Study Unit 4 Risk and Returns Exam Questions

  1. Risk may be defined as the:

1.  Chance of a financial gain or loss

2.  Variability of operating expenses

3.  Inability of a firm to generate a profit

4.  All of the above

  1. The ____ is the extent of an asset’s risk. It is found by subtracting the pessimistic outcome from the optimistic outcome

1.  Return

2.  Standard deviation

3.  Probability distribution

4.  Range

  1. How many of the statements below are correct given the following information: (Nov 2006)

Investment B / Investment C
Initial investment / R5000 000 / R5000 000
Annual rate of return:
Pessimistic / 10% / 11%
Most likely / 12% / 14%
Optimistic / 16% / 18%

a)  The range for investment B is 13%

b)  The range for investment C is 7%

c)  The risk-averse manager will prefer investment C

d)  According to sensitivity analysis investment C is preferable

1.  None

2.  One

3.  Two

4.  Three

  1. The _____the coefficient of variation, the ______the risk

1.  More stable, higher

2.  Higher, lower

3.  Lower, higher

4.  Lower, lower

  1. Unsystematic risk is the (Nov 2005)

1.  Portion of an asset’s risk that is attributable to firm-specific events

2.  Total risk associated with an asset

3.  Portion of an asset’s risk that is attributable to market factors that affect all firms

4.  Portion of an asset’s risk that is attributable to political risks

  1. If AT Ltd’s beta coefficient is 1.5, which one of the following statements is true? (Nov 2005, Nov 2006, Nov 2010)

1.  For each increase in the market’s rate of return, the corresponding increase in the firm’s rate of return is higher.

2.  The risk-free rate of return is higher than the market’s rate of return

3.  The firm’s systematic risk is zero

4.  The firm has a low risk classification

  1. Which of the following statements is false?

1. The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk.

2. When we combine many stocks in a large portfolio, the firm-specific risks for each stock will average out and be diversified.

3. Fluctuations of a stock’s returns that are due to firm-specific news are common risks.

4. The volatility in a large portfolio will decline until only the systematic risk remains.

  1. A beta coefficient of -1 represents an asset that

1.  Is unaffected by the market movement

2.  Is less responsive than the market portfolio

3.  Is more responsive than the market portfolio

4.  Has the same response as the market portfolio but in the opposite direction

  1. Which of the following statements are correct? (Nov 2005)

a.  Total risk is a combination of an asset’s non-diversifiable and diversifiable risk

b.  Diversifiable risk is also known as a systematic risk

c.  Non-diversifiable risk cannot be eliminated through diversification

d.  The beta coefficient (β) is a measure of diversifiable risk

1.  Ac

2.  Ad

3.  Abc

4.  Abd

  1. Combining two assets having perfectly negatively correlated returns will result in a portfolio with an overall risk that

1.  Remains unchanged

2.  Increases to the level above that of either asset

3.  Decreases to a level below that of either asset

4.  Stabilises to a level between the asset with the higher risk and the asset with the lower risk

  1. Combining negatively correlated assets having the same expected return results in a portfolio with _____ level of expected return and _____ level of risk

1.  The same, lower

2.  The same, higher

3.  A higher, a lower

4.  A lower, a higher

  1. You have developed the following data on three shares (May 2009, June 2010, Oct 2010)

Share / Standard deviation / Beta
A / 0,20 / 0,79
B / 0,25 / 0,61
C / 0,15 / 1,29

If you are a risk minimiser, you should choose share ___ if it is held in isolation, and share ___ if it will be held as part of a well-diversified portfolio.

1.  A, A

2.  A, B

3.  C, A

4.  C, B

  1. What would rational investors do if expected return is less than the required rate of return?

1. Buy the asset, which would drive the price up and cause expected return to reach the level of the required return.

2. Sell the asset, which would drive the price down and cause the expected return to reach the level of the required return.

3. Sell the asset, which would drive the price up and cause the expected return to reach the level of the required return.

4. Buy the asset since price is expected to increase and hence surpass the required return.

  1. Risk aversion is the behaviour exhibited by managers who require a greater than proportional… (Nov 2005) (Nov 2006)

1.  Increase in return for a given decrease in risk

2.  Increase in return for a given increase in risk

3.  Decrease in return for a given increase in risk

4.  Decrease in return for a given decrease in risk

  1. In the capital asset pricing model, the beta coefficient is the measure of ____ risk and an index of the degree of movement of an asset’s return in response to a change in

1.  Non-diversifiable risk, the treasury bill rate

2.  Diversifiable, the bond index rate

3.  Diversifiable, the prime rate

4.  Non-diversifiable, the market return

  1. One major risk a firm assumes with an aggressive financing strategy is (Nov 2005)

1.  The possibility that collections will be slower than expected

2.  The possibility that long-term funds may not be available when needed

3.  The possibility that short-term funds may not be available when needed

4.  The possibility that it will run out of cash.

17.  In the valuation process, the… is used to incorporate risk in the analysis

1.  Standard deviation

2.  Coefficient of variation (CV)

3.  Discount rate

4.  Interest rate

  1. If a financial manager’s required rate of return increases for an increase in risk, then he or she is a …

1.  Risk-taking manager.

2.  Risk-indifferent manager.

3.  Risk-averse manager.

4.  Risk-control manager.

  1. Given the following expected returns and standard deviations of assets B, M, Q and D, which asset should the prudent financial manager select? (Nov 2005)

Asset / Expected Return / Standard Deviation
B / 10% / 5%
M / 16% / 10%
Q / 14% / 9%
D / 12% / 8%

1.  Asset B

2.  Asset M

3.  Asset Q

4.  Asset D

  1. Which asset would the risk-averse financial manager prefer from the following set? (Nov 2005) (Nov 2006)

Asset / A / B / C / D
Initial investment / R15 000 / R15 000 / R15 000 / R15 000

Annual Rate of Return

Pessimistic / 8% / 5% / 3% / 11%
Most likely / 12% / 12% / 12% / 12%
Optimistic / 14% / 13% / 15% / 14%

1.  Asset A

2.  Asset B

3.  Asset C

4.  Asset D

21.  Edcon Ltd has invested in an asset. The required rate of return is 15% and the expected return (k) is 16%. Risk estimates indicate that the standard deviation is 18%. The coefficient of variation (CV) of the asset is closest to: (Nov 2006)

1.  0.89

2.  1.13

3.  1.20

4.  2.00

  1. Nsukuzonke Ltd has invested in an asset. The expected return (k) is 18%. Risk estimates indicate that the standard deviation is 21%. The coefficient of variation, (CV) of the asset is closest to…

(1) 0,85.

(2) 1,17.

(3) 1,50.

(4) 3,00.

  1. The returns of Ikhwezi Corporation’s shares have a standard deviation (σ) of 1.8% and a coefficient of variation (CV) of 0.09. The risk-free rate of return (Rf) is 12%. The beta of the share is 1.6% and the market rate of return (km ) is 17%. The required rate of return (kj) is closest to ….

(1) 13,5%.

(2) 15,2%.

(3) 19,2%.

(4) 20,0%.

  1. Investec is considering investing in Spur shares. The risk-free rate of return (Rf) is 14%. The beta of the share is 0.8% and the market rate of return (km ) is 20%. The required rate of return (kj) is closest to …

(1) 14,0%.

(2) 15,2%.

(3) 16,0%.

(4) 18,8%.

  1. Asset B has a beta of 0,9. The risk-free rate of return is 8 percent, while the return on the market portfolio of assets is 14 percent. The asset’s required rate of return is… (Nov 2005, May 2009, Nov 2009)

1.  5,4%

2.  6,0%

3.  10,0%

4.  13,4%

  1. Asset B has a beta of 0,5. The risk-free rate of return is 8 percent, while the return on the market portfolio of assets is 14 %. The asset’s required rate of return is… (Nov 2010)

1.  5,4%

2.  6,0%

3.  10,0%

4.  13,4%

  1. An asset Y has a beta of 1,2. The risk-free rate of return is 6 percent, while the return on the market portfolio of assets is 12 percent. The asset’s market risk premium is

1.  6,0%

2.  7,2%

3.  10,0%

4.  13,2%

  1. Ordinary shares in Ikageng Ltd is priced so that it provides a return of 14% per annum, if the share’s beta is 0,85 and the expected market return is 15% per annum, what is the risk-free rate? (Nov 2005) (Nov 2006)

1.  8,33%

2.  8,75%

3.  9,23%

4.  9,99%

  1. Asset G has an expected return of 22% and a beta of 1,8. The expected market return is 14%. What is the risk-free rate?

1. 1,2%

2. 3,0%

3. 4,0%

4. 6,0%

  1. What is the expected market return if the expected return on asset X is 20 percent, its beta is 1,5 and the risk free rate is 5 percent? (May 2010)

1.  11,00%

2.  15,00%

3.  20,00%

4.  22,50%

  1. An asset A was purchased six months ago for R25000 and has generated R1500 cash flow during this period. What is the asset’s annual rate of return if it can be sold for R26750 today?

1.  13%

2.  14%

3.  26%

4.  30%

  1. A tank container (purchased a year ago for R120 000) currently has a market value of R145 000. During the year it generated R4 800 in after-tax cash receipts. What is the container’s rate of return?

(1) 4,0%

(2) 13,9%

(3) 16,8%

(4) 24,8%

  1. Suppose you invested R60 in the shares of ABC company. It paid a dividend of R0,70 today and then you sold it for R65. What is your holding period return (HPR)?

1. 8,25%

2. 9,00%

3. 9,50%

4. 9,75%

  1. What is the expected rate of return if the following probabilities and associated rates of return exist?

Pt / Rate of return
0,25 / 20%
0,50 / 15%
0,25 / 10%

1.  6,00%

2.  11,25%

3.  13,50%

4.  15,00%

  1. Determine the expected rate of return if the following probabilities (Pt) and associated rates of return exist: (Nov 2005) (Nov 2006)

Pt / Rate of return
.20 / 10.00%
.50 / 12.00%
.30 / 16.00%

1.  12.00%

2.  12.80%

3.  13.66%

4.  14.46%

  1. Use the following information to calculate the expected annual rate of return. (Nov 2005)

Probability of occurrence / Rate of return
20% / 14%
70% / 16%
10% / 25%

1.  13.5%

2.  13.9%

3.  14.4%

4.  16.5%

37.  Calculate the standard deviation of the expected rand returns for Sherino Copier Centre given the following distribution of returns.

Probability / Return
0,2 / R50
0,5 / R20
0,3 / -R15

1.  R13

2.  R18

3.  R23

4.  R36

38.  Calculate the standard deviation (Ơ) for the returns of the following asset (Nov 2005) (Nov 2006)

Pt / Rate of return
.40 / 25%
.50 / 10%
.10 / -10%

1.  10.67%

2.  12.78%

3.  15.00%

4.  25.15%

  1. What is the standard deviation(s) for the returns of an asset as depicted below?

Pt / Return
0.40 / 35%
0.30 / 10%
0.30 / - 20%

(1) 21,66%

(2) 22,78%

(3) 25,00%

(4) 34,20%

  1. Consider an economy with two types of firms, A and B. A firms always move together, but B firms move independently of each other. For both types of firms there is a 70% probability that the firm will have a 20% return and a 30% probability that the firm will have a -30% return.

What is the standard deviation for the return of an individual firm?

1. 5,25%

2. 10,00%

3. 15,00%

4. 23,00%

  1. An investment analyst has recommended a R50000 portfolio containing assets R, J and K R25000 will be invested in asset R, with an expected annual return of 12 percent, R10000 will be invested in asset J with an expected return of 18 percent and R15000 will be invested in asset K, with an expected annual return of 8 percent. The expected annual return of this portfolio is

1.  10,00%

2.  12,00%

3.  12,67%

4.  13,00%

  1. Vusi owns 100 shares of stock X which has a price of R12 per share and 200 shares of stock Y which has a price of R3 per share. What is the proportion of Vusi’s portfolio invested in stock X?

1. 33%

2. 50%

3. 67%

4. 77%

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