CHAPTER 1THE INVESTMENT SETTING

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CHAPTER 1—THE INVESTMENT SETTING

TRUE/FALSE

1.The rate of exchange between certain future dollars and certain current dollars is known as the pure rate of interest.

ANS: T PTS: 1

2.An investment is the current commitment of dollars over time to derive future payments to compensate the investor for the time funds are committed, the expected rate of inflation and the uncertainty of future payments.

ANS: T PTS: 1

3.The holding period return (HPR) is equal to the holding period yield (HPY) stated as a percentage.

ANS: F PTS: 1

4.The geometric mean of a series of returns is always larger than the arithmetic mean and the difference increases with the volatility of the series.

ANS: F PTS: 1

5.The expected return is the average of all possible returns.

ANS: F PTS: 1

6.Two measures of the risk premium are the standard deviation and the variance.

ANS: F PTS: 1

7.The variance of expected returns is equal to the square root of the expected returns.

ANS: F PTS: 1

8.The coefficient of variation is the expected return divided by the standard deviation of the expected return.

ANS: F PTS: 1

9.Nominal rates are averages of all possible real rates.

ANS: F PTS: 1

10.The risk premium is a function of the volatility of operating earnings, sales volatility and inflation.

ANS: F PTS: 1

Investment Analysis and Portfolio Management (International Edition) 9e By Frank Reilly Keith Brown (Test Bank All Chapters, 100% Original Verified, A+ Grade) 1 / 4

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11.An individual who selects the investment that offers greater certainty when everything else is the same is known as a risk averse investor.

ANS: T PTS: 1

12.Investors are willing to forgo current consumption in order to increase future consumption for a nominal rate of interest.

ANS: F PTS: 1

MULTIPLE CHOICE

1.The basic trade-off in the investment process is a.between the anticipated rate of return for a given investment instrument and its degree of risk.b.between understanding the nature of a particular investment and having the opportunity to purchase it.c.between high returns available on single instruments and the diversification of instruments into a portfolio.d.between the desired level of investment and possessing the resources necessary to carry it out.e.None of the above.

ANS: A PTS: 1

2.The rate of exchange between future consumption and current consumption is a.The nominal risk-free rate.b.The coefficient of investment exchange.c.The pure rate of interest.d.The consumption/investment paradigm.e.The expected rate of return.

ANS: C PTS: 1

3.The ____ the variance of returns, everything else remaining constant, the ____ the dispersion of expectations and the ____ the risk.a.Larger, greater, lower b.Larger, smaller, higher c.Larger, greater, higher d.Smaller, greater, lower e.Smaller, greater, greater

ANS: C PTS: 1

4.The coefficient of variation is a measure of a.Central tendency.b.Absolute variability.c.Absolute dispersion.d.Relative variability.e.Relative return.

ANS: D PTS: 1 2 / 4

This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be resold, copied, or distributed without the prior consent of the publisher.

• The nominal risk free rate of interest is a function of
• The real risk free rate and the investment's variance.
• The prime rate and the rate of inflation.
• The T-bill rate plus the inflation rate.
• The tax free rate plus the rate of inflation.
• The real risk free rate and the rate of inflation.

ANS: E PTS: 1

• In the phrase "nominal risk free rate," nominal means
• Computed.
• Historical.
• Market.
• Average.
• Risk adverse.

ANS: C PTS: 1

• If a significant change is noted in the yield of a T-bill, the change is most likely attributable to
• A downturn in the economy.
• A static economy.
• A change in the expected rate of inflation.
• A change in the real rate of interest.
• A change in risk aversion.

ANS: C PTS: 1

8. The real risk-free rate is affected by a two factors:

• The relative ease or tightness in capital markets and the expected rate of inflation.
• The expected rate of inflation and the set of investment opportunities available in the

economy.

• The relative ease or tightness in capital markets and the set of investment opportunities

available in the economy.

• Time preference for income consumption and the relative ease or tightness in capital

markets.

• Time preference for income consumption and the set of investment opportunities available

in the economy.

ANS: E PTS: 1

• Which of the following is not a component of the risk premium?
• Business risk
• Financial risk
• Liquidity risk
• Exchange rate risk
• Unsystematic market risk

ANS: E PTS: 1

• The ability to sell an asset quickly at a fair price is associated with
• Business risk.
• Liquidity risk. 3 / 4

This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be resold, copied, or distributed without the prior consent of the publisher.

• Exchange rate risk.
• Financial risk.
• Market risk.

ANS: B PTS: 1

• The variability of operating earnings is associated with
• Business risk.
• Liquidity risk.
• Exchange rate risk.
• Financial risk.
• Market risk.

ANS: A PTS: 1

• The uncertainty of investment returns associated with how a firm finances its investments is known as
• Business risk.
• Liquidity risk.
• Exchange rate risk.
• Financial risk.
• Market risk.

ANS: D PTS: 1

• What will happen to the security market line (SML) if the following events occur, other things

constant: (1) inflation expectations increase, and (2) investors become more risk averse?

• Shift up and keep the same slope
• Shift up and have less slope
• Shift up and have a steeper slope
• Shift down and keep the same slope
• Shift down and have less slope

ANS: C PTS: 1

• A decrease in the market risk premium, all other things constant, will cause the security market line to
• Shift up
• Shift down
• Have a steeper slope
• Have a flatter slope
• Remain unchanged

ANS: D PTS: 1

• A decrease in the expected real growth in the economy, all other things constant, will cause the

security market line to

• Shift up
• Shift down
• Have a steeper slope
• Have a flatter slope
• Remain unchanged

ANS: B PTS: 1

• Unsystematic risk refers to risk that is
• / 4