# 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.