Chapter 13

1. The return on a risky asset which is anticipated being earned in the future is called the _____ return. a. average b. historical c. expected d. geometric e. required

Expected

35. Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities. II. The market rewards investors for diversifiable risk by paying a risk premium. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk. a. I and III only b. II and IV only c. I and IV only d. II and III only e. I, II, and III only

I and III

37. Which of the following statements concerning risk are correct? I. Nondiversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for nondiversifiable risk. IV. Diversifiable risks are those risks you cannot avoid if you are invested in the financial markets. a. I and III only b. II and IV only c. I and II only d. III and IV only e. I, II, and III only

I,III

5. Risk that affects at most a small number of assets is called _____ risk. a. portfolio b. nondiversifiable c. market d. unsystematic e. total

Unsystematic

54. The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly. a. real return b. actual return c. nominal return d. risk premium e. expected return

risk premium

4. Risk that affects a large number of assets is called _____ risk. a. idiosyncratic b. diversifiable c. systematic d. asset-specific e. total

Systematic

44. The systematic risk of the market is measured by: a. a beta of 1.0. b. a beta of 0.0. c. a standard deviation of 1.0. d. a standard deviation of 0.0. e. a variance of 1.0.

a beta of 1

34. Which of the following are examples of diversifiable risk? I. tornado strikes an industrial park in Kansas II. federal government imposes new workplace safety laws III. local government increases property tax rates IV. cost of worker's compensation insurance increases nationwide a. I and III only b. II and IV only c. II and III only d. I and IV only e. I, III, and IV only

I and III

11. The equation of the SML which defines the relationship between the expected return and beta is the: a. capital asset pricing model. b. time value of money equation. c. risk-return model. d. market equation. e. expected risk formula.

Capital Asset pricing model

10. Which one of the following is the slope of the security market line? a. reward-to-risk ratio b. portfolio weight c. beta coefficient d. risk-free interest rate e. market risk premium

Market Risk Premium

17. The expected rate of return on a stock portfolio is a weighted average where the weights are based on the: a. number of shares owned of each stock. b. market price per share of each stock. c. market value of the investment in each stock. d. original amount invested in each stock. e. cost per share of each stock held.

Market Value of the investment in each stock

9. The positively sloped linear function which illustrates the relationship between an asset's expected return and its beta coefficient is the: a. reward-to-risk ratio. b. portfolio weight. c. portfolio risk. d. security market line. e. market risk premium.

Security Market Line

46. Total risk is measured by _____ and systematic risk is measured by _____. a. beta; epsilon b. beta; standard deviation c. epsilon; beta d. standard deviation; beta e. standard deviation; variance

SD Beta

18. The portfolio expected return considers which of the following factors? I. percentage of the portfolio invested in each individual security II. projected states of the economy III. the performance of each security given various economic states IV. probability of occurrence for each state of the economy a. I and III only b. II and IV only c. I, III, and IV only d. II, III, and IV only e. I, II, III, and IV

ALL

15. The expected risk premium on a stock is equal to the expected return on the stock minus the: a. expected market rate of return. b. risk-free rate. c. inflation rate. d. standard deviation. e. variance.

Risk Free Rate

47. The intercept point of the security market line is the rate of return which corresponds to: a. the risk-free rate. b. the market rate. c. a return of zero. d. a return of 1.0 percent. e. the market risk premium.

Risk Free Rate

6. The principle of diversification tells us that: a. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. b. concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. c. spreading an investment across five diverse companies will not lower the total risk. d. spreading an investment across many diverse assets will eliminate all of the systematic risk. e. spreading an investment across many diverse assets will eliminate some of the total risk.

Spreading an investment across many diverse assets will eliminate some total risk

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk. a. efficient markets hypothesis b. systematic risk principle c. open markets theorem d. law of one price e. principle of diversification

Systematic Risk Principle

16. Standard deviation measures _____ risk. a. total b. nondiversifiable c. unsystematic d. systematic e. economic

Total

13. The expected return on a stock given various states of the economy is equal to the: a. highest expected return given any economic state. b. arithmetic average of the returns for each economic state. c. summation of the individual expected rates of return. d. weighted average of the returns for each economic state. e. return for the economic state with the highest probability of occurrence.

Weighted average of the returns at each economic state

49. The market rate of return is eleven percent and the risk-free rate of return is four percent. Treynak stock has three percent more risk than the market and has an actual return of eleven percent. This stock: a. is underpriced. b. is correctly priced. c. will plot below the security market line. d. will plot on the security market line. e. will plot to the left of the overall market on a security market line graph.

Will plot below the security line

30. Which one of the following is least apt to reduce the unsystematic risk of a portfolio? a. adding additional shares of each stock in a portfolio to that portfolio b. adding bonds to a stock portfolio c. adding international securities into a portfolio of U.S. stocks d. adding U.S. Treasury bills to a risky portfolio e. adding technology stocks to a portfolio of utility stocks

adding additional shares of each stock in the portfolio to the portfolio

41. Systematic risk is measured by: a. the mean. b. beta. c. the geometric average. d. the standard deviation. e. the arithmetic average.

beta

28. Unsystematic risk: a. can be effectively eliminated by portfolio diversification. b. is compensated for by the risk premium. c. is measured by beta. d. is measured by standard deviation. e. is related to the overall economy.

can be efffectively eliminated by diversification

32. Which one of the following is another name for systematic risk? a. diversifiable risk b. unique risk c. asset-specific risk d. market risk e. unrewarded risk

market risk

57. Which one of the following should earn the most risk premium based on CAPM? a. diversified portfolio with returns similar to the overall market b. stock with a beta of 1.23 c. stock with a beta of .98 d. U.S. Treasury bill e. portfolio with a beta of 1.16

stock with a beta of 1.23

42. The systematic risk principle implies the _____ an asset depends on that asset's systematic risk. a. variance of the returns on b. standard deviation of the returns on c. expected return on d. total risk assumed by owning e. diversification benefits of

Expected return on

19. The expected return on a portfolio: I. can never exceed the expected return of the best performing security in the portfolio. II. must be equal to or greater than the expected return of the worst performing security in the portfolio. III. is independent of the performance of the overall economy. IV. is independent of the allocation of the portfolio amongst individual securities. a. I and III only b. II and IV only c. I and II only d. I, II, and III only e. I, II, III, and IV

I and II

33. Which one of the following risks is irrelevant to a well-diversified investor? a. systematic risk b. unsystematic risk c. market risk d. nondiversifiable risk e. systematic portion of a surprise

Unsystematic risk

8. The amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset, is called the: a. beta coefficient. b. reward-to-risk ratio. c. risk ratio. d. diversifiable risk. e. Treynor index.

beta-coefficient

21. The standard deviation of a portfolio: a. is a weighted average of the standard deviations of the individual securities which comprise the portfolio. b. can never be less than the standard deviation of the most risky security in the portfolio. c. must be equal to or greater than the lowest standard deviation of any single security held in the portfolio. d. is an arithmetic average of the standard deviations of the individual securities which comprise the portfolio. e. can be less than the standard deviation of the least risky security in the portfolio

can be less than the SD of the least risky security in the portfolio

31. Which one of the following statements is correct concerning unsystematic risk? a. Assuming unsystematic risk is rewarded by the market place. b. Eliminating unsystematic risk is the responsibility of the individual investor. c. Unsystematic risk is rewarded when it exceeds the market level of unsystematic risk. d. The Capital Asset Pricing Model specifically rewards investors for assuming unsystematic risk via the application of beta in the formula. e. The higher the beta, the higher the unsystematic risk.

eliminating unsystematic risk is the responsibility of the individual investor

29. Which one of the following is an example of unsystematic risk? a. the exchange rate rises against the other major currencies b. a national sales tax is adopted c. an explosion occurs at a chemical plant d. the Federal Reserve surprisingly raises interest rates by one quarter of a percent e. consumer spending decreases on a nationwide basis

explosion at a chemical plant

53. The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is referred to as the: a. market rate of return. b. market risk premium. c. systematic return. d. total return. e. real rate of return.

market risk premium

52. The market risk premium is computed by: a. adding the risk-free rate of return to the inflation rate. b. adding the risk-free rate of return to the market rate of return. c. subtracting the risk-free rate of return from the inflation rate. d. subtracting the risk-free rate of return from the market rate of return. e. multiplying the risk-free rate of return by a beta of 1.0.

subtracting the risk free rate of return from the market rate

40. How many diverse securities are required to eliminate the majority of the diversifiable risk from a portfolio? a. 3 b. 5 c. 30 d. 40 e. 50

30

39. Which one of the following indicates a portfolio is being effectively diversified? a. an increase in the portfolio beta b. a decrease in the portfolio beta c. an increase in the portfolio rate of return d. an increase in the portfolio standard deviation e. a decrease in the portfolio standard deviation

A decrease in the portfolio SD

14. The expected return on a stock computed using economic probabilities is: a. guaranteed to equal the actual average return on the stock for the next five years. b. guaranteed to be the minimal rate of return on the stock over the next two years. c. guaranteed to equal the actual return for the immediate twelve month period. d. a mathematical expectation based on a weighted average and not an actual anticipated outcome. e. the actual return you should anticipate as long as the economic forecast remains constant.

A mathematical expectation based on a weighted average and not an actual anticipated outcome

43. Which one of the following statements is correct concerning a portfolio beta? a. Portfolio betas range between 1.0 and +1.0. b. A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio. c. A portfolio beta cannot be computed from the betas of the individual securities comprising the portfolio because some risk is eliminated via diversification. d. A portfolio of U.S. Treasury bills will have a beta of +1.0. e. The beta of a market portfolio is equal to zero.

A portfolio beta is weighted average of the betas of the individual securities

12. The minimum required return on a new risky investment is called the: a. average arithmetic return. b. expected return. c. geometric average return. d. time value of money. e. cost of capital.

Cost of capital

51. The reward-to-risk ratio for stock A exceeds the reward-to-risk ratio of stock B. Stock A has a beta of 1.4 and stock B has a beta of .90. This information implies that: a. stock A is riskier than stock B and both stocks are fairly priced. b. stock A is less risky than stock B and both stocks are fairly priced. c. either stock A is underpriced or stock B is overpriced or both. d. both stock A and stock B are correctly priced since stock A is riskier than stock B. e. either stock A is overpriced or stock B is underpriced or both.

Either stock A is underpriced or B is overpriced or both

38. The primary purpose of portfolio diversification is to: a. increase returns and risks. b. eliminate all risks. C. eliminate asset-specific risk. d. eliminate systematic risk. e. lower both returns and risks.

Eliminate Asset specific risk

23. Which one of the following statements is correct concerning a portfolio of multiple securities and multiple states of the economy when both the securities and the economic states have unequal weights? a. Given multiple economic states with unequal weights, it is impossible for the portfolio standard deviation to be less than the lowest standard deviation for any one security contained in the portfolio. b. The weights of the individual securities have no effect on the expected return of a portfolio when multiple states of the economy are involved. c. Changing the probabilities of occurrence for the various economic states will not affect the expected standard deviation of the portfolio. d. The standard deviation of the portfolio can be greater than the standard deviation of any single security in the portfolio given that the individual securities are well diversified. e. Given both the unequal weights of the securities and the unequal weights of the economic states, a portfolio can be created that has an expected standard deviation of zero.

Given both the unequal weights of the securities and the unequal weights of the economic states, a portfolio can be created that has an expected standard deviation of zero.

22. Which of the following are included in the computation of a portfolio's standard deviation? I. weight assigned to each security comprising the portfolio II. weighted average of the standard deviations of the individual securities held in the portfolio III. probability of occurrence for each economic state of the economy IV. rate of return for each individual security held in the portfolio for each economic state a. II only b. III and IV only c. I, III, and IV only d. I, II, and IV only e. I, II, III, and IV

I,III,IV

45. Which of the following variables do you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. asset standard deviation II. asset beta III. risk-free rate of return IV. market risk premium a. I and III only b. II and IV only c. III and IV only d. I, III, and IV only e. I, II, III, and IV

II,IV

36. Which of the following are examples of diversifiable risks? I. the inflation rate spikes suddenly II. terrorists strike the United States III. the price of corn increases due to a nationwide drought IV. taxes are increased on hotel room rentals a. I and III only b. II and IV only c. I and II only d. III and IV only e. I, II, and IV only

III,IV

27. Which one of the following is an example of systematic risk? a. coal miners go on strike against Deep Vein Coal Company b. Baker's Dozen experiences a kitchen fire which halts operations c. inflation unexpectedly increases by 1.5 percent in the U.S. d. government inspectors stop production at a meat packing plant e. localized flooding affects corn production

Inflation unexpectedly increases by 1.5 percent

56. According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the: a. amount of total risk assumed and the market risk premium. b. market risk premium and the amount of systematic risk inherent in the security. c. risk free rate, the market rate of return, and the standard deviation of the security. d. beta of the security and the market rate of return. e. beta of the security and the risk-free rate of return.

Market risk premium and the amount of systematic risk inherent in the security

25. Which one of the following statements is correct? a. The unexpected return is always negative. b. The expected return minus the unexpected return is equal to the total return. c. Over time, the average return is equal to the unexpected return. d. The expected return includes the surprise portion of news announcements. e. Over time, the average unexpected return will be zero.

Over time the average unexpected return will be zero

2. A group of assets, such as stocks and bonds, held by an investor is called a(n): a. index. b. portfolio. c. collection. d. grouping. e. tranche.

Portfolio

3. The percentage of a portfolio's total value invested in a particular asset is called that asset's: a. portfolio return. b. portfolio weight. c. degree of risk. d. composite value. e. index value.

Portfolio Weight

24. Which one of the following events would be included in the expected return on Delta stock? a. The directors of Delta just fired the CEO because of remarks he made this morning to one of the directors. b. A fire just destroyed Delta's main distribution warehouse which will directly impact the firm's sales for at least six months. c. This morning, Delta confirmed that its CEO is retiring at the end of the year as anticipated. d. The price of Delta stock suddenly dropped due to rumors concerning company fraud. e. Delta's research department just announced that they accidentally discovered a new substance which could replace plastic in a few years.

This moning delta confimed its CEO is retiring

26. Which one of the following is true concerning unexpected returns? a. All announcements by a firm affect that firm's unexpected returns. b. Unexpected returns over time have a negative effect on the total return of a firm. c. Unexpected returns are relatively predictable in the short-term. d. Unexpected returns generally cause the actual return to vary significantly from the expected return over the long-term. e. Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term

Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term

55. The capital asset pricing model (CAPM) assumes: I. a risk-free asset has no systematic risk. II. beta is a reliable estimate of total risk. III. the risk-to-reward ratio is constant. IV. the market rate of return can be approximated. a. I and III only b. II and IV only c. I, III, and IV only d. II, III, and IV only e. I, II, III, and IV

c

20. If a stock portfolio is well diversified, then the portfolio variance: a. will equal the variance of the most volatile stock in the portfolio. b. may be less than the variance of the least risky stock in the portfolio. c. must be equal to or greater than the variance of the least risky stock in the portfolio. d. will be a weighted average of the variances of the individual securities in the portfolio. e. will be an arithmetic average of the variance of the individual securities in the portfolio.

may be less than the variance of the least risky stock in the whole portfolio

50. If the market is efficient and securities are priced fairly then the _____ will be constant for all securities. a. systematic risk b. standard deviation c. reward-to-risk ratio d. beta e. risk premium

reward to risk ratio

48. A stock with an actual return that lies above the security market line has: a. more systematic risk than the overall market. b. more risk than warranted based on the realized rate of return. c. yielded a higher return than expected for the level of risk assumed. d. less systematic risk than the overall market. e. yielded a return equivalent to the level of risk assumed.

yielded a higher return than the expected for the level of risk