NISM Series XV Chapter 12: Fundamentals of Risk and Return Practice Questions

Question 1

What is the relationship between bond prices and interest rates, as described in the text?

Accepted Answer

They have an inverse (negative) relationship.. The text explicitly states, 'Bond prices and interest rates have an inverse relationship.'

Question 2

An investor earned a simple return of 23% over an investment period of 15 months. Based on the method described in the text, what would be the simple annualized return for this investment?

Accepted Answer

18.4%. The simple annualized return is calculated as (Holding Period Return / Number of Months Held) x 12. So, (23% / 15) x 12 = 18.4%. This calculation is provided in the text as an example

Question 3

Which of the following statements about Compounded Annual Growth Rate (CAGR) is FALSE, according to the text?

Accepted Answer

CAGR is the accepted standard measure of return for periods less than one year.. The text states: 'CAGR is the accepted standard measure of return on investment in financial markets, except in case of returns that involve periods of less than one year.'

Question 4

Which type of investment is NOT subject to market risk, according to the text?

Accepted Answer

Deposits or small savings schemes.. The text states, 'Investments such as deposits or small savings schemes are not marketable securities, and the investor gets a pre-defined amount on maturity. They have no market risk.'

Question 5

Which of the following is NOT explicitly mentioned as a form of return from an investment in the provided text?

Accepted Answer

Tax benefits. The text explicitly mentions interest, dividends, and rent as forms of periodic payouts, and appreciation in value. Tax benefits are not mentioned as a form of return

Question 6

All of the following are mentioned as manifestations of business risk EXCEPT:

Accepted Answer

Credit risk.. The text lists 'Commodity risk (fluctuations in cost of raw materials), Operations risk (Unexpected changes in employee costs due to attrition and retraining), Competition Risk, (due to introduction and position of competing products), Supply Chain Risks (arising due to marketing and distribution related aspects), Currency Risk (due to fluctuation of exchange rates in business entities engaged in International Business)' as manifestations of business risk. Credit risk is identified as a separate category of risk

Question 7

If the Reserve Bank of India cuts policy interest rates, what is the likely immediate effect on existing bond prices, according to the text?

Accepted Answer

Existing bond prices will rise.. The text explicitly states: 'If interest rates fall, or are expected to fall, bond prices go up.'

Question 8

What is primarily defined as risk in an investment according to the provided text?

Accepted Answer

The volatility and uncertainty in the returns, and in extreme cases, the loss of capital invested.. The text states, 'Risk in an investment is the volatility and uncertainty in the returns and in the extreme case, the loss of capital invested.'

Question 9

An investor bought an investment for Rs. 5000 and sold it after 3 years for Rs. 6500, having received no intermediate cash flows. Which formula correctly represents the calculation for the Compounded Annual Growth Rate (CAGR) for this investment?

Accepted Answer

( (6500 / 5000) ^ (1/3) ) - 1. The text provides the CAGR formula as: '{(End Value/Beginning Value) ^(1/n)}-1, where n is the holding period in years.' In this case, End Value = 6500, Beginning Value = 5000, and n = 3 years

Question 10

Why is inflation risk considered highest in fixed return instruments like bonds and fixed deposits?

Accepted Answer

Because the real value of the investment can be eroded even without default risk.. The text explains, 'Inflation risk is highest in fixed return instruments... Both interest payments and principal repayments are amounts fixed in absolute terms... Thus, even if there is no risk of default on payment of interest or return of principal, the real value of the investment has been eroded because of inflation.'

Question 11

In which type of investment is inflation risk (or purchasing power risk) typically highest?

Accepted Answer

Fixed return instruments like bonds and fixed deposits. The text states, 'Inflation risk is highest in fixed return instruments, such as bonds, fixed deposits and debentures, where investors are paid a fixed periodic interest and returned the principal amount at maturity.'

Question 12

According to the text, which of the following best defines 'risk' in an investment?

Accepted Answer

The difference between expected and actual returns, along with volatility and uncertainty.. The text states, 'Risk in an investment is the volatility and uncertainty in the returns and in the extreme case, the loss of capital invested. An investment is also deemed to be risky if the actual returns earned are different from the expected returns.'

Question 13

Which of the following is NOT explicitly mentioned as a form of return from an investment in the provided text?

Accepted Answer

Tax benefits from investment.. The text mentions 'periodic payouts such as interest, dividends and rent, or in the form of appreciation in the value of the investments.' Tax benefits are not listed as a form of return

Question 14

Why are fixed return instruments, such as bonds and fixed deposits, considered to have the highest inflation risk?

Accepted Answer

Because the interest payments and principal repayments are fixed in nominal terms, leading to a decline in their real value if inflation rises.. The text states that inflation risk is highest in fixed return instruments because 'Both interest payments and principal repayments are amounts fixed in absolute terms,' meaning their real value erodes with inflation

Question 15

An investor purchased 150 shares of company ABC at Rs. 25 per share, paying a Rs. 20 commission. Based on the example provided in the text, what was the total cost incurred for this investment?

Accepted Answer

Rs. 3,770. The text provides the exact calculation: 'Total Cost = shares x price per share + commission fee = 150 x Rs.25 + Rs.20 = Rs.3, 770'

Question 16

What is a key characteristic of the Compounded Annual Growth Rate (CAGR) as described in the text?

Accepted Answer

It is a smoothened average annual rate, assuming periodic returns are re-invested.. The text states, 'CAGR calculations assume that the periodic returns received from an investment are re-invested to earn returns...' and 'CAGR is the smoothened rate of return at which the return grew to the final value over the investment period. The actual return in each year of the holding period may be different from the CAGR.' It is explicitly stated that CAGR is not used for periods less than one year

Question 17

Which specific type of risk is explicitly mentioned in the text as being efficiently diversified by holding a diversified portfolio of various businesses?

Accepted Answer

Business Risk. Under the 'Business Risk' section, the text states: 'Holding a diversified portfolio various business is an efficient way to diversify this risk.'

Question 18

Which of the following components are considered part of the total returns from an investment, according to the text?

Accepted Answer

Both periodic payouts and the appreciation (or depreciation) in the value of the investment.. The text explicitly states that returns can be in the form of periodic payouts (interest, dividends, rent) or appreciation in value, and together they form the total returns

Question 19

According to the text, which of the following forms part of the total returns from an investment?

Accepted Answer

Both periodic payouts and appreciation in the value of the investment.. The text states, 'The returns from an investment can be in the form of periodic payouts such as interest, dividends and rent, or in the form of appreciation in the value of the investments. ... Together, they form the total returns from the investment.'

Question 20

Which types of investments are generally NOT subject to market risk, according to the text?

Accepted Answer

Deposits or small savings schemes. The text states, 'Investments such as deposits or small savings schemes are not marketable securities, and the investor gets a pre-defined amount on maturity. They have no market risk...'

Question 21

Why is it difficult to compare investments held for different periods using only holding period return?

Accepted Answer

Holding period return does not consider the time duration over which the return was earned.. The text states, 'Return that does not take the investment horizon into consideration makes it difficult to compare between investments that have been held for different periods.'

Question 22

Which of the following is NOT listed as a manifestation of business risk in the provided text?

Accepted Answer

Market risk. The text lists Commodity risk, Operations risk, Competition Risk, Supply Chain Risks, and Currency Risk as manifestations of business risk. Market risk is discussed as a separate category of risk

Question 23

Based on the provided text, which type of investment is typically most susceptible to inflation risk, and why?

Accepted Answer

Fixed return instruments like bonds, because their fixed payments lose purchasing power.. The text states, 'Inflation risk is highest in fixed return instruments, such as bonds, fixed deposits and debentures, where investors are paid a fixed periodic interest and returned the principal amount at maturity. Both interest payments and principal repayments are amounts fixed in absolute terms.'

Question 24

According to the text, what is the relationship between bond prices and interest rates?

Accepted Answer

They have an inverse relationship.. The text clearly states: 'Bond prices and interest rates have an inverse relationship.'

Question 25

Why is the simple annualized return calculation often not an appropriate estimation of interest earned compared to Compounded Annual Growth Rate (CAGR)?

Accepted Answer

It does not account for the compounding effect of return generation.. The text states, 'The above annualized return calculation would not be an appropriate estimation of interest earned, because it does not consider the compounding effect of the return generation process of financial investment.'

Question 26

What key financial concept does the Compounded Annual Growth Rate (CAGR) method incorporate that simple annualized return does not?

Accepted Answer

The compounding effect of return generation and time value of money. The text mentions that CAGR takes into consideration 'the compounding effect of the return generation process of financial investment' and 'Time value of money'

Question 27

According to the text, what is the relationship between bond prices and interest rates?

Accepted Answer

They have an inverse relationship; as interest rates rise, bond prices fall.. The text explicitly states, 'Bond prices and interest rates have an inverse relationship.' It further elaborates that if interest rates rise, bond prices decline

Question 28

How does an increase in interest rates generally affect equity markets, according to the text?

Accepted Answer

It increases the cost of borrowing for companies, which can reduce profits and cash flows to equity investors, pushing prices down.. The text explains that when interest rates go up, the cost of borrowing increases, leading to lesser capex and declining profits. This reduces cash flows to equity investors, which in turn reduces demand for equity and pushes prices down

Question 29

What is one of the primary purposes of calculating returns from an investment, as stated in the text?

Accepted Answer

To help investors compare different investments on the basis of returns.. The text states that calculating returns helps investors 'compare different investments on the basis of returns' and 'evaluate the performance of an investment relative to benchmark'

Question 30

How is Return on Investment (RoI) calculated over a particular period, according to the text?

Accepted Answer

(Total Returns / Total Cost) x 100. The text states, 'The RoI calculated as (Total Returns/Total Cost) x 100, is the return earned over a particular period.'

Question 31

For calculating the CAGR of an investment involving multiple intermediate cash inflows and final sale proceeds, what method is specifically recommended by the text?

Accepted Answer

Using the XIRR function in Excel.. The text states, 'This problem cannot be solved using the direct CAGR formula. The underlying CAGR for these multiple flows has to be calculated by using XIRR function in Excel.'

Question 32

What is another name for Inflation Risk, as mentioned in the provided text?

Accepted Answer

Purchasing Power Risk. The text states: 'Inflation risk is also known as purchasing power risk.'

Question 33

According to the text, why is it important for an investor to identify the type of risk in an investment?

Accepted Answer

To decide whether the investment is suitable for their situation.. The text states, 'It is important for an investor to be able to identify the type of risk in an investment to be able to decide whether it is suitable to their situation.'

Question 34

Inflation risk is also known by which other term, as mentioned in the text?

Accepted Answer

Purchasing power risk.. The text explicitly states, 'Inflation risk is also known as purchasing power risk.'

Question 35

What is considered 'risk' in an investment, according to the provided text?

Accepted Answer

The volatility and uncertainty in the returns, and the potential loss of capital.. The text defines risk as 'the volatility and uncertainty in the returns and in the extreme case, the loss of capital invested.'

Ch.12: Fundamentals of Risk and Return

What You Will Learn in This Chapter

Multiple Choice Questions (35)

Case-Based Questions (2 sets)

Most candidates guess their way through XV.
BullWiser makes you prove it.

Ch.12: Fundamentals of Risk and Return

What You Will Learn in This Chapter

Multiple Choice Questions (35)

Case-Based Questions (2 sets)

Most candidates guess their way through XV.BullWiser makes you prove it.

Most candidates guess their way through XV.
BullWiser makes you prove it.