Investments Analysis Chapters 5 Flashcards Quizlet PDF

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18/03/2021

Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Terms in this set (59) 1. The Fisher equation tells us

that the nominal rate will equal the equilibrium

that the real interest rate

real rate plus the expected inflation rate.

approximately equals the nominal rate minus the inflation rate. Suppose the inflation rate increases from 3% to 5%. Does the Fisher equation imply that this increase will result in a fall in the real rate of interest? Explain. The Fisher equation predicts ____

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18/03/2021

Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

1. The Fisher equation tells us that the real interest rate approximately equals the nominal rate minus the inflation rate. Suppose the inflation rate increases from 3% to 5%. Does the Fisher equation imply that this increase will result in a fall in

2%

the real rate of interest? Explain. Hence, if the inflation rate increases from 3% to 5% while there is no change in the real rate, then the nominal rate will increase by ____%.

1. The Fisher equation tells us

a change in the real rate of interest.

that the real interest rate approximately equals the nominal rate minus the inflation rate. Suppose the inflation rate increases from 3% to 5%. Does the Fisher equation imply that this increase will result in a fall in the real rate of interest? Explain. On the other hand, it is possible that an increase in the expected inflation rate would be accompanied by ____

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18/03/2021

Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

1. The Fisher equation tells us that the real interest rate approximately equals the nominal rate minus the inflation rate. Suppose the inflation rate increases from 3% to 5%. Does the Fisher equation imply that this increase will result in a fall in the real rate of interest? Explain. While it is conceivable that the nominal interest rate could remain constant as the inflation rate increased, implying that the real rate decreased as inflation increased, this is ____

not a likely scenario

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18/03/2021

Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

2. You've just stumbled on a new dataset that enables you to compute historical rates of return on U.S. stocks all the way back to 1880. What are the advantages and disadvantages in using these data to help estimate the expected rate of return on U.S. stocks over the coming year? If we assume that the distribution of returns remains reasonably stable over the entire history, then _____ increases the precision of the estimate of the expected rate of return; this is a consequence of the fact that the standard error decreases as the sample size increases

a longer sample period (i.e., a larger sample)

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18/03/2021

Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

2. You've just stumbled on a new dataset that enables you

expected return

to compute historical rates of return on U.S. stocks all the way back to 1880. What are the advantages and disadvantages in using these data to help estimate the expected rate of return on U.S. stocks over the coming year? However, if we assume that the mean of the distribution of returns is changing over time but we are not in a position to determine the nature of this change, then the _____ must be estimated from a more recent part of the historical period.

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

2. You've just stumbled on a new dataset that enables you to compute historical rates of return on U.S. stocks all the way back to 1880. What are the advantages and disadvantages in using these data to help estimate the expected rate of return on U.S. stocks over the coming year? In this scenario, we must

the entire data set back to 1880.

determine how far back, historically, to go in selecting the relevant sample. Here, it is likely to be disadvantageous to use ____

3. The Narnian stock market

1 + rREAL = 1 + rNominal / 1 + i = 1 + .45 / 1 + .30 =

had a rate of return of 45%

1.1154 ---> 11.54%

last year, but the inflation rate was 30%. What was the real rate of return to Narnian investors?

5. Use Figure 5.1 in the text to

If businesses reduce their capital spending, then

analyze the effect of the

they are likely to decrease their demand for funds.

following on the level of real

This will shift the demand curve in Figure 5.1 to the

interest rates:

left and reduce the equilibrium real rate of interest.

a. Businesses become more pessimistic about future demand for their products and decide to reduce their capital spending.

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

5. Use Figure 5.1 in the text to

Increased household saving will shift the supply

analyze the effect of the

of funds curve to the right and cause real interest

following on the level of real

rates to fall.

interest rates: b. Households are induced to save more because of increased uncertainty about their future Social Security benefits.

5. Use Figure 5.1 in the text to

Open market purchases of U.S. Treasury securities

analyze the effect of the

by the Federal Reserve Board are equivalent to an

following on the level of real

increase in the supply of funds (a shift of the

interest rates:

supply curve to the right). The FED buys treasuries with cash from its own account or it issues

c. The Federal Reserve Board

certificates which trade like cash. As a result, there

undertakes open-market

is an increase in the money supply, and the

purchases of U.S. Treasury

equilibrium real rate of interest will fall.

securities in order to increase the supply of money

6. You are considering the

it guarantees the purchasing power of the

choice between investing

investment.

$50,000 in a conventional 1year bank CD offering an interest rate of 5% and a 1year "Inflation-Plus" CD offering 1.5% per year plus the rate of inflation. a. Which is the safer investment? The "Inflation-Plus" CD is the safer investment because ____

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

6. You are considering the

real rate of 1.5%

choice between investing $50,000 in a conventional 1year bank CD offering an interest rate of 5% and a 1year "Inflation-Plus" CD offering 1.5% per year plus the rate of inflation. a. Which is the safer investment? Using the approximation that the real rate equals the nominal rate minus the inflation rate, the CD provides a _____ regardless of the inflation rate.

6. You are considering the choice between investing $50,000 in a conventional 1year bank CD offering an interest rate of 5% and a 1year "Inflation-Plus" CD offering 1.5% per year plus the rate of inflation. b. Can you tell which offers the higher expected return? The expected return depends on the ____

expected rate of inflation over the next year.

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

6. You are considering the

the conventional CD offers a higher real return

choice between investing

than the inflation-plus CD

$50,000 in a conventional 1year bank CD offering an interest rate of 5% and a 1year "Inflation-Plus" CD

offering 1.5% per year plus the rate of inflation. b. Can you tell which offers the higher expected return? If the expected rate of inflation is less than 3.5% then ____

6. You are considering the

the opposite is true.

choice between investing $50,000 in a conventional 1year bank CD offering an interest rate of 5% and a 1year "Inflation-Plus" CD offering 1.5% per year plus the rate of inflation. b. Can you tell which offers the higher expected return? if the expected rate of inflation is greater than 3.5%, then ____

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

6. You are considering the choice between investing $50,000 in a conventional 1year bank CD offering an interest rate of 5% and a 1year "Inflation-Plus" CD offering 1.5% per year plus the rate of inflation. c. If you expect the rate of inflation to be 3% over the next year, which is the better investment? Why? If you expect the rate of inflation to be 3% over the next year, then the _____ offers

conventional CD

you an expected real rate of return of 2%, which is 0.5% higher than the real rate on the inflation-protected CD.

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

6. You are considering the

riskier.

choice between investing $50,000 in a conventional 1year bank CD offering an interest rate of 5% and a 1year "Inflation-Plus" CD offering 1.5% per year plus the rate of inflation. c. If you expect the rate of inflation to be 3% over the next year, which is the better investment? Why? But unless you know that inflation will be 3% with certainty, the conventional CD is also ____

6. You are considering the choice between investing $50,000 in a conventional 1year bank CD offering an interest rate of 5% and a 1year "Inflation-Plus" CD offering 1.5% per year plus the rate of inflation.

your attitude towards risk versus return.

c. If you expect the rate of inflation to be 3% over the next year, which is the better investment? Why? The question of which is the better investment then depends on _____

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

6. You are considering the choice between investing $50,000 in a conventional 1year bank CD offering an interest rate of 5% and a 1year "Inflation-Plus" CD offering 1.5% per year plus the rate of inflation. d. If we observe a risk-free nominal interest rate of 5% per year and a risk-free real rate of 1.5% on inflationindexed bonds, can we infer that the market's expected rate of inflation is 3.5% per year?

No.

18/03/2021

Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

9. Determine the standard

[0.25 × (0 - 1.25)^2 + 0.25 × (1 - 1.25)^2 + 0.50 × (2 -

deviation of a random

1.25)2]^1/2 = 0.8292

variable q with the following probability distribution: Value of q Probability 0 0.25 1 0.25 2 0.50 σq = _____

10. The continuously

(a) With probability 0.9544, the value of a normally

compounded annual return

distributed variable will fall within 2 standard

on a stock is normally

deviations of the mean; that is, between -40% and

distributed with a mean of

80%. Simply add and subtract 2 standard

20% and standard deviation

deviations to and from the mean.

of 30%. With 95.44% confidence, we should expect its actual return in any particular year to be between which pair of values? (Hint: Look again at Figure 5.3.) a. −40.0% and 80.0% b. −30.0% and 80.0% c. −20.6% and 60.6% d. −10.4% and 50.4%

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

11. Using historical risk

11.69% per year.

premiums from Table 5.5 over the 1927-2018 period as your guide, what would be your estimate of the expected annual HPR on the Big/Value portfolio if the current riskfree interest rate is 3%? From Table 5.4, the average risk premium Big/Value for the period 1927-2018 was: ____

11. Using historical risk

3.00% + 11.69% = 14.69%.

premiums from Table 5.5 over the 1927-2018 period as your guide, what would be your estimate of the expected annual HPR on the Big/Value portfolio if the current riskfree interest rate is 3%? Adding 11.69% to the 3% riskfree interest rate, the expected annual HPR for the Big/Value portfolio is: _____

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

sit Professor Kenneth French’s

...

ibrary Web site: /mba.tuck.dartmouth.edu/pages/ y/ken.french/data_library.html ownload the monthly returns of rtfolios formed on size and -to-market (2 × 3).” Choose the -weighted series for the period January 1930–December 2018. the sample in half and compute verage, SD, skew, and kurtosis for of the six portfolios for the two s. Do the six split-halves tics suggest to you that returns from the same distribution over ntire period?

13. During a period of severe

= 0.80 - 0.70 / 1.70 = 0.0588 or 5.88%

inflation, a bond offered a nominal HPR of 80% per year. The inflation rate was 70% per year. a. What was the real HPR on the bond over the year?

13. During a period of severe

r_"nominal" -i=.80-.70=.10≈r_real

inflation, a bond offered a

Clearly, the approximation gives a real HPR that is

nominal HPR of 80% per

too high.

year. The inflation rate was 70% per year. b. Compare this real HPR to the approximation rreal ≈ rnom − i

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

14. Suppose that the inflation

T-bills: 0.46% real rate + 3% inflation = 3.46%

rate is expected to be 3% in the near future. Using the historical data provided in this chapter, what would be your predictions for: a. The T-bill rate?

14. Suppose that the inflation

Expected return on Big/Value:

rate is expected to be 3% in

3.46% T-bill rate + 11.69% historical risk premium =

the near future. Using the

15.15%

historical data provided in this chapter, what would be your predictions for: b. The expected rate of return on the Big/Value portfolio?

14. Suppose that the inflation

The risk premium on stocks remains unchanged. A

rate is expected to be 3% in

premium, the difference between two rates, is a

the near future. Using the

real value, unaffected by inflation.

historical data provided in this chapter, what would be your predictions for: c. The risk premium on the stock market?

15. An economy is making a

Real interest rates are expected to rise. The

rapid recovery from steep

investment activity will shift the demand for funds

recession, and businesses

curve (in Figure 5.1) to the right. Therefore the

foresee a need for large

equilibrium real interest rate will increase.

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Chapter 5: Introduction to Risk, Return, and the Historical Record (Review Questions) Flashcards | Quizlet

16. You are faced with the

STOCK PUT

probability distribution of

Excellent 0.25 $ 131.00 31.00% $ 0.00 100%

the HPR on the stock market

Good 0.45 114.00 14.00 $ 0.00 100

index fund given in

Poor 0.25 93.25 −6.75 $ 20.25 68.75

Spreadsheet 5.1 of the text.

Crash 0.05 48.00 52.00 $ 64.00 433.33

Suppose the price of a put option on a share of the

Remember that the cost of the index fund is $100

index fund with exercise

per share, and the cost of the put option is $12.

price of $110 and time to expiration of 1 year is $12. a. What is the probability distribution of the HPR on the put option?

16. You are faced with the

Excellent 0.25 $ 131.00 17.0% = (131 112)/112

probability distribution of

Good 0.45 114.00 1.8 = (114 112)/112

the HPR on the stock market

Poor 0.25 113.50 1.3 = (113.50 112)/112

index fund given in

Crash 0.05 112.00 0.0 = (112 112)/112

Spreadsheet 5.1 of the text. Suppose the price of a put option on a share of the index fund with exercise price of $110 and time to expiration of 1 year is $12. b. What is the probability distribution of the HPR on a portfolio consisting of one share of the index fund and a put option?<...