Investment Analysis Concepts

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Questions and Answers

What equation is used to compute the standard deviation of returns?

Standard deviation = variance^2

Standard deviation = 2 * variance

Standard deviation = variance * expected return

Standard deviation = square root of variance (correct)

Which investment has a higher level of risk as measured by standard deviation?

Investment Y

Neither has risk

Both have equal risk

Investment X (correct)

If an investor desires a higher expected return, what is implied about the risk they must take?

Risk must be minimized.

They must take on less risk.

There is no impact on risk.

They must take on more risk. (correct)

How is the expected rate of return calculated?

By multiplying each rate by its corresponding probability and summing them Signup and view all the answers

Which of the following represents the proper sequence of steps for calculating returns and risk?

Formulate a solution strategy, then crunch the numbers, and finally analyze results Signup and view all the answers

What is the variance of the returns calculated for the publishing company’s common stock?

124% Signup and view all the answers

In the context of investment, how should risk be viewed if the distribution of returns is symmetrical?

As both negative and positive fluctuations from expected returns Signup and view all the answers

What formula is used to calculate expected cash flow?

Expected Cash Flow = CF1 * Pb1 + CF2 * Pb2 Signup and view all the answers

Given a cash flow of $1,000 with a probability of 0.2, what is the contribution to expected cash flow?

$200 Signup and view all the answers

What expected rate of return is associated with a cash inflow of $1,400 from a $10,000 investment?

14% Signup and view all the answers

If an investment shows an expected return of 12% based on a cash flow of $1,200, what is the cash flow value?

$1,200 Signup and view all the answers

In the expected rate of return calculation, if the probability of state 1 is 0.3 and the return is 10%, what is the expected return contribution?

3% Signup and view all the answers

What is the correct summation approach for multiple cash flow states?

Expected CF = Σ(CFi * Pbi) Signup and view all the answers

If an investment involves a cash flow sequence with probabilities 0.3, 0.5, and 0.2, what must the total of probabilities equal?

1 Signup and view all the answers

How is the expected rate of return expressed in a scenario with multiple cash flow states?

Weighted average of cash flows by their probabilities Signup and view all the answers

What is the expected cash flow if the probabilities are 0.3, 0.4, and 0.3 with corresponding cash flows of $200, $300, and $500?

$320 Signup and view all the answers

Study Notes

Expected Return

To calculate the expected return for an investment, use the formula:
(rate of return for state 1 * probability of state 1) + (rate of return for state 2 * probability of state 2) + ... (rate of return for state n * probability of state n)

Standard Deviation of Returns

To calculate the riskiness of an investment, as measured by the standard deviation of returns, use the formula:
(rate of return for state 1 - expected return)^2 * probability of state 1) + (rate of return for state 2 - expected return)^2 * probability of state 2) + ... (rate of return for state n - expected return)^2 * probability of state n)

Variance

The variance is the square of the standard deviation.

Expected Cash Flow

The expected cash flow is an average of all the possible cash flows, weighted by the probability that each cash flow will occur.
The expected cash flow formula:
(cash flow in state 1 * probability of state 1) + (cash flow in state 2 * probability of state 2) + ... (cash flow in state n * probability of state n)

Expected Rate of Return

The expected rate of return is an average of all possible returns, weighted by the probability that each return will occur.
The expected rate of return formula:
(rate of return for state 1 * probability of state 1) + (rate of return for state 2 * probability of state 2) + ... (rate of return for state n * probability of state n)

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Description

This quiz covers key concepts in investment analysis including expected return, standard deviation of returns, variance, and expected cash flow. Understand how to calculate and interpret these financial metrics to assess investment opportunities effectively.