FINANCE / EXAM THREE / CHAPTER 12

The security market line can be used to determine the expected return on a security if we know the

-risk-free rate -systematic risk of that security -expected return on the market portfolio

Variations in operating income over time because of variations in unit sales, price, cost margins, and/or fixed expenses are called

business risk

If the variance for Stock A is greater than the variance for Stock B, then the coefficient of variation for Stock A

cannot be determined by this information

If the return for Stock A this year was 3% and the expected return for next year is 3%, then next year's return will actually be (Pick the closet answer.

cannot say for certain

since gold is ___________ correlated with stocks adding it to a portfolio of stocks reduces the risk of the portfolio

since gold is NEGATIVELY correlated with stocks adding it to a portfolio of stocks reduces the risk of the portfolio

The risk caused by variations in income before taxes over time because fixed interest expenses do not change when operating income rises or falls is called

financial risk

a higher coefficient of variation indicates...

more risk per unit of return

assets that are more volatile than the market have a beta of

more than 1

Investing in is a way for small investors to enjoy the benefits of professional management and diversification.

mutual funds

The benefits of diversification are greatest when asset returns have

negative correlations

the only relevant risk for investors that hold well diversified portfolios of securities is...

nondiversifiable risk

The total risk of a well-diversified portfolio of U.S. stocks appears to be about what proportion of the risk of an average one-stock portfolio?

one-half

The total risk of a well-diversified international portfolio of stocks appears to be about what proportion of the risk of an average one-stock portfolio?

one-third

The risk caused by changes in inflation that affect revenues, expenses and profitability is called

purchasing power risk

a portfolio that has a negatively correlated investments gains the most from diversification in terms of...

reducing the risk of the investment

in an efficient market unexpected news should cause...

stock prices to move up or down

If a person requires greater return when risk increases, that person is said to be

risk averse

in an efficient market, investors cannot consistently earn about average profits after taking what into account?

risk difference

coefficient of variance is a measure of

risk per unit of return

the coefficient of variation measures the

risk per unit of return

in general, large company stocks are more ______ than treasury bonds

risky

If prices in a particular market fully reflect all public and private knowledge, the market is efficient in the

strong form

portfolio risk is comprised of

systematic and unsystematic risk

The Capital Asset Pricing Model (CAPM) states that the expected return on an asset depends upon its level of

systematic risk

Variations in a firm's tax rate and tax-related charges over time due to changing tax laws and regulations is called

task risk

if a market is semi-strong form efficient, it also is by definition

weak-form efficient

the existence of chartists or technicians suggests that some investors believe that markets are not ___________________

weak-form efficient

when does diversification occur?

when we invest in several different assets rather than just a single one

After controlling for risk, if someone were able to earn greater than the average returns for the market on a consistent basis using publicly available information, which form of market efficiency is violated?

semi-strong

The U.S. stock market appears to be a fairly good example of a ....

semi-strong form efficient market

The portfolio that contains all risky assets is known as the

market portfolio

The market portfolio would have a beta of

+1 Beta measures the systemic risk of a stock compared to the market portfolio. Since the market portfolio has the same risk as itself, its beta is 1

if a financial asset has a historical variance of 25, then its standard deviation must be _____

5 square root of 25

Maximum diversification benefit can be achieved if one were to form a portfolio of two stocks whose returns had a correlation coefficient of

-1.0 perfectly negatively correlated, change in opposite directions by same percentage

In an efficient market which of the following would not be expected to cause a quick price change in the stock of a company?

-an unexpected announcement by a major competitor -higher than predicted earnings announcement -unexpected death of CEO

The strong-form efficient market implies that

-no investor can consistently beat the market after adjusting for risk differences -stock prices reflect all public and private knowledge -even corporate officers and insiders cannot earn above-average, risk-adjusted profits

As defined in accordance with efficient markets notions, a strong-form efficient market would be a market in which asset prices reflect

-past public information -current public information -past private information -current private information

The correlation between the return on the risk-free asset with a constant return over time and the return on a risky asset is always

0 Correlation relates movements in one set of returns to movements in another set over time a constant return asset has 0 correlation with movements of returns for a risky asset

If we assume that asset X has an expected return of 10 and a variance of 10, then its coefficient of variation is: (Pick the closest answer.)

0.316

A fruit company has 20% returns in periods of normal rainfall and negative 3% returns in droughts. The probability of normal rainfall is 60% and droughts 40%. What would the fruit company's expected returns be? (Pick the closet answer.)

10.8% E(R) = (60%)(20%) +(40%)(-3%) = 12% - 1.2% = 10.8%

Rico bought 100 shares of Banana Republic stock for $24.00 per share on January 1, 2010. He received a dividend of $2.00 per share at the end of 2010 and $3.00 per share at the end of 2011. At the end of 2012, Rico collected a dividend of $4.00 per share and sold his stock for $18.00 per share. What was Rico's realized holding period return? (Pick the closet answer.)

12.5%

Assume the probability of a pessimistic, most likely and optimistic state of nature is .25, .45 and .30, and the returns associated with those states of nature are 10%, 12%, and 16% for asset X. Based on this information, the expected return and standard deviation of return are: (Pick the closest answer.)

12.7% and 2.3%

If you invest 40% of your investment in GE with an expected rate of return of 10% and the remainder in IBM with an expected rate of return of 16%, the expected return on your portfolio is: (Pick the closet answer.)

13.6% E(Rp) = (40%)(10%) + (60%)(16%) = 4% + 9.6% = 13.6%

A stock that went from $40 per share at the beginning of the year to $45 at the end of the year and paid a $2 dividend provided an investor with a ____ return. (Pick the closest answer.)

17.5% dollar return = $45 - $40 + $2 = $7 →% 𝐫𝐞𝐭𝐮𝐫𝐧 = $𝟕/$𝟒𝟎 = 𝟏𝟕. 𝟓%

If the expected return on Stock 1 is 6%, and the expected return on Stock 2 is 20%, the expected return on a two-asset portfolio that holds 10% of its funds in Stock 1 and 90% in Stock 2 is: (Pick the closet answer.)

18.6% (10%) (6%) + (90%)(20%) = 0.6% + 18% = 18.6%

If IBM has a beta of 1.2 when the risk-free rate is 6% and the expected return on the market portfolio is 18%, the expected return on IBM is: (Pick the closet answer.)

20.4%

If Stock A had a price of $120 at the beginning of the year, $150 at the end of the year and paid a $6 dividend during the year, what would be the annualized holding period return? Pick the closest answer.

30% dollar return = ($150 - $120) + $6 = $36 → % 𝐫𝐞𝐭𝐮𝐫𝐧 = $𝟑𝟔/$𝟏𝟐𝟎 = 𝟑𝟎%

if a financial asset has a historical variance of 16, then its standard deviation must be _____

4 square root of 16

If the variance in returns for Stock A is 400% and the expected return is 5%, then the coefficient of variation is: (Pick the closet answer.)

4 𝐂𝐕 =𝛔/𝐑̅ since 𝛔𝐀 = √𝟒𝟎𝟎 = 𝟐𝟎% and 𝐑̅ = 𝟓% → 𝐂𝐕 = 𝟐𝟎% / 𝟓% = 4

Assume the probability of a pessimistic, most likely and optimistic state of nature is .25, .55 and .20, and the returns associated with those states of nature are 5%, 10%, and 13% for asset Y. Based on this information, the expected return, standard deviation, and coefficient of variation for asset Y are: (Pick the closest answer.)

9.35%, 2.76% and 0.295 respectively

can nondiversifiable (systematic) risk be eliminated by diversification?

NO

Perfectly positively correlated series move exactly together and have a correlation coefficient of _______ while perfectly negatively correlated series move exactly in opposite directions and have a correlation coefficient of _________

Perfectly positively correlated series move exactly together and have a correlation coefficient of +1.0 while perfectly negatively correlated series move exactly in opposite directions and have a correlation coefficient of - 1.0.

According to the definitions given in the text, if Stock A has a standard deviation of 4% and expected returns of 9%, and Stock B has a standard deviation of 3% and expected returns of 1%, which stock is riskier?

Stock B

unsystematic risk

a kind of risk that can be diversified away as assets are added to a portfolio

informationally efficient

a market in which prices adjust quickly after the arrival of new important news surprises

weak-form efficient market

a market in which prices reflect all past information

Combining negatively correlated assets having the same expected return results in...

a portfolio with the same level of expected return and a lower level of risk

the market portfolio truly estimates...

all unsystematic risk

Which of the following is not a component of the security market line equation?

an asset's unsystematic risk

portfolio

any combination of financial assets or investments

If the risk-free rate, the expected return on the market portfolio, and the _____________ of a stock is known, an investor can use the security market line to determine the expected return on that stock.

beta

The slope of the linear relation between the returns on a stock and the returns on the market portfolio is called the

beta

the greatest level of risk reduction through diversification can be achieved when...

combining two securities whose returns are perfectly negatively correlated

A statistical concept that relates movements in one set of returns to movements in another set over time is called

corrleation

The effect on revenues and expenses from variations in the value of the U.S. dollar in terms of other currencies is called

exchange rate risk

when we speak of ex-ante returns, we are referring to ______ or _______ information or data

expected or forcasted

ex-ante

expected or forecasted information

The Security Market Line describes the relationship between the

expected return on securities and their systematc risk

unsystematic risk is also known as

firm-specific risk

future returns and risk _______ be predicted precisely from past measures

future returns and risk CANNOT be predicted precisely from past measures

in general, securities with higher historical standard deviations have provided _______ returns

higher

in an efficient market

information flows are random, both in timing and in content

Which one of the following is not considered to be a generally recognized type of market efficiency?

insider-information form illegal under Securities Exchange Act of 1934

The risk caused by variations in interest expense unrelated to sales or operating income arising from changes in the level of interest rates in the economy is called

interest rate risk

If the variance for Stock A is greater than the variance for Stock B, then the standard deviation for Stock A

is greater than the standard deviation for Stock B

Systematic risk is rewarded with higher returns in the market because

it is associated with market movements which cannot be eliminated through diversification

The Capital Asset Pricing Model (CAPM) states that the expected return on assets depends on...

its level of systematic risk, measured by its beta

If the expected return on the market portfolio is 12%, and the beta on Consolidated Edison is 0.8, then using the Security Market Line, the expected return on Con Ed is

less than 12%

A lower the coefficient of variation indicates ____________ risk per unit of return.

lower

in general, securities with lower returns have ___________ historical standard deviations

lower

If Stock A is considered to be of lower risk than Stock B, then Stock A should have returns that are

lower than Stock B

Which of the following is not required to compute the expected return of a three-asset portfolio?

the correlation between the returns on each stock

if standard deviation is used to measure the risk of stocks what is one problem that arises?

the inability to tell which stock is riskier by looking at the standard deviation alone

a predictable trend implies...

the market does not quickly and correctly process new information to determine asset prices

the variance measures...

the risk per unit of return squared

systematic risk

the risk that is inherent in the macro economy and cannot be eliminated through diversification

standard deviation

the square root of the variance

what does beta measure?

the variability of an asset's returns relative to the market portfolio

expected rate of return on a portfolio

the weighted average of the expected returns of the individual assets in the portfolio

the return on a portfolio is simply equal to...

the weighted average return of the securities that compromise it

standard deviation is stated in the same units of measurements (e.g., dollars, percent) as...

those of the data from which they were generated