8.7 Risks, Returns, & Investment Portfolios

Financial risk refers to:

I. the possibility of financial loss

II. volatility of returns

III. the loss of purchasing power

• I only

• I and III

• II and III

• I, II, and III

Which of the following assets has the least marketability risk?

• stocks traded on the New York Stock Exchange

• rental real estate

• gold held as collectible coins

• municipal bonds

In which of the following investment should someone with a very high risk tolerance be comfortable investing?

I. stocks

II. bonds

III. commodities

• I only

• III only

• I and II only

• I, II, and III

Volatility refers to:

• how liquid an investment becomes over time

• how wildly returns fluctuate over time

• the maximum expected loss someone can expect over time

• the degree to which purchasing power is lost as a result of inflation

Wookjae has discovered a new mutual fund with a 3-year return and standard deviation of 9% and 14%, respectively. What is the worst possible return that Wookjae can expect 95% of the time if he invests in this mutual fund?

• -5%

• -19%

• -23%

• -33%

Answer explanation

Because Wookjae wants to know, with 95% confidence, the worst possible loss amount. The solution requires the standard deviation to be subtracted from the average (mean) twice

Wookjae has discovered a new mutual fund with a 3-year return and standard deviation of 9% and 14%, respectively. Wookjae would like to know, with 99% certainty, the maximum return he might see in any given year. What is the number?

• 14%

• 23%

• 37%

• 51%

Answer explanation

Because Wookjae wants to know, with 99% confidence, the best possible gain amount. The solution requires the standard deviation to be added to the average (mean) three times

Wookjae has discovered a new mutual fund with a 3-year return and standard deviation of 9% and 14%, respectively. Which of the following statements is TRUE regarding the mutual fund and Wookjae?

I. this mutual fund is appropriate for Wookjae assuming his risk tolerance is low

II. this mutual fund is appropriate for Wookjae assuming his risk tolerance is high

III. the standard deviation of returns associated with this mutual fund indicates an investment with low marketability

• II only

• III only

• I and III only

• II and III only

Holding all other factors constant, someone who is concerned about losing money should invest in assets that have a standard deviation:

• greater than the average return of the investment

• greater than 10%

• less than the average return of the investment

• less than 10%

Diversification is important in investing because…

• It helps you to balance your risk across different types of investments.

• It increases your overall risk, which guarantees that you will make more money.

• It ensures that you only make low-risk investments.

• It helps you gain the highest rate of return despite any risks.

Which of the following correctly orders the investments from LOWER risk to HIGHER risk?

• Treasury bond − Stock − Diversified mutual fund

• Stock − Treasury bond − Diversified mutual fund

• Treasury bond − Diversified mutual fund – Stock

• Diversified mutual fund − Treasury bond − Stock