# FINANCE

hapter 6

8) Stock A has the following returns for various states of the economy:
State of
the Economy               Probability       Stock A’s Return
Recession                    10%                 -30%
Below Average            20%                 -2%
Average                       40%                 10%
Above Average           20%                 18%
Boom                           10%                 40%
Stock A’s expected return is
A) 5.4%.
B) 7.2%.
C) 8.2%.
D) 9.6%

9) You are considering a sales job that pays you on a commission basis or a salaried position that pays you \$50,000 per year. Historical data suggests the following probability distribution for your commission income. Which job has the higher expected income?
Probability of
Commission     Occurrence
\$15,000                       .15
\$35,000                       .20
\$48,000                       .35
\$67,000                       .22
\$80,000                       .18
A) The salary of \$50,000 is greater than the expected commission of \$49,630.
B) The salary of \$50,000 is greater than the expected commission of \$48,400.
C) The salary of \$50,000 is less than the expected commission of \$50,050.
D) The salary of \$50,000 is less than the expected commission of \$52,720.

10) Stock W has an expected return of 12% with a standard deviation of 8%. If returns are normally distributed, then approximately two-thirds of the time the return on stock W will be
A) between 12% and 20%.
B) between 8% and 12%.
C) between -4% and 28%.
D) between 4% and 20%.

11) Which of the following investments is clearly preferred to the others for an investor who is not holding a well-diversified portfolio?
Investment
A         18%     20%
B          20%     20%
C          20%     22%
A) Investment A
B) Investment B
C) Investment C
D) Cannot be determined without information regarding the risk-free rate of return.

12) Assume that you have \$330,000 invested in a stock that is returning 11.50%, \$170,000 invested in a stock that is returning 22.75%, and \$470,000 invested in a stock that is returning 10.25%. What is the expected return of your portfolio?
A) 15.6%
B) 14.9%
C) 18.3%
D) 12.9%

13) Assume that you have \$100,000 invested in a stock that is returning 14%, \$150,000 invested in a stock that is returning 18%, and \$200,000 invested in a stock that is returning 15%. What is the expected return of your portfolio?
A) 15.78%
B) 14.97%
C) 15.67%
D) 12.24%

14) Investment A has an expected return of 15% per year, while investment B has an expected return of 12% per year. A rational investor will choose
A) investment A because of the higher expected return.
B) investment B because a lower return means lower risk.
C) investment A if A and B are of equal risk.
D) investment A only if the standard deviation of returns for A is higher than the standard deviation of returns for B.

15) Investment A has an expected return of 14% with a standard deviation of 4%, while investment B has an expected return of 20% with a standard deviation of 9%. Therefore
A) a risk averse investor will definitely select investment A because the standard deviation is lower.
B) a rational investor will pick investment B because the return adjusted for risk (20% – 9%) is higher than the return adjusted for risk for investment A (\$14% – 4%).
C) it is irrational for a risk-averse investor to select investment B because its standard deviation is more than twice as big as investment A’s, but the return is not twice as big.
D) rational investors could pick either A or B, depending on their level of risk aversion.

16) The minimum rate of return necessary to attract an investor to purchase or hold a security is referred to as the
A) stock’s beta.
B) investor’s risk premium.
C) risk-free rate.
D) investor’s required rate of return.

17) Which of the following statements is MOST correct concerning diversification and risk?
A) Risk-averse investors often choose companies from different industries for their portfolios because the correlation of returns is less than if all the companies came from the same industry.
B) Risk-averse investors often select portfolios that include only companies from the same industry group because the familiarity reduces the risk.
C) Only wealthy investors can diversify their portfolios because a portfolio must contain at least 50 stocks to gain the benefits of diversification.
D) Proper diversification generally results in the elimination of risk.

18) Most stocks have betas between
A) -1.00 and 1.00.
B) 0.00 and 1.00.
C) 0.60 and 1.60.
D) 1.00 and 2.00.

19) Which of the following measures the average relationship between a stock’s returns and the market’s returns?
A) beta coefficient
B) standard deviation
C) geometric regression
D) coefficient of validation

20) An investor currently holds the following portfolio:
Amount
Invested
4,000 shares of Stock H                      \$8,000             Beta = 1.3
7,500 shares of Stock I                        \$24,000                       Beta = 1.8
12,500 shares of Stock J                      \$48,000                       Beta = 2.2
The beta for the portfolio is
A) 1.77.
B) 1.99.
C) 1.88.
D) 1.45.

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