CHAPTER 10

Risk and Return Lessons from Market History

Multiple Choice Questions:

I. DEFINITIONS

RISK PREMIUM
a 1. The excess return required from a risky asset over that required from a risk-free asset is
called the:
a. risk premium.
b. geometric premium.
c. excess return.
d. average return.
e. variance.

Difficulty level:  Easy

VARIANCE
b 2. The average squared difference between the actual return and the average return is
called the:
a. volatility return.
b. variance.
c. standard deviation.
d. risk premium.
e. excess return.

Difficulty level:  Easy

STANDARD DEVIATION
c 3. The standard deviation for a set of stock returns can be calculated as the:
a. positive square root of the average return.
b. average squared difference between the actual return and the average return.
c. positive square root of the variance.
d. average return divided by N minus one, where N is the number of returns.
e. variance squared.

Difficulty level:  Easy

NORMAL DISTRIBUTION
d 4. A symmetric, bell-shaped frequency distribution that is completely defined by its mean
and standard deviation is the _____ distribution.
a. gamma
b. Poisson
c. bi-modal
 d. normal
e. uniform

Difficulty level:  Easy

GEOMETRIC AVERAGE RETURN

d 5. The average compound return earned per year over a multi-year period is called the
_____ average return.
a. arithmetic
b. standard
c. variant
d. geometric
e. real

Difficulty level:  Medium

ARITHMETIC AVERAGE RETURN

a 6. The return earned in an average year over a multi-year period is called the _____
average return.
a. arithmetic
b. standard
c. variant
d. geometric
e. real

Difficulty level:  Easy

RISK PREMIUM
c 7. The excess return you earn by moving from a relatively risk-free investment to a risky
investment is called the:
a. geometric average return.
b. inflation premium.
c. risk premium.
d. time premium.
e. arithmetic average return.

Difficulty level:  Easy

TOTAL RETURN
e 8. The capital gains yield plus the dividend yield on a security is called the:
a. variance of returns.
b. geometric return.
c. average period return.
d. current yield.
 e. total return.

Difficulty level:  Easy

II. CONCEPTS

HISTORICAL RECORD
d 9. A portfolio of large company stocks would contain which one of the following types of
securities?
a. stock of the firms which represent the smallest 20 % of the companies listed on the
NYSE
b. U.S. Treasury bills
c. long-term corporate bonds
d. stocks of firms included in the S&P 500 index
e. long-term government bonds

Difficulty level:  Easy

HISTORICAL RECORD
d 10. Based on the period of 1926 through 2004, _____ have tended to outperform other
securities over the long-term.
a. U.S. Treasury bills
b. large company stocks
c. long-term corporate bonds
d. small company stocks
e. long-term government bonds

Difficulty level:  Easy

HISTORICAL RECORD
a 11. Which one of the following types of securities has tended to produce the lowest real
rate of return for the period 1926 through 2004?
a. U.S. Treasury bills
b. long-term government bonds
c. small company stocks
d. large company stocks
e. long-term corporate bonds

Difficulty level:  Easy

HISTORICAL RECORD
d 12. On average, for the period 1926 through 2004:
a. the real rate of return on U.S. Treasury bills has been negative.
 b. small company stocks have underperformed large company stocks.
c. long-term government bonds have produced higher returns than long-term corporate
bonds.
d. the risk premium on long-term corporate bonds has exceeded the risk premium on
long-term government bonds.
e. the risk premium on large company stocks has exceeded the risk premium on small
company stocks.

Difficulty level:  Medium

HISTORICAL RECORD
e 13. Over the period of 1926 through 2004, the annual rate of return on _____ has been
more volatile than the annual rate of return on_____ .
a. large company stocks; small company stocks.
b. U.S. Treasury bills; small company stocks.
c. U.S. Treasury bills; long-term government bonds.
d. long-term corporate bonds; small company stocks.
e. large company stocks; long-term corporate bonds.

Difficulty level:  Medium

HISTORICAL RECORD
d 14. Which one of the following is a correct ranking of securities based on their volatility
over the period of 1926 to 2004? Rank from highest to lowest.
a. large company stocks, U.S. Treasury bills, long-term government bonds
b. small company stocks, long-term corporate bonds, large company stocks
c. small company stocks, long-term government bonds, long-term corporate bonds
d. small company stocks, large company stocks, long-term corporate bonds
e. long-term corporate bonds, large company stocks, U.S. Treasury bills

Difficulty level:  Easy

HISTORICAL RECORD
e 15. Over the period of 1926 to 2004, small company stocks had an average return of __ %.
a. 8.8
b. 10.2
c. 12.4
d. 14.6
e. 17.5

Difficulty level:  Medium

HISTORICAL AVERAGE RETURNS

c 16. Over the period of 1926 to 2004, the average rate of inflation was _____ %.
 a. 2.0
b. 2.7
c. 3.1
d. 3.8
e. 4.3

Difficulty level:  Medium

HISTORICAL AVERAGE RETURNS

c 17. The average annual return on long-term corporate bonds for the period of 1926 to 2004
was _____ %.
a. 3.8
b. 5.8
c. 6.2
d. 7.9
e. 8.4

Difficulty level:  Medium

HISTORICAL AVERAGE RETURNS

b 18. The average annual return on small company stocks was about _____ % points greater
than the average annual return on large-company stocks over the period of 1926 to
2004.
a. 3
b. 5
c. 7
d. 9
e. 11

Difficulty level:  Medium

RISK PREMIUM
a 19. The average risk premium on U.S. Treasury bills over the period of 1926 to 2004 was
_____ %.
a. 0.0
b. 1.6
c. 2.2
d. 3.1
e. 3.8

Difficulty level:  Medium

RISK PREMIUM
a 20. Which one of the following is a correct statement concerning risk premium?
 a. The greater the volatility of returns, the greater the risk premium.
b. The lower the volatility of returns, the greater the risk premium.
c. The lower the average rate of return, the greater the risk premium.
d. The risk premium is not correlated to the average rate of return.
e. The risk premium is not affected by the volatility of returns.

Difficulty level:  Medium

RISK PREMIUM
c 21. The risk premium is computed by ______ the average return for the investment.
a. subtracting the inflation rate from
b. adding the inflation rate to
c. subtracting the average return on the U.S. Treasury bill from
d. adding the average return on the U.S. Treasury bill to
e. subtracting the average return on long-term government bonds from

Difficulty level:  Medium

DIVIDEND YIELD
c 22. The Zolo Co. just declared that they are increasing their annual dividend from $1.00
per share to $1.25 per share. If the stock price remains constant, then:
a. the capital gains yield will decrease.
b. the capital gains yield will increase.
c. the dividend yield will increase.
d. the dividend yield will also remain constant.
e. neither the capital gains yield nor the dividend yield will change.

Difficulty level:  Medium

VARIANCE
e 23. Which of the following statements are correct concerning the variance of the annual
returns on an investment?
I. The larger the variance, the more the actual returns tend to differ from the average
return.
II. The larger the variance, the larger the standard deviation.
III. The larger the variance, the greater the risk of the investment.
IV. The larger the variance, the higher the expected return.
a. I and III only
b. II, III, and IV only
c. I, III, and IV only
d. I, II, and III only
e. I, II, III, and IV

Difficulty level:  Medium
VARIANCE
a 24. The variance of returns is computed by dividing the sum of the:
a. squared deviations by the number of returns minus one.
b. average returns by the number of returns minus one.
c. average returns by the number of returns plus one.
d. squared deviations by the average rate of return.
e. squared deviations by the number of returns plus one.

Difficulty level:  Medium

STANDARD DEVIATION
b 25. Which of the following statements concerning the standard deviation are correct?
I. The greater the standard deviation, the lower the risk.
II. The standard deviation is a measure of volatility.
III. The higher the standard deviation, the less certain the rate of return in any one given
year.
IV. The higher the standard deviation, the higher the expected return.
a. I and III only
b. II, III, and IV only
c. I, III, and IV only
d. I, II, and III only
e. I, II, III, and IV

Difficulty level:  Medium

STANDARD DEVIATION
a 26. The standard deviation on small company stocks:
I. is greater than the standard deviation on large company stocks.
II. is less than the standard deviation on large company stocks.
III. had an average value of about 33 % for the period 1926 to 2004.
IV. had an average value of about 20 % for the period 1926 to 2004.
a. I and III only
b. I and II only
c. II and III only
d. II and IV only
e. I and IV only

Difficulty level:  Medium

ARITHMETIC VS. GEOMETRIC AVERAGES

b 27. Estimates using the arithmetic average will probably tend to _____ values over the
long-term while estimates using the geometric average will probably tend to _____
values over the short-term.
a. overestimate; overestimate
 b. overestimate; underestimate
c. underestimate; overestimate
d. underestimate; underestimate
e. accurately; accurately

Difficulty level:  Medium

CAPITAL GAINS
b 28. A capital gain occurs when 
a. the selling price is less than the purchase price. 
b. the purchase price is less than the selling price. 
c. there is no dividend paid. 
d. there is no income component of return. 
e. never, as they can not exist. 

Difficulty level:  Easy

CAPITAL MARKET RETURNS
b 29. Capital market history shows us that the average return relationship from lowest to 
highest between securities is: 
a. inflation, corporate bonds, Treasuries, small company stocks, large company stocks. 
b. Treasury bills, inflation, small company stocks, large company stocks. 
c. Treasury bills, corporate bonds, government bonds, large common stocks, small 
company stocks. 
d. Treasury bills, government bonds, corporate bonds, large common stocks, small 
company stocks. 
e. There is no ordering. 

Difficulty level:  Medium

III. PROBLEMS

DOLLAR RETURNS
b 30. One year ago, you purchased a stock at a price of $32.50. The stock pays quarterly
dividends of $.40 per share. Today, the stock is worth $34.60 per share. What is the
total amount of your dividend income to date from this investment?
a. $.40
b. $1.60
c. $2.10
d. $2.50
e. $3.70
 Difficulty level:  Easy

DOLLAR RETURNS
d 31. Six months ago, you purchased 100 shares of stock in ABC Co. at a price of $43.89 a
share. ABC stock pays a quarterly dividend of $.10 a share. Today, you sold all of your
shares for $45.13 per share. What is the total amount of your capital gains on this
investment?
a. $1.24
b. $1.64
c. $40.00
d. $124.00
e. $164.00

Difficulty level:  Medium

DOLLAR RETURNS
d 32. A year ago, you purchased 300 shares of IXC Technologies, Inc. stock at a price of
$9.03 per share. The stock pays an annual dividend of $.10 per share. Today, you sold
all of your shares for $28.14 per share. What is your total dollar return on this
investment?
a. $5,703
b. $5,733
c. $5,753
d. $5,763
e. $5,853

Difficulty level:  Medium

DIVIDEND YIELD
b 33. You purchased 200 shares of stock at a price of $36.72 per share. Over the last year,
you have received total dividend income of $322. What is the dividend yield?
a. 3.2 %
b. 4.4 %
c. 6.8 %
d. 9.2 %
e. 11.4 %

Difficulty level:  Medium

DIVIDEND YIELD
d 34. Winslow, Inc. stock is currently selling for $40 a share. The stock has a dividend yield
of 3.8 %. How much dividend income will you receive per year if you purchase 500
shares of this stock?
 a. $152
b. $190
c. $329
d. $760
e. $1,053

Difficulty level:  Medium

DIVIDEND YIELD
c 35. One year ago, you purchased a stock at a price of $32 a share. Today, you sold the stock
and realized a total return of 25 %. Your capital gain was $6 a share. What was your
dividend yield on this stock?
a. 1.25 %
b. 3.75 %
c. 6.25 %
d. 18.75 %
e. 21.25 %

Difficulty level:  Medium

CAPITAL GAIN
a 36. You just sold 200 shares of Langley, Inc. stock at a price of $38.75 a share. Last year
you paid $41.50 a share to buy this stock. Over the course of the year, you received
dividends totaling $1.64 per share. What is your capital gain on this investment?
a. -$550
b. -$222
c. -$3
d. $550
e. $878

Difficulty level:  Medium

CAPITAL GAIN
b 37. You purchased 300 shares of Deltona, Inc. stock for $44.90 a share. You have received
a total of $630 in dividends and $14,040 in proceeds from selling the shares. What is
your capital gains yield on this stock?
a. 4.06 %
b. 4.23 %
c. 4.68 %
d. 8.55 %
e. 8.91 %

Difficulty level:  Medium
CAPITAL GAIN
d 38. Today, you sold 200 shares of SLG, Inc. stock.. Your total return on these shares is 12.5
%. You purchased the shares one year ago at a price of $28.50 a share. You have
received a total of $280 in dividends over the course of the year. What is your capital
gains yield on this investment?
a. 4.80 %
b. 5.00 %
c. 6.67 %
d. 7.59 %
e. 11.67 %

Difficulty level:  Medium

TOTAL RETURN
d 39. Six months ago, you purchased 1,200 shares of ABC stock for $21.20 a share. You
have received dividend payments equal to $.60 a share. Today, you sold all of your
shares for $22.20 a share. What is your total dollar return on this investment?
a. $720
b. $1,200
c. $1,440
d. $1,920
e. $3,840

Difficulty level:  Medium

TOTAL RETURN
c 40. Eight months ago, you purchased 400 shares of Winston, Inc. stock at a price of $54.90
a share. The company pays quarterly dividends of $.50 a share. Today, you sold all of
your shares for $49.30 a share. What is your total percentage return on this
investment?
a. -10.2 %
b. -9.3 %
c. -8.4 %
d. 12.0 %
e. 13.4 %

Difficulty level:  Medium

STANDARD DEVIATION
d 41. A stock had returns of 8 %, -2 %, 4 %, and 16 % over the past four years. What is the
standard deviation of this stock for the past four years?
a. 6.3 %
b. 6.6 %
c. 7.1 %
d. 7.5 %
e. 7.9 %
 Difficulty level:  Medium

RETURN DISTRIBUTIONS
a 42. A stock has an expected rate of return of 8.3 % and a standard deviation of 6.4 %.
Which one of the following best describes the probability that this stock will lose 11 %
or more in any one given year?
a. less than 0.5 %
b. less than 1.0 %
c. less than 1.5 %
d. less than 2.5 %
e. less than 5 %

Difficulty level:  Challenge

RETURN DISTRIBUTIONS
d 43. A stock has returns of 3 %, 18 %, -24 %, and 16 % for the past four years. Based on
this information, what is the 95 % probability range for any one given year?
a. -8.4 to 11.7 %
b. -16.1 to 22.6 %
c. -24.5 to 34.3 %
d. -35.4 to 41.9 %
e. -54.8 to 61.3 %

Difficulty level:  Challenge

RETURN DISTRIBUTIONS
c 44. A stock had returns of 8 %, 14 %, and 2 % for the past three years. Based on these
returns, what is the probability that this stock will earn at least 20 % in any one given
year?
a. 0.5 %
b. 1.0 %
c. 2.5 %
d. 5.0 %
e. 16.0 %

Difficulty level:  Challenge

RETURN DISTRIBUTIONS
c 45. A stock had returns of 11 %, 1 %, 9 %, 15 %, and -6 % for the past five years. Based on
these returns, what is the approximate probability that this stock will earn at least 23 %
in any one given year?
a. 0.5 %
b. 1.0 %
 c. 2.5 %
d. 5.0 %
e. 16.0 %

Difficulty level:  Challenge

RETURN DISTRIBUTIONS
c 46. A stock had returns of 8 %, 39 %, 11 %, and -24 % for the past four years. Which one
of the following best describes the probability that this stock will NOT lose more than
43 % in any one given year?
a. 84.0 %
b. 95.0 %
c. 97.5 %
d. 99.0 %
e. 99.5 %

Difficulty level:  Challenge

RETURN DISTRIBUTIONS
b 47. Over the past five years, a stock produced returns of 14 %, 22 %, -16 %, 2 %, and 10
%. What is the probability that an investor in this stock will NOT lose more than 8 %
nor earn more than 21 % in any one given year?
a. 34 %
b. 68 %
c. 95 %
d. 99 %
e. 100 %

Difficulty level:  Challenge

ARITHMETIC AVERAGE
b 48. What are the arithmetic and geometric average returns for a stock with annual returns
of 4 %, 9 %, -6 %, and 18 %?
a. 5.89 %; 6.25 %
b. 6.25 %; 5.89 %
c. 6.25 %; 8.33 %
d. 8.3 %; 5.89 %
e. 8.3 %; 6.25 %

Difficulty level:  Medium

ARITHMETIC VS. GEOMETRIC AVERAGES

c 49. What are the arithmetic and geometric average returns for a stock with annual returns
of 21 %, 8 %, -32 %, 41 %, and 5 %?
 a. 5.6 %; 8.6 %
b. 5.6 %; 6.3 %
c. 8.6 %; 5.6 %
d. 8.6 %; 8.6 %
e. 8.6 %; 6.3 %

Difficulty level:  Medium

GEOMETRIC AVERAGE
b 50. A stock had returns of 6 %, 13 %, -11 %, and 17 % over the past four years. What is the
geometric average return for this time period?
a. 4.5 %
b. 5.7 %
c. 6.2 %
d. 7.3 %
e. 8.2 %

Difficulty level:  Medium

GEOMETRIC AVERAGE
b 51. A stock had the following prices and dividends. What is the geometric average return
on this stock?
Year Price Dividend
1 $23.19 -
2 $24.90 $.23
3 $23.18 $.24
4 $24.86 $.25
a. 3.2 %
b. 3.4 %
c. 3.6 %
d. 3.8 %
e. 4.0 %

Difficulty level:  Medium

TOTAL RETURN
b 52. You bought 100 shares of stock at $20 each. At the end of the year, you received a 
total of $400 in dividends, and your stock was worth $2,500 total.  What was your 
total return? 
a. 20% 
b. 45% 
c. 50% 
d. 90% 
e. None of the above. 
 Difficulty level:  Easy

CAPITAL GAIN AND TOTAL RETURNS
c 53. You bought 100 shares of stock at $20 each. At the end of the year, you received a 
total of $400 in dividends, and your stock was worth $2,500 total.  What was total 
dollar capital gain and total dollar return? 
a. $400; $500 
b. $400; $900 
c. $500; $900 
d. $900; $2,500 
e. None of the above. 

Difficulty level:  Medium

CAPITAL GAIN RETURN
a 54. Excelsior shares are currently selling for $25 each.  You bought 200 shares one year 
ago at $24 and received dividend payments of $1.50 per share.  What was your 
percentage capital gain this year? 
a. 4.17% 
b. 6.25% 
c. 10.42% 
d. 104.17% 
e. 110.42% 

Difficulty level:  Medium

TOTAL RETURN
c 55. Excelsior share are currently selling for $25 each.  You bought 200 shares one year 
ago at $24 and received dividend payments of $1.50 per share.  What was your total 
rate of return? 
a. 4.17% 
b. 6.25% 
c. 10.42% 
d. 104.67% 
e. 110.42% 

Difficulty level:  Easy
HOLDING PERIOD RETURN
d 56. The prices for IMB over the last 3 years are given below.  Assuming no dividends 
were paid, what was the 3­year holding period return?  Given the following 
information:  Year 1 return = 10%, Year 2 return = 15%, Year 3 return = 12%. 
a. 12.3% 
b. 13.9% 
c. 15.8% 
d. 41.7% 
e.  46.5%

Difficulty level:  Medium

RETURN AND STANDARD DEVIATION
a 57. Kids Toy Co. has had total returns over the past five years of 0%, 7%, ­2%, 10%, and 
12%.   What was the arithmetic average return on this stock? 
a. 5.40% 
b. 5.50% 
c. 6.15% 
d. 6.33% 
e.  6.75% 

Difficulty level:  Easy

ARITHMETIC AVERAGE RETURN
b 58. The return on your portfolio over the last 5 years were ­5%, 20%, 0%, 10% and 5%.  
What is the arithmetic average return? 
a. 5.0% 
b. 6.0% 
c. 7.5% 
d. 8.0% 
e.  10.0%.

Difficulty level:  Easy

RETURNS
b 59. If the expected return on the market is 16%, then using the historical risk premium on 
large stocks of 8.6%, the current risk­free rate is 
a. 4.6% 
 b. 7.4% 
c. 8.4% 
d. 10.6% 
e. 12.6% 

Difficulty level:  Easy

RISK PREMIUM
b 60 The total annual returns on large company common stocks averaged 12.4% from 1926 
to 2004 small company stocks averaged 17.5%, long­term government bonds averaged
5.8%, while Treasury Bills averaged 3.8%.  What was the average risk premium 
earned by long­term government bonds, and small company stocks respectively? 
a. 1.8%; 13.3% 
b. 2.0%; 13.7% 
c. 4.4%; 11.9% 
d. 9.5%; 1.8% 
e.  None of the above.

Difficulty level:  Medium

STANDARD DEVIATION
c 61. The return on your portfolio over the last 5 years were ­5%, 20%, 0%, 10% and 5%.  
What is the standard deviation of your return? 
a. 2.74% 
b. 5.21% 
c. 9.62% 
d. 10.12% 
e. 12.70% 

Difficulty level:  Medium

RETURN PROBABILITIES
c 62. Suppose you own a risky asset with an expected return of 12% and a standard 
deviation of 20%.  If the returns are normally distributed, the approximate probability 
of receiving a return greater than 32% is approximately:
a. 2%. 
b. 5%. 
c. 16%. 
d. 33%. 
 e.  67%.

Difficulty level:  Medium

AVERAGE AND HOLDING PERIOD RETURNS
b 63. The return pattern on your favorite stock has been 5%, 8%, ­12%, 15%, 21% over the 
last five years.  What has your average return and holding period return over the last 5 
years? 
a. 4.5%; 6.5% 
b. 7.4%; 38.9% 
c. 7.4%; 7.76% 
d. 7.4%; 76.73% 
e. None of the above. 

Difficulty level:  Medium

AVERAGE RISK PREMIUM
a 64. The long term inflation rate average was 3.2% and you invested in long term corporate
bonds over the same period which earned 6.1%.  What was the average risk premium 
you earned? 
a. 2.9% 
b. 3.1% 
c. 9.3% 
d. 9.4% 
e. None of the above. 

Difficulty level:  Easy

RISK PREMIUM
c 65. The market portfolio of common stocks earned 14.7% in one year.  Treasury bills 
earned 5.7%.  What was the real risk premium on equities? 
a. 5.0% 
b. 6.5% 
c. 9.0% 
d. 12.2% 
e. 18.7% 

Difficulty level:  Easy
ARITHMATIC AVERAGE RETURN AND VARIANCE
b 66. You have a sample of returns observations for the Malta Stock Fund.  The 4 returns 
are 0.0725, 0.056, 0.125, 0.010.  What is the average return and variance of these 
returns? 
a. 6.50%; 16.9 
b. 6.60%; 22.5 
c. 6.60%; 4.75 
d. 26.35%; 67.6 
e.  None of the above.

Difficulty level:  Medium

IV. ESSAYS

HISTORICAL RETURNS
67. What securities have offered the highest average annual returns over the last several
decades? Can we conclude that return and risk are related in real life?

The purpose of this question is to check student understanding of the capital market history
discussion of the chapter, as well as to reiterate the concept of the risk-return trade-off. The
securities categories discussed in the chapter are listed below in descending order of
historical returns (and risk):
1. small company stocks
2. large company stocks
3. long-term corporate bonds
4. long-term government bonds
5. U.S. Treasury bills
By learning this hierarchy, and given that they are familiar with the attributes of each
security, students should be left with little doubt that the maxim “The greater the risk, the
greater the return” is an apt description of financial markets.

LESSONS
68. What are the lessons learned from capital market history? What evidence is there to suggest
these lessons are correct?

First, there is a reward for bearing risk, and second, the greater the risk, the greater the
reward. As evidence, the students should provide a brief discussion of the historical rates of
return and standard deviation of returns of the various asset classes discussed in the text.

RISK AND RETURN

69. Suppose you have $30,000 invested in the stock market and your banker comes to you and
tries to get you to move that money into the bank’s certificates of deposit (CDs). He
explains that the CDs are 100% government insured and that you are taking unnecessary
risks by being in the stock market. How would you respond?
 The usual response is that bank CDs typically will offer a very low rate of return because
of their low level of risk. Even if students do not know the relationship between yields on
CDs and historical returns on stocks, they should recognize that because of the risk
differences the CDs must have a lower expected return. So, if the investor in the question is
willing to trade off some safety in order to have the chance to earn larger returns, the stock
market is the correct investment.

RETURNS
70. Little John Industries sold for $1.90 on January 1 and ended the year at a price of $2.50.  In
addition, the stock paid dividends of $0.20 per share.  Calculate Little John's dividend yield,
capital gain yield, and total rate of return for the year. 

Dividend yield  = $0.20/$1.90 = 10.53%
Capital Gain    = $0.60/$1.90 = 31.58%
Total return     = 10.53% + 31.58% = 42.11%

HOLDING PERIOD RETURNS
71. You earned a total return of ­5% on NoDotCom this year, earned ­40% last year, and earned 
30% two years ago.  Calculate both the three­year holding period return and the average 
three year return.

3­year holding period return = (0.95) (0.60) (1.30) = 0.741­1  =  –25.9%
Average three­year return = (­.05 + ­.40 + .30) / 3 = ­.15/3= ­5%.
 SOLUTIONS TO TEST BANK PROBLEMS

Chapter 10
30. Dividend income = $.40  4 = $1.60
31. Capital gains = ($45.13 - $43.89)  100 = $124.00
32. Total dollar return = ($28.14 - $9.03 + $.10)  300 = $5,763
33. Dividend per share = $322  200 = $1.61; Dividend yield = $1.61  $36.72 = 4.4 %
34. Dividend income = $40  .038  500 = $760
35. Capital gains yield = $6  $32 = 18.75 %; Dividend yield = 25 % – 18.75% = 6.25 %
36. Capital gain = ($38.75 – $41.50)  200 = ­$550 (capital loss)
37. Cost = 300  $44.90 = $13,470; 
Capital gains yield = ($14,040 - $13,470)  $13,470 = 4.23 %
38. Dividend yield = $280  (200  $28.50) = 4.91 %; 
Capital gains yield = 12.5% – 4.91 %  = 7.59 %
39. Total dollar return = ($22.20 – $21.20 + $.60)  1,200 = $1,920
40. Total percentage return = ($49.30 – $54.90 + $.50 + $.50)  $54.90 = ­8.4 % (loss)
41. Average return = (.08 – .02 + .04 + .16)  4 = .065; Total squared deviation = (.08 – 
.065)2 + (­.02 – .065)2 + (.04 – .065)2 + (.16 – .065)2 = .000225 + .007225 + .000625 + 
.009025 = .0171; Standard deviation = (.0171  (4 – 1) = .0057 = .075498 = 7.5 %
42. Lower bound of 99 % probability range = .083 – (3  .064) = ­.109 =­10.9 %; 
Probability of losing 11 % or more is less than 0.5 %.
43. Average return = (.03 + .18 – .24 + .16)  4 = .0325; Total squared deviation = (.03 – .
0325)2 + (.18 – .0325)2 + (­.24 – .0325)2 + (.16 – .0325)2 = .00000625 + .02175625 + .
07425625 + .01625625 = .112275; Standard deviation = (.112275  (4 ­ 1) = .037425 = .
19346 = 19.346 %; 95% probability range = 3.25 %  (2  19.346 %) = ­35.4 to 41.9 %
44. Average return = (.08 + .14 + .02)  3 = 8 %; Total squared deviation = (.08 – .08)2 + (.14 
– .08)2  + (.02 – .08)2 = .00 + .0036 + .0036 = .0072; Standard deviation = (.0072  (3 – 1) 
= .06 = 6 %; Upper end of the 95 % probability range = 8 % + (2  6 %) = 20 %; Probability
of earning at least 20 % in any one year is 2.5 %.
45. Average return = (.11 + .01 + .09 + .15 – .06)  5 = 6 %; Total squared deviation = (.11 – .
06)2 + (.01 – .06)2 + (.09 – .06)2 + (.15 – .06)2 + (­.06 – .06)2 = .0025 + .0025 + .0009 + .
0081 + .0144 = .0284; Standard deviation = (0.284  (5 ­ 1) = .0071 = .084;
Upper end of the 95 % probability range = .06 + (2  .084) = 22.8 %; Probability of earning 
more than 23 % in any one year is just slightly less than 2.5 %.
46. Average return = (.08 + .39 + .11 - .24)  4 = 8.5 %; Total squared deviation = (.08 – .085)2
+ (.39 – .085)2 + (.11 – .085)2 + (­.24 – .085)2 = .000025 + .093025 + .000625 + .105625 = .
1993; Standard deviation = .1993  (4 – 1) = .06643333 = 25.7747 %; 
Lower bound of the 95 % probability range = 8.5 % – (2  25.7747 %) = ­43.05; Probability
of NOT losing more than 43 % in any given year is 97.5 %.
47. Average return = (.14 + .22 ­ .16 + .02 + .10)  5 = 6.4 %; Total squared deviation = (.14 – .
064)2 + (.22 – .064)2 + (­.16 – .064)2 + (.02 – 0.064)2 + (.10 – .064)2 = .005776 + .024336 + .
 050176 + .001936 + .001296 = .08352; Standard deviation = .08352  (5­1) = .02088 = 
14.45 %; 68% probability range = 6.4 %  14.45 % = ­8.05 % to 20.85 %; Answer is 68 %.
48. Arithmetic average = (.04 + .09 – .06 + .18)  4 = 6.25 %; Geometric return = (1.04  1.09 
 .94  1.18).25 – 1 = 5.89 %
49. Arithmetic average = (.21 + .08 – .32 + .41 + .05)  5 = 8.6 %; Geometric return = (1.21  
1.08  .68  1.41  1.05).20 – 1 = 5.6 %
50. Geometric average = (1.06  1.13  .89  1.17).25 – 1 = 5.7 %
51. Return for year 2 = ($24.90 – $23.19 + $.23)  $23.19 = 8.3657 %; Return for year 3 = 
($23.18 – $24.90 + $.24)  $24.90 = ­5.9438 %; Return for year 4 = ($24.86 – $23.18 + 
$.25)  $23.18 = 8.3261 %; Geometric return = (1.083657  .940562  1.083261).3333 – 1 = 
3.4 %
52. $ Invest = $20(100) = $2,000
$ Return = ($2,500 + $400 ­ $2,000)/$2,000 = .45 = 45%
53. $CG =$2,500 ­ $2,000 = $500
$Total Return = CG + DIV = $500 + $400 = $900
54. %CG = ($25 ­ $24)/$25 = .04167 = 4.17%
55. % Total Return = ($25 + $1.50)/ $24 = .1041667 = 10.42%
56. HPR = (1.10) (1.15) (1.12) = 1.4168 1 = 41.68%
57. Arithmetic average = (0 + 7 – 2 + 10 + 12)/5 = 5.40%
58. Arithmetic average = (­5 + 20 + 0 + 10 + 5)/5 = 6%
59. Risk­free rate = 16% ­ 8.6% = 7.4%
60. Long Term Government = 5.8% ­ 3.8% = 2.0%
Small Stocks = 17.5% ­ 3.8% = 13.7%
61. Standard Deviation = [(­.05­.06)2 +(.20­.06)2 +(0­.06)2+(.10­.06) 2+(.05­.06)2]/4 = .0370/4 
= .925 = .09617 = 9.62%
62. Z = (32 12)/20 = 1; 32 is 1 standard deviation above the mean.  The probability of being 
within 1 standard deviation is approximately 68%; therefore, probability above the mean is 
approximately 32%/2 = 16%.
63. Average return = (5+8­12+15+21)/5 = 37/5 = 7.4%
HPR = [(1.05)(1.08)(.88)(1.15)(1.21)] ­ 1 = (1.389) ­ 1 = .3886 = 38.9%
64. Average risk premium = 6.1% ­ 3.2% = 2.9%
65. Risk premium = 14.7% ­ 5.7% = 9.0%
66. Average return = (.0725 + .056 + .125 + .01)/4 = .2625/4 = .065875 = 6.6%
 Variance = [(7.25­6.6)2 +(5.6­6.6)2 +(12.5­6.6)2 +(1­6.6)2]/3 = 67.5925/3 = 22.53