Chapter 6 Test - Finance

T/F Accounting profits is the most relevant variable the financial manager uses to measure returns.

False

T/F Actual returns are always less than expected returns because actual returns are determined at the end of the period and must be discounted back to present value.

False

T/F As the required rate of return of an investment decreases, the market price of the investment decreases.

False

T/F 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

T/F 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

T/F Historically, investments with the highest returns have the lowest standard deviations because investors do not like risk.

False

T/F Portfolio performance is determined mainly by stock selection and market timing, with less emphasis on asset allocation.

False

T/F Proper diversification generally results in the elimination of risk.

False

T/F The characteristic line for any well-diversified portfolio is horizontal.

False

T/F The market rewards the patient investor, for the period between 1926 and 2016, there has never been a time when an investor lost money if she held an all-large-stock portfolio for ten years.

False

T/F The risk-return trade-off that investors face on a day-to-day basis is based on realized rates of return because expected returns involve too much uncertainty.

False

You are considering investing in Ford Motor Company. Which of the following are examples of diversifiable risk? I. Risk resulting from possibility of a stock market crash. II. Risk resulting from uncertainty regarding a possible strike against Ford. III. Risk resulting from an expensive recall of a Ford product. IV. Risk resulting from interest rates decreasing.

II, III

How can investors reduce the risk associated with an investment portfolio without having to accept a lower expected return?

Purchase a variety of securities; i.e., diversify.

How is risk defined?

Risk is defined as the the chances of changes in volatility.

Which of the following statements is MOST correct concerning diversification and risk?

Risk-averse investors often choose companies from different industries for their portfolios because the correlation of returns is less than if all the companies came from the same industry.

Define systematic and unsystematic risk. What method is used to measure a firm's market risk?

Systematic risk, or market risk, cannot be diversified to lessen risk. Unsystematic, or company-unique risk, can be diversified by to lessen risk. Standard deviation is used to measure a firm's market risk.

T/ F Company unique risk can be virtually eliminated with a portfolio consisting of approximately 20 securities.

True

T/F A security with a beta of one has a required rate of return equal to the overall market rate of return.

True

T/F An all-stock portfolio is more risky than a portfolio consisting of all bonds.

True

T/F Variation in the rate of return of an investment is a measure of the riskiness of that investment.

True

A typical measure for the risk-free rate of return is the

U.S. Treasury bill rate.

If you were to use the standard deviation as a measure of investment risk, which of the following has historically been the least risky investment?

U.S. Treasury bills

What is diversifying among different kinds of assets known as?

asset allocation

If we are able to fully diversify, what is the appropriate measure of risk to use?

beta

The appropriate measure for risk according to the capital asset pricing model is

beta.

Portfolio risk is typically measured by ________ while the risk of a single investment is measured by ________.

beta; standard deviation

The relevant variable a financial manager uses to measure returns is

cash flows.

Of the following different types of securities, which is typically considered most risky?

common stocks of small companies

Changes in the general economy, like changes in interest rates or tax laws, represent what type of risk?

market risk

The capital asset pricing model

provides a risk-return trade-off in which risk is measured in terms of beta.

The category of securities with the highest historical risk premium is

small company stocks.

What is the name given to the equation that financial managers use to measure an investor's required rate of return?

the capital asset pricing model