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
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
, 13. The two most common calculations investors use to measure return performance are arithmetic
means and geometric means.
ANS: T PTS: 1
14. The arithmetic mean is a superior measure of the long-term performance because it indicates the
compound annual rate of return based on the ending value of the investment versus its beginning
value.
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 OBJ: Multiple Choice
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 OBJ: Multiple Choice
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 OBJ: Multiple Choice
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 OBJ: Multiple Choice
5. The nominal risk free rate of interest is a function of
a. The real risk free rate and the investment's variance.
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
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
, 13. The two most common calculations investors use to measure return performance are arithmetic
means and geometric means.
ANS: T PTS: 1
14. The arithmetic mean is a superior measure of the long-term performance because it indicates the
compound annual rate of return based on the ending value of the investment versus its beginning
value.
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 OBJ: Multiple Choice
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 OBJ: Multiple Choice
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 OBJ: Multiple Choice
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 OBJ: Multiple Choice
5. The nominal risk free rate of interest is a function of
a. The real risk free rate and the investment's variance.
