Chapter 13

The measure of risk is best described as

• potential loss

• the variability of outcomes around some expected value

• the probability of expected values

• the potential expected loss

Which of the following is a false statement?

• Risky investments may produce large losses

• Risky investments may produce large gains

• The coefficient of variation is a risk measure

• Risk-averse investors cannot be induced to invest in risky assets

If one project has a higher standard deviation than another,

• it may have a lower risk

• it may have a lower expected value

• it has fewer possible outcomes

• it may be riskier, but this can only be determined by the coefficient of variation

A project has the following projected outcomes in dollars: $250, $350, and $500. The probabilities of their outcomes are 25%, 50%, and 25%, respectively. What is the expected value of these outcomes?

D P DP

250 0.25 62.5

350 0.50 175.0

500 0.25 125.0

362.5

• $362.5

• $89.4

• $94.5

• $178.3

Modigliani and Associates has forecasted the following payoffs from a project:

Outcome Probability of Outcome Assumptions

$ 0 20% pessimistic

$ 3,500 60% moderately successful

$ 6,000 20% optimistic

What is the expected value of the outcomes?

D=∑ DP

D P DP

$0 0.20 0

$ 3,500 0.60 2,100

$ 6,000 0.20 1,200

$ 3,300 =%media:2formula6.mml%

• $0

• $3,300

• $3,700

• Cannot be determined. Depends upon which prediction is correct

The coefficient of variation (V) can be defined as the

• expected value multiplied by the standard deviation

• standard deviation divided by the mean (expected value)

• mean (expected value) divided by the standard deviation

• standard deviation squared, divided by the expected value

In determining the appropriate discount rate for an individual project, the financial manager will be most influenced by the

• expected value

• internal rate of return

• standard deviation

• coefficient of variation

A project’s coefficient of variation is 0.55. The project has a positive coefficient of correlation of 0.20. The expected value is $1,200. What is the standard deviation?

V=σ/D

0.55=σ/$1,200

σ=$660

• $400

• $220

• $660

• $1,200

A project’s cash flows have a beta of 1.2, a standard deviation of $340, and a coefficient of variation of 0.40. What is the expected cash flow?

V=σ/D

0.4=$340/D

D=$850

• $850

• $167

• $2,400

• $500

Risk may be integrated into capital budgeting decisions by

• adjusting the standard deviation of possible outcomes

• determining the expected value

• adjusting the discount rate

• adjusting the time horizon