CHAPTER 10

        1.        Coming out of the depression, small stocks earned their highest one year historical return of 143% in 1933. However, in the four years prior to that you would have lost (going from 1929 to 1932, in order) about 50%, 40%, 50%, and 5%. Suppose you started into this five year stretch with $10,000 invested. How much did you still have heading into 1933? How much would you have at the end of that year? Based on these numbers, do you think the 143% return should be included in the return series?

        2.     Rank the historical volatility of the following portfolios in descending order: small stocks, Treasury bills, long-term government bonds, and common stocks.

        A)        Common stocks, long-term government bonds, small stocks, and Treasury bills

        B)        Treasury bills, small stocks, long-term government bonds, and common stocks

        C)        Small stocks, common stocks, long-term government bonds, and Treasury bills

        D)        Long-term government bonds, small stocks, common stocks, and Treasury bills

        E)        Small stocks, long-term government bonds, common stocks, and Treasury bills

        3.        Which of the following is accurate regarding market efficiency?

        A)    In an efficient market, prices adjust quickly and correctly to new information

        B)        Asset prices in an efficient market are usually too high or too low

        C)        When stock prices move in an overreaction and correction pattern as a result of the release of new information, the market for this stock is efficient

        D)    A market is weak form efficient if all information of every kind is reflected in stock prices

        E)     You cannot make money by trading on inside information in a market that is semistrong form efficient

        4.     You purchased a bond for $900 one year ago. Today, you receive your only interest payment for the year of $100. The bond could be sold for $975 today. Your percentage return on your investment is ____________. (Ignore taxes)

        A)        8.3%

        B)        11.1%

        C)        18.0%

        D)        19.4%

        E)        23.8%

        5.     The excess return required from an investment in a risky asset over a risk-free investment is called the _________.

        A)        risk-free rate of interest

        B)        market rate of interest

        C)    risk premium

        D)    real rate of interest

        E)        holding-period return

        6.     The dividend yield for stocks is similar in principle to the current yield for bonds.

        A)    True

        B)    False

        7.     You purchased 200 shares of preferred stock on January 1 for $42.27 per share. The stock pays an annual dividend of $5 per share. On December 31, the market price is $43.88 per share. What is your percentage return for the year if you hold on to the stock?

        A)        4.9%

        B)        8.0%

        C)        14.9%

        D)        15.1%

        E)        15.6%

        8.     On the basis of historical data from the 1926-97 period, the return on the average common stock has fluctuated less than the return on the average stock of small firms.

        A)    True

        B)    False

Use the following to answer question 9:

Asset        Average Return        Standard Deviation

Large-company stocks        13.0%        20.3%

Small-company stocks        17.7%        33.9%

Long-term government bonds        5.6%        9.2%

U.S. Treasury bills  3.8%        3.2%

        9.        What is the historical risk premium large-company stocks earn over long-term government bonds?

        A)    0%

        B)        1.6%

        C)        2.3%

        D)        7.4%

        E)        9.2%

        10.   Last year you purchased 100 shares of Marvel Entertainment stock for $12 per share. According to today's Wall Street Journal, the stock is currently selling for $18 per share. The stock pays no dividends. Your return on this investment is comprised of ____________.

        A)    an income component only

        B)    an income component and a capital gains component

        C)    a real return only

        D)    a capital gains component only

        E)     a dividend yield only

        11.        Given the following historical returns, what is the variance? Year 1 = 8%; year 2 = -12%; year 3 = 6%; year 4 = 1%; and year 5 = -19%.

        A)        .0063

        B)        .0089

        C)        .0139

        D)        .0394

        E)        .1178

        12.        Which of the following investments have grown faster than the rate of inflation over the period 1926-97?

                I. Common stocks

                II. Treasury bills

                III. Long-term government bonds

                IV. Small stocks

        A)    I and III only

        B)    I, II, and IV

        C)    III and IV only

        D)    I and II only

        E)     I, II, III, and IV

        13.        Which of the following two stocks is more volatile based on their historical returns?

                        Year         Stock A Return        Stock B Return

                        1      .04        .08

                        2      .06        .09

                        3      .08        .10

                        4      .10        .11

                        5      .12        .12

        A)    A because it has a lower mean

        B)    B because it has a higher mean

        C)    A because it has a higher standard deviation

        D)    B because it has a lower standard deviation

        E)     B because it has a higher variance

Use the following to answer questions 14-15:

Suppose you purchase 100 shares of common stock at a price of $45 per share. One period later, the shares are selling for $47 per share. In addition, a dividend of $4 per share is paid at the end of the period.

        14.        What is the capital gains yield?

        A)        4.4%

        B)        5.5%

        C)        8.5%

        D)        8.9%

        E)        13.3%

        15.        What is the total dollar return from the investment?

        A)    $400

        B)    $500

        C)    $600

        D)    $800

        E)        $1,200

        16.   The lessons from capital market history tell us:

                I. There is a reward for bearing risk

                II. The greater the potential reward from a risky asset, the greater is the risk

                III. The NYSE stock exchange is an inefficient market

        A)    I only

        B)    II only

        C)    I and II only

        D)    I and III only

        E)     I, II, and III

        17.        Which asset below is generally considered to represent the risk-free return?

        A)        Common stocks

        B)        Treasury bills

        C)        Small stocks

        D)        Long-term government bonds

        E)        Long-term corporate bonds

        18.   Over the 1926-97 period, the nominal risk premium on small stocks has averaged ______ percent per year.

        A)    0.0

        B)    1.6

        C)    2.3

        D)    9.2

        E)     13.9

        19.        Which of the following is implied by the evidence regarding market efficiency?

        A)        Prices in well organized capital markets are unfair

        B)        There is a simple way to identify mispriced stocks if they do exist

        C)        Prices don't respond rapidly to new information

        D)    It is difficult to predict future price movements based on public information

        E)        Insiders cannot make money from their private information

        20.   On the basis of historical data from the 1926-97 period, the return on the average Treasury bill has fluctuated more than the return on the average long-term government bond.

        A)    True

        B)    False

Answer Key

        1.     This question gives students the chance to convert returns into values and to see the impact of several years' losses on invested wealth. If you began with $10,000, your investment declines (year-by-year) to $5,000, $3,000, $1,500, and $1,425. So, you begin 1933 with only $1,425 left. At the end of that year, you have $3,463, a far cry from your starting point of $10,000. The astute student will point out that by the time the 143% return rolls around, the value of the investment has declined so much that the large single return is due in part to the low amount of funds invested at the start of that year. Nonetheless, the return should be included in the series. In fact, this period of time significantly reinforces the lessons we draw from this series of returns.

        2.     C    

        3.     A    

        4.     D    

        5.     C    

        6.     A    

        7.     E     

        8.     A    

        9.     D    

        10.   D    

        11.   C    

        12.   E     

        13.   C    

        14.   A    

        15.   C    

        16.   C    

        17.   B     

        18.   E     

        19.   D