Question

1A) The XYZ Stock has an expected return of 12% and a standard deviation of 8%. Assuming that returns are adequately explained by a normal distribution, what is the range of return you would expect to see 95% of the time?

	a.	-12% to 36%
	b.	0% to 16%
	c.	4% to 20%
	d.	-4% to 28%

1B) Which of the following statements correctly explains the coefficient of variation (CV)?

(1) The CV is a relative measure of risk/return.

(2) The CV is an absolute measure of risk/return.

(3) The higher the CV value the more acceptable the risk/return profile for a risk-averse investor.

(4) The lower the CV value the more acceptable the risk/return profile for a risk-averse investor.

	a.	1 and 3
	b.	2 and 3
	c.	2 and 4
	d.	1 and 4

1C) The common stock of Finn Ice Cream Company has a beta 1.2. The market premium is 6% and the risk-free rate is 4%. What is the required rate of return on this stock (using the CAPM)?

	a.	12.0%
	b.	11.2%
	c.	10.0%
	d.	6.4%

1D) What type of risk might be contained in a 20-year U.S. treasury bond?

(1)  Marketability risk

(2)  Reinvestment risk

(3)  Purchasing-power (inflation) risk

(4)  Default risk

	a.	2 only
	b.	2, 3, and 4
	c.	2 and 3
	d.	1 and 2

Answer 1

1. Answer is D

For a normal distribution, a 95% confidence interval is defined by the mean +/- 2 standard deviations.

Mean = expected return = 12%

Standard Deviation = 8%

SO mean - 2 standard deviations = 12 - (2 * 8) = -4

and

mean + 2 standard deviations = 12 + (2 * 8) = 28

Range = -4% to 28%

2. Answer is D

Cofficient of Variation actually determines the dispersion of data around its mean. In other words, it defines the volatility of an investment Higher the CV value, higher the volatility and higher the risk

3. Answer is B

Beta = 1.2

Risk free rate ( Rf ) = 4%

Market risk premium (Rm - Rf) = 6%

Required rate of return from CAPM formula = Rf + Beta*(Rm-Rf)

So Required rate of return = 4 + 1.2 * 6 = 11.2%

4. Answer is C

Treasury bond are safe investments as they are backed by Govt. So they do not have Default Risk

Also, these bonds are relatively liquid and sometimes also traded on exchange. So can be easily bought and sold. So these bond do not have Marketability risk also