Chapter 11 Study Guide

Which one of the following is the slope of the security market line?

Market risk premium

Based on the capital asset pricing model, investors are compensated based on which of the following?

Market risk premium Portfolio beta Risk free rate

If a security plots to the right and below the security market line, then the security has _______ systematic risk than the market and is _______.

More; overpriced

Assume you own a portfolio of diverse securities which are each correctly priced. Given this, the reward-to-risk ratio:

Of each security must equal the slope of the security market line

Systematic risk is:

Measured by beta

The addition of a risky security to a fully diversified portfolio:

May or may not affect the portfolio beta

The expected return on a security is currently based on a 22 percent chance of a 15 percent return given an economic boom and 78 percent change of a 12 percent return given a normal economy. Which of the following changes will decrease the expected return on this security?

1) A decrease in the rate of return given a normal economy 2) An increase in the probability of a normal economy

Which of the following terms can be used to describe unsystematic risk?

1) Asset specific risk 2) Diversifiable risk 3) Unique risk

A risky security has less risk than the overall market. What must the beta of this security be?

>0 but < 1

A stock is expected to return 13 percent in an economic boom, 10 percent in a normal economy, and 3 percent in a recessionary economy. Which one of the following will lower the overall expected rate of return on this stock?

A decrease in the probability of an economic boom

Which one of the following statements is correct?

An underpriced security will plot above the security market line

Which one of the following is the computation of the risk premium for an individual security?

B[E(Rm)-Rf]

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to that in an average risky asset?

Beta coefficient

The capital asset pricing model:

Considers the time value of money

Which one of the following is the minimum required rate of return on a new investment that makes the investment attractive?

Cost of capital

Which of the following statements is correct?

If a risky security is correctly prices, its expected risk premium will be positive

Which one of the following is the best example of systematic risk?

Decrease in gross domestic product

Which one of the following terms best refers to the practice of investing in a variety of diverse assets as a means of reducing risk?

Diversification

Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock. Which one of the following best describes the 16.5 percent rate?

Expected Return

Which one of the following best describes a portfolio?

Group of assets held by an investor

Which one of the following is an example of systematic risk?

Increase in consumption created by a reduction in personal tax rates

World United stock currently plots of the security market line and has a beta of 1.05. Which one of the following will increase that stock's rate of return without affecting the risk level of the stock, all else constant?

Increase in the market risk to reward ratio

Julie wants to create a $5,000 portfolio. She also wants to invest as much as possible in a high risk stock with the hope of earning a high rate of return. However, she wants her portfolio to have no more risk than the overall market. Which one of the following portfolios are most apt to meet all of her objectives?

Invest $2,500 in a risk free asset and $2,500 in a stock with a beta of 2.0

Stock A compromises 28 percent on Susan's portfolio. Which one of the following terms applies to the 28 percent?

Portfolio weight

Which one of the following is the best example of an announcement that is most apt to result in an unexpected return?

Statement by a firm that it has just discovered a manufacturing defect and is recalling its product

The risk premium for an individual security is based on which one of the following types of risk?

Systematic

The beta of a risky portfolio cannot be less than _______ nor greater than _______.

The lowest individual beta in the portfolio; the highest individual beta in the portfolio

Consider a portfolio comprised of four risky securities. Assume the economy has three states with varying probabilities of occurrence. Which one of the following will guarantee that the portfolio variance will equal zero?

The portfolio expected rate of return must be the same for each economic state

You are assigned the task of computing the expected return on a portfolio containing several individual stocks. Which one of the following statements is correct concerning this task?

The summation of the return deviation from the portfolio expected return for each economic state must equal zero

Standard deviation measures _________ risk while beta measures _______ risk.

Total; systematic

Portfolio diversification eliminates which one of the following?

Unsystematic risk

A portfolio is compromised of 35 securities with varying betas. The lowest beta for an individual security is .74 and the highest of the security betas of 1.51. Given this information, you know that the portfolio beta:

Will be greater than or equal to .74 but less than or equal to 1.51

Which one of the following represents the amount of compensation an investor should expect to receive for accepting the unsystematic risk associated with an individual security?

Zero

Which of the following statements related to the security market line is correct?

A security with a beta of 1.54 will plot on the security market line if it is correctly priced

Based on the capital asset pricing model, which one of the following must increase the expected return on an individual security, all else constant?

A decrease in the risk free rate given a security beta of 1.06

Which of the following portfolios will have a beta of zero?

A portfolio comprised solely of US treasury bills

Which one of the following is the best example of unsystematic risk?

A warehouse fire

The security market line is a linear function that is graphed by plotting data points based on the relationship between which two of the following variables?

Expected return and beta

The security market line is defined as a positively sloped straight line that displays the relationship between which two of the following variables?

Expected return and beta

The systematic risk principle states that the expected return on a risky asset depends only on which one of the following?

Market risk

Diversifiying a portfolio across various sectors and industries might do more than one of the following. However, this diversification must do which one of the following?

Reduce the portfolio's unique risk

Which one of the following is the vertical intercept of the security market line?

Risk free rate

The expected return on a security depends on which of the following?

Risk free rate of return Market rate of return

Which one of the following describes systematic risk?

Risk that affects a large number of assets

The expected rate of return on Delaware Shores, Inc. stock is based on three possible states of the economy. These states are boom, normal, and recession which have probabilities of occurrence of 20 percent, 75 percent, and 5 percent respectively. Which one of the following statements is correct concerning the variance of the returns on this stock?

The variance must be positive provided that each state of the economy produces a different expected rate of return

Which of the following best exemplifies unsystematic risk?

Unexpected increase in the variable cost for a firm