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
Ans:
A

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.
True
7-1

B)
Ans:

False
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
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

7-2

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
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
7-3

Ans:

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
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
7-4

A)
B)
Ans:

expected return of that asset.

True
False
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
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

7-5

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
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.
7-6

A)
B)
Ans:

True
False
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 riskfree rate.
A)
True
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
7-7

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
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?
7-8

A)
B)
C)
D)
Ans:

$50
$75
$80
$100
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
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Easy
40.Use the following table to calculate the expected return for the asset.

A)
B)
C)

Return

Probability

0.1
0.2
0.25
15.00%
17.50%
18.75%

0.25
0.5
0.25

7-9

D)
Ans:

20.00%
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

A)
B)
C)
D)
Ans:

Probability

0.05
0.1
0.1
0.15
0.15
0.5
0.25
0.25
12.50%
13.75%
15.75%
16.75%
C
Feedback:
(0.5)(0.1) + (0.1)(0.15) + (0.15)(0.5) + (0.25)(0.25) = 0.1575
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)
B)
C)
D)
Ans:

Probability

0.1
0.25
0.2
0.5
0.25
0.25
0.002969
0.000613
0.015195
0.054486
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

7-10

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)
B)
C)
D)
Ans:

0.1
0.25
0.2
0.5
0.25
0.25
0.002969
0.000613
0.015195
0.054486
D
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

0.1
x

0.25
0.5
7-11

x
A)
B)
C)
D)
Ans:

0.25

0.20
0.15
0.10
None of the above
C

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

A)
B)
C)
D)
Ans:

Probability

Poor
0.2
0.25
Lukewarm
?
0.5
Dynamite!
0.4
0.25
20%
30%
40%
It is impossible to determine.
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?
Return

A)
B)
C)
D)
Ans:

Probability

Poor
0.15
0.2
Lukewarm
0.28
0.7
Dynamite!
0.19
?
5%
10%
15%
20%
B
Feedback:
0.2 + 0.7 + X = 1.0 ===> X = 0.1 or 10%
7-12

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
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:
7-13

$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
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.
7-14

Ans:

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
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%
7-15

D)
Ans:

38%
D
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
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.
7-16

A)
B)
C)
D)
Ans:

17.90 pounds
21.05 pounds
53.95 pounds
57.10 pounds
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%
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:
7-17

{ 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
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
7-18

the economy during the year. Use the following information to calculate the standard
deviation of the return distribution for Tommie's investment.
State

A)
B)
C)
D)
Ans:

Return

Probability

Weak
0.13
0.3
OK
0.2
0.4
Great
0.25
0.3
0.0453
0.0467
0.0481
0.0495
B
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

A)
B)
C)
D)
Ans:

Weak
OK
Great
0.0536
0.0543
0.0550
0.0557
D
Feedback:

Return

Probability

0.10
0.17
0.28

0.8
0.1
0.1

7-19

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:
1

Coefficient

of

Variation

2 2

0.125, 2 0.000625
E ( R ) 0.20

Format: Multiple Choice

Learning Objective: LO 5
Level of Difficulty: Medium
70.You have invested 40 percent of your portfolio in an investment with an expected return
of 12 percent and 60 percent of your portfolio in an investment with an expected return
of 20 percent. What is the expected return of your portfolio?
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A)
B)
C)
D)
Ans:

15.2%
16.0%
16.8%
17.6%
C
Feedback:
E ( R ) 0.4(0.12) 0.6(0.20) 0.168

Format: Multiple Choice

Learning Objective: LO 5
Level of Difficulty: Medium
71.You have invested 20 percent of your portfolio in Homer, Inc., 40 percent in Marge Co.,
and 20 percent in Bart Resources. What is the expected return of your portfolio if Homer,
Marge, and Bart have expected returns of 2 percent, 18 percent, and 3 percent,
respectfully?
A)
7.7%
B)
8.2%
C)
8.7%
D)
9.2%
Ans:
B
Feedback:
E ( R) 0.2(0.02) 0.4(0.18) 0.2(0.03) 0.082
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
72.You invested $3,000 in a portfolio with an expected return of 10 percent and $2,000 in a
portfolio with an expected return of 16 percent. What is the expected return of the
combined portfolio?
A)
6.2%
B)
12.4%
C)
13.0%
D)
13.6%
Ans:
B
Feedback:
3, 000
2, 000
(0.1)
(0.16) 0.124
5, 000
5, 000

Format: Multiple Choice

Learning Objective: LO 5
Level of Difficulty: Medium
73.Given the returns for two stocks with the following information, calculate the covariance
of the returns for the two stocks. Assume the expected return is 10.8 percent for Stock 1
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and 9.7 percent for Stock 2.

Prob

A)
B)
C)
D)
Ans:

0.4
0.5
0.1
0.000094
0.00051600
0.00032100
0.71750786
A
Feedback:

Stock 1 Stock 2
0.09
0.11
0.17

0.11
0.08
0.13

Cov(R1,R2)
=0.4*(0.09-0.108)*(0.11-0.097)+0.5*(0.11-0.108)*(0.08-0.097)+0.1*(0.17-0.108)*(0.13-0.097)
= 0.000094
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
74.Given the returns for two stocks with the following information, calculate the correlation
coefficient of the returns for the two stocks. Assume the expected return for Stock 1 is
10.8 percent and 9.7 percent for Stock 2.
Prob

A)
B)
C)
D)
Ans:

Stock 1 Stock 2

0.4
0.09
0.11
0.5
0.11
0.08
0.1
0.17
0.13
0.230967
0.00002548
0.00032100
0.17671455
A
Feedback:
From the solution to Problem 73, we find that the covariance between the stocks is
0.000094. We must now solve for the standard deviation of the returns of each individual
stock.

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 12 0.4(0.09 0.108) 2 0.5(0.11 0.108) 2 0.1(0.17 0.108)2 0.000516,

1 0.02271563
22 0.4(0.11 0.097) 2 0.5(0.08 0.097) 2 0.1(0.18 0.097)2 0.000321,
2 0..01791647

Format: Multiple Choice

Learning Objective: LO 5
Level of Difficulty: Medium
75.Given the returns for two stocks with the following information, calculate the covariance
of the returns for the two stocks. Assume the expected return is 14.4 percent for Stock 1
and 15.9 percent for Stock 2.
Prob

A)
B)
C)
D)
Ans:

Stock 1 Stock 2

0.5
0.11
0.18
0.3
0.17
0.15
0.2
0.19
0.12
0.001204001
0.000549003
-0.00079
0.3372012
C
Feedback:
Cov( R1 , R2 ) PState1 ( RState1,1 E ( R1 )( RState1,2 E ( R2 )) PState 2) ( RState 2,1 E ( R1 ))( RState 2,2 E ( R2 ))

PState3 ( RState 3,1 E ( R1 ))( RState 3,2 E ( R2 )) 0.00007192

Cov(R1,R2) = .
(0.5*(0.11-0.144)*(0.18-0.159)+0.3*(0.17-0.144)*(0.15-0.159)+0.2*(0.19-0.144)*(0.12-0.159)
= -0.00079
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
76.Given the returns for two stocks with the following information, calculate the correlation
coefficient of the returns for the two stocks. Assume the expected return is 14.4 percent
for Stock 1 and 15.9 percent for Stock 2.
Prob
Stock 1 Stock 2
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A)
B)
C)
D)
Ans:

0.5
0.11
0.18
0.3
0.17
0.15
0.2
0.19
0.12
0.001204001
0.000549003
0.00271370
-0.971689
D
Feedback:
12 0.5(0.11 0.144) 2 0.3(0.17 0.144) 2 0.2(0.10 0.144)2 0.001204

1 0.03469873
22 0.5(0.18 0.159) 2 0.3(0.15 0.159) 2 0.2(0.12 0.159)2 0.000549,
2 0.02343075
Cov(R1,R2) = -0.00079
so p =
- .00079
= -.971689
(.03469873)(.02343075)

Format: Multiple Choice

Learning Objective: LO 5
Level of Difficulty: Medium
77.The covariance of the returns between Einstein Stock and Bohr Stock is 0.0087. The
standard deviation of Einstein is 0.26, and the standard deviation of Bohr is 0.37. What is
the correlation coefficient between the returns of the two stocks?
A)
0.090437
B)
0.096200
C)
0.90437
D)
0.96200
Ans:
A
Feedback:
Cov( R1 , R2 )
0.0087

0.090437
1 2
(0.26)(0.37)
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
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78.The covariance of the returns between Wildcat Stock and Sun Devil Stock is 0.09875.
The variance of Wildcat is 0.2116, and the variance of Sun Devil is 0.1369. What is the
correlation coefficient between the returns of the two stocks?
A)
0.170200
B)
0.293347
C)
0.340823
D)
0.578731
Ans:
D
Feedback:
Cov( R1 , R2 )
0.09875

0.578731
1 2
(0.2116) 2 (0.1369) 2
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
79.Horse Stock returns have exhibited a standard deviation of 0.57, whereas Mod T Stock
returns have a standard deviation of 0.63. The correlation coefficient between the returns
is 0.078042. What is the covariance of the returns?
A)
0.028025
B)
0.217327
C)
0.359100
D)
0.993094
Ans:
A
Feedback:
Cov( R1 , R2) 12 1 2 (0.078042) X (0.57) X (0.63) 0.028025

Format: Multiple Choice

Learning Objective: LO 4
Level of Difficulty: Hard
80.Batman Stock has exhibited a standard deviation in stock returns of 0.5, whereas
Superman Stock has exhibited a standard deviation of 0.6. The correlation coefficient
between the stock returns is 0.5. What is the variance of a portfolio composed of 70
percent Batman and 30 percent Superman?
A)
0.1549
B)
0.2179
C)
0.4668
D)
0.5500
Ans:
B
Feedback:
Var ( port ) x12 12 x22 22 2 x1 x2 1 2 12

(0.7) 2 (0.5) 2 (0.3) 2 (0.6) 2 2(0.7)(0.3)(0.5)(0.6)(0.5) 0.2179

7-25

Format: Multiple Choice

Learning Objective: LO 4
Level of Difficulty: Hard
81.Aquaman Stock has exhibited a standard deviation in stock returns of 0.7, whereas Green
Lantern Stock has exhibited a standard deviation of 0.8. The correlation coefficient
between the stock returns is 0.1. What is the standard deviation of a portfolio composed
of 70 percent Aquaman and 30 percent Green Lantern?
A)
0.32122
B)
0.54562
C)
0.56676
D)
0.75000
Ans:
C
Feedback:
Var ( port ) x12 12 x22 22 2 x1 x2 1 2 12

(0.7) 2 (0.7) 2 (0.3) 2 (0.8) 2 2(0.7)(0.3)(0.7)(0.8)(0.1) 0.32122

Std ( port ) Sqrt (Var ( port )) Sqrt (0.32122) 0.566763

Format: Multiple Choice

Learning Objective: LO 5
Level of Difficulty: Hard
82.Most of the risk-reduction benefits from diversification can be achieved in a portfolio
consisting of
A)
5 to 10 stocks
B)
10 to 15 stocks
C)
15 to 20 stocks
D)
20 to 25 stocks
Ans:
C
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Hard
83.Which of the following investors should be willing to pay the highest price for an asset?
A)
An investor with a single-asset portfolio.
B)
An investor with a 50-asset portfolio.
C)
An investor who is not completely diversified.
D)
An investor who is so risk-averse that he does not recognize the benefits of
diversification.
Ans:
B
Format: Multiple Choice
Learning Objective: LO 6
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Level of Difficulty: Hard

84.A portfolio with a level of systematic risk the same as that of the market has a beta that is
A)
equal to zero.
B)
equal to one.
C)
less than the beta of the risk-free asset.
D)
less than zero.
Ans:
B
Format: Multiple Choice
Learning Objective: LO 6
Level of Difficulty: Hard
85.The beta of Elsenore, Inc., stock is 1.6, whereas the risk-free rate of return is 8 percent. If
the expected return on the market is 15 percent, then what is the expected return on
Elsenore?
A)
11.20%
B)
19.20%
C)
24.00%
D)
32.00%
Ans:
B
Feedback:
E ( REls ) Rrf Els ( E ( RM ) Rrf ) 0.08 1.6(0.15 0.08) 0.1920

Format: Multiple Choice

Learning Objective: LO 6
Level of Difficulty: Hard
86.The beta of RicciCo.'s stock is 3.2, whereas the risk-free rate of return is 9 percent. If the
expected return on the market is 18 percent, then what is the expected return on
RicciCo.?
A)
28.80%
B)
37.80%
C)
48.60%
D)
57.60%
Ans:
B
Feedback:
E ( RRicci ) Rrf Ricci ( E ( RM ) Rrf ) 0.09 3.2(0.18 0.09) 0.378

Format: Multiple Choice

Learning Objective: LO 6
Level of Difficulty: Hard
87.The risk-free rate of return is currently 3 percent, whereas the market risk premium is 6
percent. If the beta of Lenz, Inc., stock is 1.8, then what is the expected return on Lenz?
A)
8.40%
B)
10.80%
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C)
D)
Ans:

13.80%
19.20%
C
Feedback:
E ( RLenz ) Rrf Lenz ( E ( RM ) Rrf ) 0.09 3.2(0.06) 0.138

Format: Multiple Choice

Learning Objective: LO 6
Level of Difficulty: Hard
88.The expected return on Kiwi Computers stock is 16.6 percent. If the risk-free rate is 4
percent and the expected return on the market is 10 percent, then what is Kiwi's beta?
A)
1.26
B)
2.10
C)
2.80
D)
3.15
Ans:
B
Feedback:
E ( RKiwi ) 0.166 Rrf Kiwi ( E ( RM ) Rrf ) 0.04 Kiwi (0.10 0.04) Kiwi 2.1

Format: Multiple Choice

Learning Objective: LO 6
Level of Difficulty: Hard
89.The expected return on Mike's Seafood stock is 17.9 percent. If the expected return on
the market is 13 percent and the beta for Kiwi is 1.7, then what is the risk-free rate?
A)
4.5%
B)
5.0%
C)
5.5%
D)
6.0%
Ans:
D
Feedback:
E ( RMike ) 0.179 Rrf Mike ( E ( RM ) Rrf ) Rrf 1.7(0.13 Rrf ) Rrf 0.06

Format: Multiple Choice

Learning Objective: LO 6
Level of Difficulty: Hard
90.The expected return on KarolCo. stock is 16.5 percent. If the risk-free rate is 5 percent
and the beta of KarolCo is 2.3, then what is the risk premium on the market?
A)
2.5%
B)
5.0%
C)
7.5%
D)
10.0%
Ans:
B
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Feedback:
E ( RKarole ) 0.165 Rrf Karol ( E ( RM ) Rrf ) 0.05 2.3( Risk Pr emium) Risk Pr emium 0.05

Format: Multiple Choice

Learning Objective: LO 1
Level of Difficulty: Easy
91.Which of the following statements is most correct?
A)
The greater the risk associated with an investment, the lower the return investors
expect from it.
B)
When choosing between two investments that have the same level of risk,
investors prefer the investment with the higher return.
C)
If two investments have the same expected return, investors prefer the riskiest
alternative.
D)
When choosing between two investments that have the same level of risk,
investors prefer the investment with the lower return.
Ans:
B

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
92.Holding Period Return: George Wilson purchased Bright Light Industries common
stock for $47.50 on January 31, 2010. The firm paid dividends of $1.10 during the last
12 months. George sold the stock today (January 30, 2011) for $54.00. What is Georges
holding period return? Round off the nearest 0.01%.
A)
16.00%
B)
14.35%
C)
11.28%
D)
19.60%
Ans:
A
Feedback:

R1

P1 P 0 CF 1 $54.00 $47.50 $1.10

.1600 16.00%
P0
$47.50

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Format: Multiple Choice

Learning Objective: LO 3
Level of Difficulty: Medium
93.Expected Return: Security Analysts that have evaluated Concordia Corporation have
determined that there is a 15% chance that the firm will generate earnings per share of
$2.40; a 60% probability that the firm will generate earnings per share of $3.10; and a
25% probability that the firm will generate earnings per share of $3.80. What are the
expected earnings per share for Concordia Corporation? (Round off to the nearest $0.01)
A)
$3.10
B)
$3.17
C)
$2.75
D)
$2.91
Ans:
B
Feedback:

Probabilit Projected Expected

y
EPS
EPS
15.00%$2.40
$0.36
60.00%
3.10
1.86
25.00%
3.80
0.95
100.00%
$3.17

7-30

Format: Multiple Choice

Learning Objective: LO 4
Level of Difficulty: Medium
94.Standard Deviation: View Point Industries has forecast a rate of return of 20.00% if the
economy booms (25.00% probability); a rate of return of 15.00% if the economy in in a
growth phase (45.00% probability); a rate of return of 2.50% if the economy in in
decline (20.00% probability); and a rate of return of -15.00% if the economy in a
depression (10.00% probability). What is View Points standard deviation of returns?
A)
17.31%
B)
9.25%
C)
15.00%
D)
10.46%
Ans:
D
Feedback:
Standard

Deviation

Probability
Calc. Of Proj. Ret.
State of
of
Projected Expected Minus
Col. E
Economy Occurance Return
Return Exp. Ret. Squared

G
Col. F
times
Col. B

Boom

25.00%

20.00%

5.00%

9.25%

0.856% 0.214%

Growth

45.00%

15.00%

6.75%

4.25%

0.181% 0.081%

Decline

20.00%

2.50%

0.50%

-8.25%

0.681% 0.136%

Depression

10.00%

-15.00%

100.00%

Total

-1.50% -25.75%
10.75%

6.631% 0.663%
Variance

1.09

Standard Deviation 10.46%

Format: Multiple Choice

Learning Objective: LO 7
Level of Difficulty: Medium
95.Which of the following represents a plot of the relation between expected return and
systemic risk?
A)
The beta coefficient.
B)
The covariance of returns line.
C)
The security market line.
D)
The variance.
Ans:
C
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Format: Essay
Learning Objective: LO 6
96.Explain the difference between systematic and nonsystematic risk.
Ans:
Systematic risk is risk that cannot be diversified away and describes the risk that is
inherent in the general economic world of investing. Nonsystematic risk is risk that
can be diversified away and describes risk that is unique to a particular investment.
Format: Essay
Learning Objective: LO 5
97.If you were to regress the historical returns of a stock on the historical return of a general
market index, you would plot the line of best fit through those data points. The slope of
that line represents the beta of the stock in question. However, in most instances the date
points do not lie exactly on that line. Describe why.
Ans:
The slope of the line of best fit describes the beta of the stock in question that is
capturing the systematic risk inherent in investing in that stock. The vertical
distance between each point and the line represents the nonsystematic, or
diversifiable, risk in investing in the stock.

7-32