fin 3312 exam 2

CAPM shows that the expected return for an asset depends on which three things?

- The pure time value of money - The reward for bearing systematic risk - The amount of systematic risk

As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?

- likely to decrease - eventually be almost totally eliminated

The systematic risk principle argues that the market does not reward risks:

-borne unnecessarily -diversifiable market ONLY rewards systematic risk

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

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

> 0 but < 1

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 one of the following is the hypothesis that securities markets are efficient?

Efficient markets hypothesis

What is a risk premium?

It is additional compensation for taking risk, over and above the risk-free rate

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 is has just discovered a manufacturing defect and is recalling its product

The rate of return on which one of the following is used as the risk-free rate?

U.S. Treasury bill

percentage returns are NOT

difficult to compute

The security market line is defined as a positively sloped straight line that displays the relationship between the: -risk premium and beta of a portfolio -systematic and unsystematic risks of a security -beta and standard deviation of a portfolio -nominal and real rates of return -expected return and beta of either a security or a portfolio

expected return and beta of either a security or a portfolio

which statement is true? A. The expected rate of return on any portfolio must be positive B. The arithmetic average of the betas for each security held in a portfolio must equal 1.0 C. The beta of any portfolio must be 1.0 D. The weights of the securities held in any portfolio must equal 1.0 E. The standard deviation of any portfolio must equal 1.0

D. The weights of the securities held in any portfolio must equal 1.0

Which one of the following combinations will always result in an increased dividend yield?

Decrease in the stock price combined with a higher dividend amount

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

Based on the capital asset pricing model, investors are compensated based on which of the following? I. Market risk premium II. Portfolio standard deviation III. Portfolio beta IV. Risk-free rate

I, III, and IV only

Which one of the following statements is correct?

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

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 is 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

Which of the following are examples of a portfolio?

Investing $100,000 in a combination of US and Asian stocks Investing $100,000 in the stocks of 50 publicly traded corporations Investing $100,000 in a combination of stocks and bonds

Which one of the following statements is correct concerning both the dollar return and the percentage return on a stock investment?

The dollar return is dependent on the size of the investment while the percentage return is not

Which one of the following statements is correct?

The higher the expected rate of return, the wider the distribution of returns

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

Systematic/Market-related/Nondiversifiable Risk (all the same)

The portion of a security's risk or variability that can't be eliminated through investor diversification. This type of variability or risk results from factors that affect all securities.

If you wish to create a portfolio of stocks, what is the required minimum number of stocks?

You must invest in stocks of more than one corporation.

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

According to the efficient markets hypothesis, professional investors will earn:

a dollar return equal to the value paid for an investment

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

a portfolio comprised sole of U.S. Treasury bills

Which one 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 prices

The variance is the average squared difference between which of the following?

actual return and average return

In an efficient market ________ investments have a _______ NPV

all, zero

examples of systematic risk

changes in GDP, inflation, interest rates, regulatory changes in tax rates

Which one of the following best describes a portfolio?

group of assets held by an investor

Risk-averse investors want the ____________ return for the _______________ risk

highest, lowest

World United stock currently plots on the security market line and has a beta of 1.04. 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

If the dispersion of returns on a particular security is very spread out from the security's mean return, the security ______

is highly risky

The lower the standard deviation of returns on a security, the _____ the expected rate of return and the _____ the risk.

lower; lower

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

market risk

Unsystematic risk can be defined by all of the following except: -firm-specific risk -market risk -asset-specific risk -diversifiable risk -unique risk -unrewarded risk

market risk

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

Stock A has an expected return of 12% and a standard deviation of 22%. Stock B has an expected return of 10% and a standard deviation of 15%. Which would be preferred by every risk-averse investors?

neither

When, if ever, will the geometric average return exceed the arithmetic average return for a given set of returns?

never

Which one of the following is defined as a bell-shaped frequency distribution that is defined by its average and its standard deviation?

normal distribution

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

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

portfolio weight

The risk ________ can be interpreted as the reward for bearing risk

premium

Investors require a 4 percent return on risk-free investments. On a particular risky investment, investors require an excess return of 7 percent in addition to the risk-free rate of 4 percent. What is this excess return called?

risk premium

If an asset has a reward-to-risk ratio of 6.0%, that means it has a __________ of 6.0% per unit of _______

risk premium, systematic risk

Stock A has an expected return of 12% and a standard deviation of 22%. Stock B has an expected return of 12% and a standard deviation of 15%. Which would be preferred by every risk-averse investors?

stock B

If the financial markets are efficient then:

stock prices should respond only to unexpected news and events

One year ago, you purchased 100 shares of a stock. This morning you sold those shares and realized a total return of 8.2 percent. Given this information, you know for sure the:

sum of the dividend yield and the capital gains yield is 8.2 percent

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

systematic

even if the portfolio is well diversified, the investor is still exposed to _____ risk

systematic

Beta measures _________________ risk

systematic, market, ______

"the market has already discounted the announcement" means

the announcement isnt news ---> less impact on market

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

Assume the securities markets are strong form efficient. Given this assumption, you should expect which one of the following to occur?

the prices of each security in the market will frequently fluctuate

systematic risk principle

the reward for bearing risk depends only on the systematic risk of an investment

unanticipated part of the return is...

the true risk

Standard Deviation measures ______________ risk

total

Market risk and unsystematic risk are the two components of risky return in the ______

total return equation

Standard deviation measures _____ risk while beta measures _____ risk.

total; systematic

T/F The expected return is the return that an investor expects to earn on a risky asset in the future

true

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 one of the following is the computation of the risk premium for an individual security? E(R) is the expected return on the security, Rf is the risk-free rate, β is the security's beta, and E(RM) is the expected rate of return on the market.

β[E(RM) - Rf]

Which one of the following is an example of systematic risk? A. Major layoff by a regional manufacturer of power boats B. Increase in consumption created by a reduction in personal tax rates C. Surprise firing of a firm's chief financial officer D. Closure of a major retail chain of stores E. Product recall by one manufacturer

B. increase in consumption created by a reduction in personal tax rates

Which one of the following is the best example of unsystematic risk? A. Inflation exceeding market expectations B. warehouse fire C. Decrease in corporate tax rates D. Increase in consumer spending E. Decrease in the value of the dollar

B. warehouse fire

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

risk-free rate

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

Which type of stock price adjustment time path occurs when there is a bubble (price run up) in the path followed by a decline after the market receives information about the stock? A. Delayed reaction B. Efficient market reaction C. Overreaction and correction

C. overreaction and correction

Which one of the following statements is correct? A. The risk premium on a risk-free security is generally considered to be one percent. B. The expected rate of return on any security, given multiple states of the economy, must be positive. C. There is an inverse relationship between the level of risk and the risk premium given a risky security. D. If a risky security is correctly priced, its expected risk premium will be positive. E. If a risky security is priced correctly, it will have an expected return equal to the risk-free rate

D. If a risky security is correctly priced, its expected risk premium will be positive.

The expected return on a security depends on which of the following? I. Risk-free rate of return II. Amount of the security's unique risk III Market rate of return IV. Standard deviation of returns

I and III only

Percentage returns: I. are easy to understand. II. relay info about a security more easily than dollar returns do. III. are not affected by the amount of the investment. IV. easily separated into dividend yield and capital gain yield.

I, II, III, and IV

Which one of the following best describes an arithmetic average return?

Return earned in an average year over a multiyear period

Which one of the following could cause the total return on an investment to be a negative rate?

Stock price that declines over the investment period

New Labs just announced that it has received a patent for a product that will eliminate all flu viruses. This news is totally unexpected and viewed as a major medical advancement. Which one of the following reactions to this announcement indicates the market for New Labs stock is efficient?

The price of New Labs stock increases rapidly to a higher price and then remains at the price

Which one of the following describes systemic risk?

risk that affects a large number of assets

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

Which one of the following statements is correct?

an underpriced security will plot above the security market line

An efficient capital market is best defined as a market in which security prices reflect which one of the following?

available information

The average return on the stock market can be used to ______

compare stock returns with the returns of other securities

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 that investment attractive? -Risk-free rate -Expected return minus the risk-free rate -Market risk premium -Market rate of return -Cost of capital

cost of capital

Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio _____

declines

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

systematic risk is unaffected by _____

diversification

what two factors determine a stock's total return

expected return and unexpected return

An efficient market is one in which any change in available information will be reflected in the company's stock price _____

immediately

examples of unsystematic risk

labor strikes, part shortages, increase in competition in the industry (economy wide effects)

The slope of the security market line represents the: -market rate of return -market risk premium -risk premium on an individual asset -beta coefficient -risk-free rate

market risk premium

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

may or may not affect the portfolio beta

Systematic risk is:

measured by beta

Which one of the following is the positive square root of the variance?

standard deviation

to get the average return, the yearly returns are ______ and then ______ by the number of returns

summed, divided

Which one of the following best exemplifies unsystematic risk?

unexpected increase in the variable costs for a firm

Portfolio diversification eliminates which one of the following?

unsystematic risk

The standard deviation measures the _____ of a security's returns over time.

volatility

A portfolio is comprised of 35 securities with varying betas. The lowest beta for an individual security is 0.74 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