FINA Chapter 11: Risk and Return

A portfolio is:

a group of assets held by an investor.

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]

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

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

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

Which statement is correct? (security)

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

Which statement is correct? (security)

An underpriced security will plot above the security market line.

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

Decrease in gross domestic product

Which term 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 these represents systematic risk?

Increase in consumption created by a reduction in personal tax rates

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

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

Systematic

Consider a portfolio comprised of four risky securities. Assume the economy has three economic 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.

Which statement is true?

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

Which one of the following best exemplifies unsystematic risk?

Unexpected increase in the variable costs for a firm

The security market line is a linear function that is graphed by plotting data points based on the relationship between the:

expected return and beta.

The slope of the security market line represents the:

market risk premium.

Unsystematic risk can be defined by all of the following except:

market risk.

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

may or may not affect the portfolio beta.

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.

The expected return on a security is not affected by the:

security's unique risks.

Portfolio diversification eliminates:

unsystematic risk.

A portfolio is comprised 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.