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Foundations of Finance, 7e (Keown) Chapter 6 The Meaning and Measurement of Risk and Return 6.1 Learning Objective 1 True or False 1) Accounting profits is the most relevant variable the financial manager uses to measure returns. Answer: FALSE Diff: 1 Keywords: Accounting Profits, Cash Flows, Returns 2) Cash flows is the most relevant variable to measure the returns on debt instruments, while GAAP net income is the most relevant variable to measure the returns on common stock. Answer: FALSE Diff: 1 Keywords: Return, Cash Flow, Net Income 3) The expected rate of return from an investment is equal to the expected cash flows divided by the initial investment. Answer: TRUE Diff: 1 Keywords: Expected Rate of Return, Expected Cash Flows 4) Actual returns are always less than expected returns because actual returns are determined at the end of the period and must be discounted back to present value. Answer: FALSE Diff: 1 Keywords: Actual Returns, Expected Returns 5) Another name for an asset's expected rate of return is holding-period return. Answer: FALSE Diff: 1 Keywords: Holding Period Return, Expected Return 6) The realized rate of return, or holding period return, is equal to the holding period dollar gain divided by the price at the beginning of the period. Answer: TRUE Diff: 1 Keywords: Holding Period Return, Holding Period Dollar Gain 7) The risk-return tradeoff that investors face on a day-to-day basis is based on realized rates of return because expected returns involve too much uncertainty. Answer: FALSE Diff: 2 Keywords: Realized Rate of Return, Expected Rate of Return 1 Copyright 2011 Pearson Education, Inc. Multiple Choice 1) Stock A has the following returns for various states of the economy: State of the Economy Probability Stock A's Return Recession 10%-30% Below Average 20%-2% Average 40% 10% Above Average 20% 18% Boom 10% 40% Stock A's expected return is: A) 5.4%. B) 7.2%. C) 8.2%. D) 9.6% Answer: C Diff: 1 Keywords: Expected Return, Probability 2) Stock A has the following returns for various states of the economy: State of the Economy Probability Stock A's Return Recession 9%-72% Below Average 16%-15% Average 51% 16% Above Average 14% 35% Boom 10% 85% Stock A's expected return is: A) 9.9%. B) 12.7%. C) 13.8%. D) 16.5%. Answer: B Diff: 1 Keywords: Expected Return 2 Copyright 2011 Pearson Education, Inc. 3) You are considering a sales job that pays you on a commission basis or a salaried position that pays you \$50,000 per year. Historical data suggests the following probability distribution for your commission income. Which job has the higher expected income? Probability of Commission Occurrence \$15,000 .15 \$35,000 .20 \$48,000 .35 \$67,000 .22 \$80,000 .18 A) The salary of \$50,000 is greater than the expected commission of \$49,630.... View Full Document

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