(TURE OR FALSE) 1. If the discount rate is appropriate for the level of risk, a
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Question
(TURE OR FALSE)
1. If the discount rate is appropriate for the level of risk, a satisfactory investment will have a present value of benefits equal to or greater than than the present value of costs.
2.One reason that the holding period return should not be used to compare long-term investments is that it does not consider the time value of money.
3.If you own an investment providing periodic returns, your actual yield on the investment will depend on the reinvestment rate you are able to obtain.
4.Investments with lower standard deviations can be expected to produce higher rates of return.
5.A portfolio that offers the lowest risk for a given level of return is known as an efficient portfolio.
6.By plotting the efficient frontier, investors can find the unique portfolio that is ideal for all investors.
7.Negatively correlated assets reduce risk more than positively correlated assets.
8.Investing globally offers better diversification than investing only domestically.
9.The transaction costs of investing directly in foreign-currency-denominated assets can be reducedby purchasing American Depositary Shares (ADSs).
10.Standard deviation is a measure that indicates how the price of an individual security responds to market forces.
11.Market return is estimated from the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index.
Explanation / Answer
1. If the discount rate is appropriate for the level of risk, a satisfactory investment will have a present value of benefits equal to or greater than than the present value of costs. TRUE A satisfactory investment is one for which the PV of benefits >= PV of costs. Therefore, if the discount rate is proportional to the risk, then the above will be true for a satisfactory investment. 2.One reason that the holding period return should not be used to compare long-term investments is that it does not consider the time value of money. TRUE The holding period return (HPR) is the total return from an investment for a specific period of time. It does not take into account the time value of money and hence it is used when the holding period is less than or equal to one year 3.If you own an investment providing periodic returns, your actual yield on the investment will depend on the reinvestment rate you are able to obtain. TRUE Reinvestment rate is the rate at which the periodic proceeds of the investment will be invested. The actual yield will vary when the reinvestment rate changes 4.Investments with lower standard deviations can be expected to produce higher rates of return. FALSE Standard deviation is a statistical tool to measure risk. Higher the standard deviation indicates that there is more dispersion from the mean which means the risk is higher. Lower standard deviation generally means lower risk. Lower risk means lower returns. Therefore, investments with lower standard deviations can be expected to produce lower rates of return. 5.A portfolio that offers the lowest risk for a given level of return is known as an efficient portfolio. TRUE Efficient portfolio is a set of all optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. 6.By plotting the efficient frontier, investors can find the unique portfolio that is ideal for all investors. FALSE Efficient portfolio is a set of all optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Any portfolio on the efficient frontier is optimal and it can be different for different investors. e.g. risk averse investors will choose a low risk portfolio on the efficient frontier and so on 7.Negatively correlated assets reduce risk more than positively correlated assets. TRUE Correlation measures the degree to which returns on investments move together. Negatively correlated assets means the returns tend to move in opposite direction which is very beneficial while diversifying a portfolio. It helps to reduce more risk than positively correlated assets. 8.Investing globally offers better diversification than investing only domestically. TRUE Investing globally helps to diversify the portfolio with respect to the country risk which cant be possible if the invest is restricted to the domestic level only. 9.The transaction costs of investing directly in foreign-currency-denominated assets can be reducedby purchasing American Depositary Shares (ADSs). TRUE With the help of ADSs investment in foreign companies is possible without dealing with currency conversions and other transaction costs. 10.Standard deviation is a measure that indicates how the price of an individual security responds to market forces. FALSE Standard deviation is a statistical tool to measure risk by measuring the dispersion of returns with respect to its mean. Higher the standard deviation indicates that there is more dispersion from the mean which means the risk is higher. 11.Market return is estimated from the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index. TRUE Market return is like a benchmark return and is estimated by an average on major stocks in the industry
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