

Expected value = 16.9% Expected value = 17.05%

Variance A = 17.48 Variance = 35.65
SD = 4.18% SD = 5.97%
(c) CV = SD / r
Copier A: CV = 4.18/16.90 = 0.25
Copier B: CV = 5.97/17.05 = 0.35
The College Copy Shop should buy copier A.
Diff: 2
Topic: Risk Measurement
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Analytical Thinking

20) Given the following probability distribution for assets X and Y, compute the expected rate of
return, variance, standard deviation, and coefficient of variation for the two assets. Which asset
seems to be a better investment?

Answer:

Expected value = 10.7% Expected value = 11.15%

Variance = 2.01 Variance = 0.63
SD = 1.42% SD = 0.79%
CV = SD/r
Asset X: CV = 1.42/10.70 = 0.13
Asset Y: CV = 0.79/11.15 = 0.07
Asset Y is preferred.
Diff: 2
Topic: Risk Measurement
Learning Objective: LG 2
Learning Outcome: F-11
AACSB: Analytical Thinking

21) An investment advisor has recommended a $50,000 portfolio containing assets R, J, and K;
$25,000 will be invested in asset R, with an expected annual return of 12 percent; $10,000 will
be invested in asset J, with an expected annual return of 18 percent; and $15,000 will be invested
in asset K, with an expected annual return of 8 percent. The expected annual return of this
portfolio is ________.
A) 12.67%
B) 12.00%
C) 10.00%
D) 11.78%
Answer: B
Diff: 2
Topic: Portfolio Return and Standard Deviation
Learning Objective: LG 3
Learning Outcome: F-11
AACSB: Analytical Thinking

22) Given the returns of two stocks J and K in the table below over the next 4 years. Find the
expected return and standard deviation of holding a portfolio of 40% of stock J and 60% in stock
K over the next 4 years:

Stock J Stock K
2020 10% 9%
2021 12% 8%
2022 13% 10%
2023 15% 11%

A) 10.7% and 1.34%

B) 10.6% and 1.79%
C) 10.6% and 1.16%
D) 14.3% and 2.02%
Answer: A
Diff: 2
Topic: Portfolio Return and Standard Deviation
Learning Objective: LG 3
Learning Outcome: F-11
AACSB: Analytical Thinking

23) Akai has a portfolio of three assets. Find the expected rate of return for the portfolio
assuming he invests 50 percent of its money in asset A with 10 percent rate of return, 30 percent
in asset B with a rate of return of 20 percent, and the rest in asset C with 30 percent rate of
return.
Answer:

Expected rate of return = 17 percent.

Diff: 2
Topic: Portfolio Return and Standard Deviation
Learning Objective: LG 3
Learning Outcome: F-11
AACSB: Analytical Thinking