Question 1
Multiple ChoiceOver extended time periods, which of the following best describes the performance characteristics of long-term government bonds compared to small-cap equities?
Explanation
Historically, long-term government bonds have provided lower average annual returns and lower volatility (measured by standard deviation of returns) compared to small-cap equities. Equities, especially small-cap stocks, have tended to offer higher returns but with significantly more risk over long horizons.
Question 2
Multiple ChoiceWhich of the following best describes the historical relationship between average annual returns and volatility (standard deviation) among U.S. asset classes?
Explanation
Data from U.S. markets over long periods (e.g., 1926–2008) shows a positive relationship between risk and return: asset classes like small-cap stocks have shown higher average returns and higher standard deviations, while T-bills and bonds have exhibited lower returns and lower volatility.
Question 3
Multiple ChoiceStock A Stock B
E(R) 0.07 0.11
\sigma^{2} 0.0036 0.0025
COV_{A,B} =0.002
The correlation between the returns of Stock A and Stock B is closest to:
Explanation
To calculate the correlation coefficient, use the formula:
ρ = Cov(X,Y) / (σX × σY)
σX = √0.0036 = 0.06
σY = √0.0025 = 0.05
So,
ρ = 0.002 / (0.06 × 0.05) = 0.002 / 0.003 = 0.67
Question 4
Multiple ChoiceWhich of the following U.S. asset classes has historically demonstrated the lowest volatility, as measured by the standard deviation of monthly returns?
Explanation
Treasury bills have historically exhibited the lowest standard deviation of returns among major asset classes due to their short maturity and low default risk. In contrast, small-cap stocks and longer-term bonds typically show higher volatility due to greater exposure to market and interest rate risks.