Investments Chapter 5-8

5.00%

According to the CAPM, what is the market risk premium given an expected return on a security of 17.0%, a stock beta of 1.4, and a risk-free interest rate of 10%? 14.00% 7.70% 10.00% 5.00%

closer to 1

An adjusted beta will be ______ than the unadjusted beta. lower higher closer to 1 closer to 0

an abnormal price change immediately after the announcement

Assume that a company announces unexpectedly high earnings in a particular quarter. In an efficient market one might expect _____________. - an abnormal price change immediately after the announcement - an abnormal price increase before the announcement - an abnormal price decrease after the announcement - no abnormal price change before or after the announcement

3.7%

Security A has an expected rate of return of 12% and a beta of 1.1. The market expected rate of return is 8%, and the risk-free rate is 5%. The alpha of the stock is _________. -1.7% 3.7% 5.5% 8.7%

.8

Which of the following correlation coefficients will produce the least diversification benefit? -.6 -.3 0 .8

All

You are considering adding a new security to your portfolio. To decide whether you should add the security, you need to know the security's: I. Expected return II. Standard deviation III. Correlation with your portfolio

systematic

Beta measures ___ risk

neglected stocks

Fundamental analysis is likely to yield best results for _______. - NYSE stocks - neglected stocks - stocks that are frequently in the news - fast-growing companies

beta

In the context of the capital asset pricing model, the systematic measure of risk is captured by _________. unique risk beta the standard deviation of returns the variance of returns

all of these options

Risk that can be eliminated through diversification is called ______ risk. unique firm-specific diversifiable all of these options

total risk

Standard deviation of portfolio returns is a measure of ___________. total risk relative systematic risk relative nonsystematic risk relative business risk

security characteristic line (SCL)

Systematic risk is the slope of the ___ ___ ___ (___).

SDA Corp. stock's alpha is -.75%

The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, _________. SDA Corp. stock is underpriced SDA Corp. stock is fairly priced SDA Corp. stock's alpha is -.75% SDA Corp. stock alpha is .75%

SML

The graph of the relationship between expected return and beta in the CAPM context is called the _________. CML CAL SML SCL

diversified

The risk of the ___ portfolio consists primarily of systematic risk.

1

What must be the beta of a portfolio with E(rP) = 12.00%, if rf = 4% and E(rM) = 12%?

0.89

You invest $700 in security A with a beta of 1.1 and $500 in security B with a beta of .6. The beta of this portfolio is _________. 0.66 1.28 0.89 1.70

nonsystematic

Diversification can reduce or eliminate __________ risk. all systematic nonsystematic only an insignificant

greater

If deviations on a graph are far from the SCL, the undiversified portfolio has ___ risk.

unsystematic

In a well-diversified portfolio, __________ risk is negligible. nondiversifiable market systematic unsystematic

systematic risk

Investors require a risk premium as compensation for bearing ______________. unsystematic risk alpha risk residual risk systematic risk

all publicly available information

The semistrong form of the EMH states that ________ must be reflected in the current stock price. - all security price and volume data - all publicly available information - all information, including inside information - all costless information

technical and/or fundamental analysis

The semistrong-form of the efficient market hypothesis implies that ____________ cannot generate abnormal returns

.086

The standard deviation of return on investment A is .29, while the standard deviation of return on investment B is .24. If the covariance of returns on A and B is .006, the correlation coefficient between the returns on A and B is _________. .006 −.086 .086 −.006

the difference between the rate of return earned and the risk-free rate

The term excess return refers to ______________. returns earned illegally by means of insider trading the difference between the rate of return earned and the risk-free rate the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent risk the portion of the return on a security that represents tax liability and therefore cannot be reinvested

stock price changes that are random and unpredictable

The term random walk is used in investments to refer to ______________. - stock price changes that are random but predictable - stock prices that respond slowly to both old and new information - stock price changes that are random and unpredictable - stock prices changes that follow the pattern of past price changes

firm-specific

The undiversified investor is exposed primarily to ____ risk.

-1.0

To construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________. -0.5 0.0 0.5 -1.0

1

What is the most likely correlation coefficient between a stock-index mutual fund and the S&P 500? -1 0 1 .5

fall

When the market risk premium rises, stock prices will ________. - rise - fall - recover - have excess volatility

Stock prices follow recurring patterns.

Which of the following beliefs would not preclude charting as a method of portfolio management? - The market is strong-form efficient. - The market is semistrong-form efficient. - The market is weak-form efficient. - Stock prices follow recurring patterns.

1%

You consider buying a share of stock at a price of $25. The stock is expected to pay a dividend of $1.50 next year, and your advisory service tells you that you can expect to sell the stock in 1 year for $28. The stock's beta is 1.1, rf is 6%, and E[rm] = 16%. What is the stock's abnormal return? 1% 2% -1% -2%

index

A mutual fund that attempts to hold quantities of shares in proportion to their representation in the market is called an __________ fund. - stock - index - hedge - money market

.833

A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 20%, while stock B has a standard deviation of return of 15%. Stock A comprises 60% of the portfolio, while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .030, the correlation coefficient between the returns on A and B is _________. .833 .500 .333 .125

abnormal return

A stock's alpha measures the stock's ____________________. expected return abnormal return excess return residual return

along the security market line

According to the capital asset pricing model, a fairly priced security will plot _________. above the security market line along the security market line below the security market line at no relation to the security market line

up; left

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______. up; right up; left down; right down; left

optimal mix of risk-free asset and risky asset

An investor's degree of risk aversion will determine his or her ______. optimal risky portfolio risk-free rate optimal mix of the risk-free asset and risky asset capital allocation line

technical analysis

Choosing stocks by searching for predictable patterns in stock prices is called ________. - fundamental analysis - technical analysis - index management - random-walk investing

16.25%

Consider the multifactor APT with two factors. Portfolio A has a beta of .5 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and 2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________ if no arbitrage opportunities exist. 13.5% 15% 16.25% 23%

increase the unsystematic risk of the portfolio

Decreasing the number of stocks in a portfolio from 50 to 10 would likely ________________. increase the systematic risk of the portfolio increase the unsystematic risk of the portfolio increase the return of the portfolio decrease the variation in returns the investor faces in any one year

negatively correlated

Diversification is most effective when security returns are _________. high negatively correlated positively correlated uncorrelated

greater

If SCL is steeper for diversified portfolio, systematic risk is ____

have the same intercept with a steeper slope; fall

If all investors become more risk averse, the SML will _______________ and stock prices will _______________. shift upward; rise shift downward; fall have the same intercept with a steeper slope; fall have the same intercept with a flatter slope; rise

stock's standard deviation

If an investor does not diversify his portfolio and instead puts all of his money in one stock, the appropriate measure of security risk for that investor is the ________. stock's standard deviation variance of the market stock's beta covariance with the market index

expected returns to fall; risk premiums to fall

If enough investors decide to purchase stocks, they are likely to drive up stock prices, thereby causing _____________ and ___________. expected returns to fall; risk premiums to fall expected returns to rise; risk premiums to fall expected returns to rise; risk premiums to rise expected returns to fall; risk premiums to rise

1 (market is always 1)

If the beta of the market index is 1 and the standard deviation of the market index increases from 12% to 18%, what is the new beta of the market index? .8 1 1.2 1.5

strong

If you believe in the __________ form of the EMH, you believe that stock prices reflect all relevant information, including information that is available only to insiders. - semistrong - strong - weak - perfect

All

In a simple CAPM world which of the following statements is (are) correct? I. All investors will choose to hold the market portfolio, which includes all risky assets in the world. II. Investors' complete portfolio will vary depending on their risk aversion. III. The return per unit of risk will be identical for all individual assets. IV. The market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio.

diversification

In an efficient market and for an investor who believes in a passive approach to investing, what is the primary duty of a portfolio manager? accounting for results diversification identifying undervalued stocks no need for a portfolio manager

none of these options (With a correlation of 1, no risk will be reduced.)

Investing in two assets with a correlation coefficient of 1 will reduce which kind of risk? market risk unique risk unsystematic risk none of these options (With a correlation of 1, no risk will be reduced.)

lucky event

J. M. Keyes put all his money in one stock, and the stock doubled in value in a matter of months. He did this three times in a row with three different stocks. J. M. got his picture on the front page of the Wall Street Journal. However, the paper never mentioned the thousands of investors who made similar bets on other stocks and lost most of their money. This is an example of the ________ problem in deciding how efficient the markets are. - magnitude - selection bias - lucky event - small firm

1

Market beta is always equal to __, regardless of volatility

a passive investment strategy

Proponents of the EMH typically advocate __________. - a conservative investment strategy - a liberal investment strategy - a passive investment strategy - an aggressive investment strategy

that markets are functioning efficiently

Random price movements indicate ________. - irrational markets - that prices cannot equal fundamental values - that technical analysis to uncover trends can be quite useful - that markets are functioning efficiently

the month of January

Small firms have tended to earn abnormal returns primarily in __________. - the month of January - the month July - the trough of the business cycle - the peak of the business cycle

the returns on the stock and bond portfolios tend to vary independently of each other

Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______. the returns on the stock and bond portfolios tend to move inversely the returns on the stock and bond portfolios tend to vary independently of each other the returns on the stock and bond portfolios tend to move together the covariance of the stock and bond portfolios will be positive

recognizes only one systematic risk factor

The most significant conceptual difference between the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is that the CAPM _____________. places less emphasis on market risk recognizes multiple unsystematic risk factors recognizes only one systematic risk factor recognizes multiple systematic risk factors

all past information, including security price and volume data

The weak form of the EMH states that ________ must be reflected in the current stock price. - all past information, including security price and volume data - all publicly available information - all information, including inside information - all costless information

You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.

Which of the following stock price observations would appear to contradict the weak form of the efficient market hypothesis? The average rate of return is significantly greater than zero. The correlation between the market return one week and the return the following week is zero. You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall. You could have consistently made superior returns by forecasting future earnings performance with your new Crystal Ball forecast methodology.

Expected return for your fund = T-bill rate + risk premium = 4.6% + 13.2% = 17.80% Expected return of client's overall portfolio = (0.70 × 17.80%) + (0.30 × 4.6%) = 13.84% Standard deviation of client's overall portfolio = 0.70 × 46% = 32.20%

You manage an equity fund with an expected risk premium of 13.2% and a standard deviation of 46%. The rate on Treasury bills is 4.6%. Your client chooses to invest $105,000 of her portfolio in your equity fund and $45,000 in a T-bill money market fund. What is the expected return and standard deviation of return on your client's portfolio?