Learning about Return and Risk from the Historical Record

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Chapter 05
Learning about Return and Risk from the Historical Record

Multiple Choice Questions

1. Over the past year you earned a nominal rate of interest of 10 percent on your money. The inflation rate was 5 percent over the same period. The exact actual growth rate of your purchasing power was A. 15.5%.

B. 10.0%.
C. 5.0%.
D. 4.8%.
E. 15.0%
r = (1+R) / (1+i) - 1; 1.10% / 1.05% - 1 = 4.8%.

Difficulty: Moderate

3. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 7%. What is your approximate annual real rate of return if the rate of inflation was 3% over the year? A. 4%.

B. 10%.
C. 7%.
D. 3%.
E. none of the above.
7% - 3% = 4%.

Difficulty: Easy

7. You purchased a share of stock for $20. One year later you received $1 as dividend and sold the share for $29. What was your holding period return? A. 45%
B. 50%
C. 5%
D. 40%
E. none of the above
($1 + $29 - $20)/$20 = 0.5000, or 50%.

Difficulty: Moderate

9. Which of the following determine(s) the level of real interest rates? I) the supply of savings by households and business firms
II) the demand for investment funds
III) the government's net supply and/or demand for funds
A. I only
B. II only
C. I and II only
D. I, II, and III
E. none of the above
The value of savings by households is the major supply of funds; the demand for investment funds is a portion of the total demand for funds; the government's position can be one of either net supplier, or net demander of funds. The above factors constitute the total supply and demand for funds, which determine real interest rates.

Difficulty: Moderate

10. Which of the following statement(s) is (are) true?
I) The real rate of interest is determined by the supply and demand for funds. II) The real rate of interest is determined by the expected rate of inflation. III) The real rate of interest can be affected by actions of the Fed. IV) The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation. A. I and II only.

B. I and III only.
C. III and IV only.
D. II and III only.
E. I, II, III, and IV only
The expected rate of inflation is a determinant of nominal, not real, interest rates. Real rates are determined by the supply and demand for funds, which can be affected by the Fed.
Difficulty: Moderate

12. Other things equal, an increase in the government budget deficit A. drives the interest rate down.
B. drives the interest rate up.
C. might not have any effect on interest rates.
D. increases business prospects.
E. none of the above.
An increase in the government budget deficit, other things equal, causes the government to increase its borrowing, which increases the demand for funds and drives interest rates up.
Difficulty: Moderate

13. Ceteris paribus, a decrease in the demand for loanable funds A. drives the interest rate down.
B. drives the interest rate up.
C. might not have any effect on interest rate.
D. results from an increase in business prospects and a decrease in the level of savings. E. none of the above.
A decrease in demand, ceteris paribus, always drives interest rates down. An increase in business prospects would increase the demand for funds. The savings level affects the supply of, not the demand for, funds.

Difficulty: Moderate

15. Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2005 show that A. stocks offered investors greater rates of return than bonds and bills. B. stock returns were less volatile than those of bonds and bills. C. bonds offered investors greater rates of return than stocks and bills. D. bills outperformed stocks and bonds.

E. treasury bills always offered a rate of return greater than inflation. The historical data show that, as expected, stocks offer a greater return and greater volatility than the other investment alternatives. Inflation sometimes exceeded the...
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