Chapter 13

How many diverse securities are required to eliminate the majority of the diversifiable risk from a portfolio?

25

Which one of the following statements is correct concerning a portfolio beta?

A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio.

Which one of the following statements is correct concerning unsystematic risk?

Eliminating unsystematic risk is the responsibility of the individual investor

Which of the following statements concerning risk are correct? I. Nondiversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for nondiversifiable risk. IV. Diversifiable risks are market risks you cannot avoid.

I and III only

Which of the following are examples of diversifiable risk? I. earthquake damages an entire town II. federal government imposes a $100 fee on all business entities III. employment taxes increase nationally IV. toymakers are required to improve their safety standards

I and IV only

Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.

I, II and III only

The expected return on a portfolio: I. can never exceed the expected return of the best performing security in the portfolio. II. must be equal to or greater than the expected return of the worst performing security in the portfolio. III. is independent of the unsystematic risks of the individual securities held in the portfolio. IV. is independent of the allocation of the portfolio amongst individual securities.

I, II, and III only

The capital asset pricing model (CAPM) assumes which of the following? I. a risk-free asset has no systematic risk. II. beta is a reliable estimate of total risk. III. the reward-to-risk ratio is constant. IV. the market rate of return can be approximated

I, III, IV

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. asset's standard deviation II. asset's beta III. risk-free rate of return IV. market risk premium

II and IV

Which one of the following statements is correct? A. The unexpected return is always negative. B. The expected return minus the unexpected return is equal to the total return. C. Over time, the average return is equal to the unexpected return. D. The expected return includes the surprise portion of news announcements. E. Over time, the average unexpected return will be zero.

Over time, the average unexpected return will be zero.

The systematic risk of the market is measured by:

a beta of 1.0

Which one of the following indicates a portfolio is being effectively diversified?

a decrease in the portfolio standard deviation

Which one of the following is the best example of a diversifiable risk? A. interest rates increase B. energy costs increase C. core inflation increases D. a firm's sales decrease E. taxes decrease

a firm's sales decrease

A stock with an actual return that lies above the security market line has:

a higher return than expected for the level of risk assumed

The expected return on a stock computed using economic probabilities is:

a mathematical expectation based on a weighted average and not an actual anticipated outcome

Systematic risk is measured by:

beta

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset?

beta

Unsystematic risk:

can be effectively eliminated by portfolio diversification.

The standard deviation of a portfolio:

can be less than the standard deviation of the least risky security in the portfolio AND can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?

capital asset pricing model

What is an example of unsystematic risk?

consumer spending on entertainment decreased nationally

Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the:

cost of capital

The primary purpose of portfolio diversification is to:

eliminate asset-specific risk

What is most directly affected by the level of systematic risk in a security?

expected rate of return

You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?

expected return

Which one of the following is an example of systematic risk?

investors panic causing security prices around the globe to fall precipitously

What is represented by the slope of the security market line?

market risk premium

According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the:

market risk premium and the amount of systematic risk inherent in the security

The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:

market value of the investment in each stock.

If a stock portfolio is well diversified, then the portfolio variance:

may be less than the variance of the least risky stock in the portfolio.

Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at $82,500 total. Which one of the following terms most applies to Suzie's investments?

portfolio

Steve has invested in twelve different stocks that have a combined value today of $121,300. Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which one of the following?

portfolio weight

Which one of the following is least apt to reduce the unsystematic risk of a portfolio?

reducing the number of stocks held in the portfolio

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the:

risk premium

The expected risk premium on a stock is equal to the expected return on the stock minus the:

risk-free rate

Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas?

security market line

The principle of diversification tells us that:

spreading an investment across many diverse assets will eliminate some of the total risk.

Total risk is measured by _____ and systematic risk is measured by _____.

standard deviation; beta

Which one of the following is a risk that applies to most securities?

systematic

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.

systematic risk principle

The intercept point of the security market line is the rate of return which corresponds to:

the risk-free rate.

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent?

unsystematic

What statement is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights?

Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.

The expected return on a portfolio considers which of the following factors? I. percentage of the portfolio invested in each individual security II. projected states of the economy III. the performance of each security given various economic states IV. probability of occurrence for each state of the economy

I, II, III, and IV

Which one of the following statements related to risk is correct?

The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio

Which one of the following events would be included in the expected return on Sussex stock? A. The chief financial officer of Sussex unexpectedly resigned. B. The labor union representing Sussex' employees unexpectedly called a strike. C. This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated. D. The price of Sussex stock suddenly declined in value because researchers accidentally discovered that one of the firm's products can be toxic to household pets.

This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.

Which one of the following statements related to unexpected returns is correct?

Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.

The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that:

either stock A is overpriced or stock B is underpriced or both

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock:

is underpriced

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?

reward-to-risk ratio

The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly.

risk premium

Which one of the following should earn the most risk premium based on CAPM? A. diversified portfolio with returns similar to the overall market B. stock with a beta of 1.38 C. stock with a beta of 0.74 D. U.S. Treasury bill E. portfolio with a beta of 1.01

stock with a beta of 1.38

The market risk premium is computed by:

subtracting the risk-free rate of return from the market rate of return.

Standard deviation measures which type of risk?

total

Which one of the following risks is irrelevant to a well-diversified investor?

unsystematic risk

The expected return on a stock given various states of the economy is equal to the:

weighted average of the returns for each economic state