FIN4504 Chapter 5

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The holding period return is the rate at which the investor's funds have grown over the ______.

investment period

The ______ average ignores compounding.

arithmetic

A probability distribution for HPRs lets us derive measurements for the ______ of the investment.

a.risk
b.reward
c.both a and b above

The standard deviation is the ______ of the variance.

square root

During the 1926 to 1998 period, the geometric mean return on Treasury bills exceeded the geometric mean rate of inflation by _______.

0.7%

The _______ caused a very high spread between 3-month CDs and T-bills.

first OPEC oil crisis

An investor with a degree of risk aversion A-5 will demand a risk premium of _____ on a portfolio with a standard deviation of 10%.

2.5%

The complete portfolio refers to the investment in __________.

a.the risk-free asset
b.the risky portfolio
c.the sum of a and b

Of the alternatives available, __________ typically have the highest standard deviation of returns.

stocks

The holding period return on a stock is equal to __________.

the capital gain yield over the period plus the dividend yield

The return on an asset over a period between portfolio revisions is called __________.

a holding period return

If you purchase a stock for $50, receive dividends of $2, and sell the stock at the end of the year for $55, what is your holding period return?

14%

The arithmetic average of 12%, 15% and 20% is _________.

15.7%

The geometric average of 10%, 20% and 25% is __________.

18.2%

The dollar weighted return is the same as the __________.

internal rate of return

Returns on assets with regular cash flows are usually quoted as __________.

annual percentage rates

Annual percentage rates can be converted to effective annual rates by means of the following formula:

(1+(APR/n))n-1

Suppose you pay $9,700 for a Treasury bill maturing in three months. What is the holding period return for this investment?

3.1%

Suppose you pay $9,800 for a Treasury bill maturing in two months. What is the annual percentage rate of return for this investment?

12.2%

Suppose you pay $9,700 for a Treasury bill maturing in six months. What is the effective annual rate of return for this investment?

6.28%

A scenario analysis provides __________.

a.a probability estimate of different states of the economy or scenario
b.a holding period return for each asset-class in each scenario
c.both a and b

The risk-free rate is usually approximated by ___________.

the return on Treasury bills

The market risk premium is defined as ___________.

the difference between the return on an index fund and the return on Treasury bills

The excess return is _____.

the rate of return in excess of the Treasury bill rate

The rate of return on _____ is known at the beginning of the holding period while the rate of return on ____ is not known until the end of the holding period.

Treasury bills, risky assets

The reward/variability ratio is given by __________.

the slope of the capital allocation line

The capital allocation line is also the __________.

investment opportunity set formed with a risky asset and a risk-free asset

Historical records regarding returns on stocks, Treasury bonds, and Treasury bills between 1926 and 1998 show that __________.

stocks offered investors greater rates of return than bonds and bills

During the 1926 to 2001 period, the geometric mean return on small firm stocks was _______.

12.2%

During the 1926 to 2001 period, the geometric mean return on Treasury bills was __________.

3.8%

During the 1926 to 2001 period, the geometric mean rate of price inflation was __________.

3.1%

During the 1926 to 2001 period, the standard deviation of returns on large firm stocks was __________.

20.3%

During the 1926 to 2001 period, the standard deviation of returns on long-term government bonds was __________.

8.2%

During the 1926 to 2001 period, the geometric average return on large stocks was ____ percent while the arithmetic average return on large stocks was ____ percent.

10.5, 12.5

Historical returns have generally been __________ for stocks of small firms as/than for stocks of large firms.

higher

Historically small firm stocks have earned higher returns than large firm stocks. When viewed in the context of an efficient market, this suggests that ____________.

small firms are riskier than large firms

During the 1926 to 2000 period, the geometric average return on the largest decile NYSE/AMEX/NASDAQ stocks was _____ percent while the geometric average return on the smallest decile stocks was _____ percent.

0.3, 13.1

If you are promised a nominal return of 12%, on a one year investment, and you expect the rate of inflation to be 3%, what real rate do you expect to earn?

8.74%

If you require a real growth in the purchasing power of your investment of 8%, and you expect the rate of inflation over the next year to be 3%, what is the lowest nominal return that you would be satisfied with?

11.24%

__________ is a true statement.

a.Risk-averse investors reject investments that are fair games
b.Risk-neutral investors judge risky investments only by their expected returns
c.both a and b

A Treasury bill pays a 6% rate of return. A risk averse investor __________ invest in a risky portfolio that pays 12% with a probability of 40% or 2% with a probability of 60% because __________.

would not; because she is not rewarded any risk premium

In the mean-standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called __________.

the capital allocation line

__________ is a true statement regarding risk averse investors.

They only accept investments that offer risk premium over the risk-free rate

Investors wanting to reduce the risk of their portfolio should _____.

shift wealth from the risky portfolio to the risk-free asset

Historically the best asset for the long term investor wanting to fend off the threats of inflation and taxes while making his money grow has been _____.

stocks

The highest reward-to-variability ratio was during the ____ period.

1945-1963

The lowest reward-to-variability ratio was during the ____ period.

1964-1982

Consider a treasury bill with a rate of return of 5% and the following risky securities: Security A: E(r) = .15; σ2 = .0400
Security B: E(r) = .10; σ2 = .0225 Security C: E(r) = .12; σ2 = .1000 Security D: E(r) = .13; σ2 = .0625 The investor must develop a complete portfolio by combining the risk-free asset with one of the securities mentioned above. The security the investor would choose as part of his complete portfolio would be __________.

security A

You purchased a share of stock for $20. One year later you received $1 as dividend and sold the share for $24. Your holding-period return was __________.

25 percent

A treasury bill pays 5%. __________ would definitely not be chosen by a risk averse investor.

An asset that pays 10% with a probability of 20% or 3.75% with a probability of 80%

The holding period return on a stock was 25%. Its ending price was $18 and its beginning price was $16. Its cash dividend must have been __________.

$2.00

An investor invests 40% of his wealth in a risky asset with an expected rate of return of 15% and a variance of 4% and 60% in a treasury bill that pays 6%. Her portfolio's expected rate of return and standard deviation are __________ and __________ respectively.

9.6%, 8%

The holding period return on a stock was 30%. Its ending price was $26 and its cash dividend was $1.50. Its beginning price must have been __________.

$21.15

Consider the following two investment alternatives. First, a risky portfolio that pays 15% rate of return with a probability of 60% or 5% with a probability of 40%. Second, a treasury bill that pays 6%. The risk premium on the risky investment is __________.

5%

Consider the following two investment alternatives. First, a risky portfolio that pays 20% rate of return with a probability of 60% or 5% with a probability of 40%. Second, a treasury that pays 6%. If you invest $50,000 in the risky portfolio, your expected profit would be __________.

$7,000

You invest $100 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 12% and a standard deviation of 15% and a treasury bill with a rate of return of 5%. __________ of your money should be invested in the risky asset to form a portfolio with an expected rate of return of 9%

57%

You invest $100 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 12% and a standard deviation of 10% and a treasury bill with a rate of return of 5%.
Reference: 6-2
__________ of your complete portfolio should be invested in the risk-free asset if you want your complete portfolio to have a standard deviation of 9%.

90%

You invest $100 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 12% and a standard deviation of 10% and a treasury bill with a rate of return of 5%.
Reference: 6-2
A portfolio that has an expected outcome of $115 could be formed if you __________.

borrow $42.86 at the risk-free rate and invest $142.86 in the risky asset

You invest $100 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 12% and a standard deviation of 10% and a treasury bill with a rate of return of 5%.
Reference: 6-2
The slope of the capital allocation line formed with the risky asset and the risk-free asset is __________.

. 7

You have $500,000 available to invest. The risk-free rate as well as your borrowing rate is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should __________.

borrow $375,000

The return on the risky portfolio is 15%. The risk-free rate as well as the investor's borrowing rate is 10%. The standard deviation of return on the risky portfolio is 20%. If the standard deviation on the complete portfolio is 25%, the expected return on the complete portfolio is __________.

16.00%

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of treasury bills that pay 5% and a risky portfolio, P, constructed with 2 risky securities X and Y. The weight of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14% and Y has an expected rate of return of 10%.
Reference: 6-1
To form a complete portfolio with an expected rate of return of 11%, you should invest __________ of your complete portfolio in treasury bills.

19%

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of treasury bills that pay 5% and a risky portfolio, P, constructed with 2 risky securities X and Y. The weight of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14% and Y has an expected rate of return of 10%.
Reference: 6-1
To form a complete portfolio with an expected rate of return of 8%, you should invest __________, __________ and __________ of your complete portfolio in the treasury bill, X, and Y respectively.

60%, 24%, 16%

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of treasury bills that pay 5% and a risky portfolio, P, constructed with 2 risky securities X and Y. The weight of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14% and Y has an expected rate of return of 10%.
Reference: 6-1
The dollar values of your positions in X and Y respectively would be __________ and __________ if you decide to hold 30% of your complete portfolio in the risky portfolio and 60% in the treasury bills.

b.$180, $120

You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of treasury bills that pay 5% and a risky portfolio, P, constructed with 2 risky securities X and Y. The weight of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14% and Y has an expected rate of return of 10%.
Reference: 6-1
The dollar values of your positions in X, Y, and treasury bills respectively would be __________, __________ and __________ if you decide to hold a complete portfolio that has an expected return of 8%.

$243, $162, $595

The asset allocation decision does not help the investor _____.

identify specific securities to include in a portfolio

The change from a straight to a kinked capital allocation line is a result of the ____.

borrowing rate exceeding the lending rate

A standard deviation _____.

is the square root of the variance

The Manhawkin Fund has an expected return of 12% and a standard deviation return of 16%. The risk free rate is 4%. What is the reward-to-volatility ratio for the Manhawkin Fund?

a.0.5

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