UNT FINA 3770 Ch. 6 Yi Zheng

16) Small company stocks have historically had higher average annual returns than large company stocks, and also a higher risk premium.

True

2) Actual returns could me more or less than expected returns because actual returns are determined at the end of the period and must be discounted back to present value.

True

7) The Beta of a T-bill is zero.

True

10) Company unique risk can be virtually eliminated with a portfolio consisting of approximately 20 securities.

True, Through diversification

1) The expected rate of return from an investment is equal to the expected cash flows divided by the initial investment.

True

17) According to the CAPM, for each unit of Beta an asset's required rate of return increases by the market's risk premium.

True

T Bill correlates with the stock market

False

Standard deviation

A measure of how much the individual returns on the stock deviate from the expected value or the mean

Beta

A measure of how much the individual returns on the stock "move with" the overall market

You are considering buying some stock in Continental Grain. Which of the following are examples of non-diversifiable risks? I. Risk resulting from a general decline in the stock market. II. Risk resulting from a possible increase in income taxes. III. Risk resulting from an explosion in a grain elevator owned by Continental. IV. Risk resulting from a pending lawsuit against Continental. A) I and II B) III and IV C) I only D) II, III, and IV

A) I and II

A typical measure for the risk-free rate of return is the A) U.S. Treasury Bill rate. B) prime lending rate. C) money market rate. D) short-term AAA-rated bond rate.

A) U.S. Treasury Bill rate.

Changes in the general economy, like changes in interest rates or tax laws represent what type of risk? A) company-unique risk B) market risk C) unsystematic risk D) diversifiable risk

A) company-unique risk

What is the name given to the equation that financial managers use to measure an investor's required rate of return? A) the standard deviation B) the capital asset pricing model C) the coefficient of variation D) the MIRR

B) the capital asset pricing model

Most stocks have betas between A) -1.00 and 1.00. B) 0.00 and 1.00. C) 0.60 and 1.60. D) 1.00 and 2.00.

C) 0.60 and 1.60.

Portfolio risk is typically measured by ________ while the risk of a single investment is measured by ________. A) standard deviation; beta B) security market line; standard deviation C) beta; standard deviation D) beta; slope of the characteristic line

C) beta; standard deviation

The minimum rate of return necessary to attract an investor to purchase or hold a security is referred to as the A) stock's beta. B) investor's risk premium. C) investor's required rate of return. D) risk-free rate.

C) investor's required rate of return.

Beta is a statistical measure of A) unsystematic risk. B) total risk. C) the standard deviation. D) the relationship between an investment's returns and the market return.

D) the relationship between an investment's returns and the market return.

Beginning with an investment in one company's securities, as we add securities of other companies to our portfolio, which type of risk declines? A) systematic risk B) market risk C) non-diversifiable risk D) unsystematic risk

D) unsystematic risk

9) Because risk is measured by variability of returns, how long we hold our investments does not matter very much when it comes to reducing risk.

False, Longer holding periods can reduce risk

14) Asset allocation is not recommended by financial planners because mixing different types of assets, such as stocks with bonds, makes it more difficult to track performance and adjust portfolios to changing market conditions.

False, Mixing different types of assets enhances diversification

15) Adding stocks to a bond portfolio will increase the riskiness of the portfolio because stocks have higher standard deviations of returns than bonds.

False, depends on correlation

What does the preferred investment depend on?

On the investors risk tolerance.

What does Beta measure

Systematic risk

11) Total risk equals systematic risk plus unsystematic risk.

True

12) The required rate of return for an asset is equal to the risk-free rate plus a risk premium.

True

13) Diversifying among different kinds of assets is called asset allocation.

True

3) Beta represents the average movement of a company's stock returns in response to a movement in the market's returns

True

4) The benefits of diversification occur as long as the investments in a portfolio are not perfectly positively correlated.

True

5) A stock with a beta of 1 has systematic or market risk equal to the "typical" stock in the marketplace.

True

6) Beta is a measurement of the relationship between a security's returns and the general market's returns.

True

8) A well-diversified portfolio typically has systematic risk equal to about 40% of the portfolio's total risk.

True

How to measure risk

With Standard deviation or Beta

Stock A has a beta of 1.2 and a standard deviation of returns of 18%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the market risk premium increases, then

the required return on stock B will increase more than the required return on stock A becasue stock B has a higher beta