FIN 481 FINAL - RISK MANAGEMENT

Amazon.com stock prices gave a realized return of 5%, -5%, 11%, and -11% over four successive quarters. What is the holding period return for Amazon.com for the year? A) -1.46% B) 2.91% C) 0.00% D) 1.46%

A) -1.46%

Suppose you invest in 100 shares of Harley-Davidson (HOG) at $40 per share and 230 shares of Yahoo (YHOO) at $25 per share. If the price of Harley-Davidson increases to $50 and the price of Yahoo decreases to $20 per share, what is the return on your portfolio? A) -1.54% B) 12.25% C) -10.50% D) -5.20%

A) -1.54%

The average annual return for the S&P 500 from 1886 to 2006 is 15%, with a standard deviation of 25%. Based on these numbers, what is a 95% confidence interval for 2007's returns? A) -35%, 65% B) -17.5%, 32.5% C) -25%, 55% D) -20%, 50%

A) -35%, 65%

A portfolio has three stocks — 240 shares of Yahoo (YHOO), 150 Shares of General Motors (GM), and 40 shares of Standard and Poor's Index Fund (SPY). If the price of YHOO is $30, the price of GM is $30, and the price of SPY is $130, calculate the portfolio weight of YHOO and GM. A) 42.6%, 26.6% B) 23.4%, 49.3% C) 12.8%, 16.0% D) 40.5%, 28.0%

A) 42.6%, 26.6%

If the returns on a stock index can be characterized by a normal distribution with mean 12%, the probability that returns will be lower than 12% over the next period equals ________. A) 50% B) 25% C) 46% D) 33%

A) 50%

The standard deviation of returns of ________. I. small stocks is higher than that of large stocks II. large stocks is lower than that of corporate bonds III. corporate bonds is higher than that of Treasury bills Which statement is true? A) I and III B) I, II, and III C) I and II D) I only

A) I and III

41. If a stock pays dividends at the end of each quarter, with realized returns of R1, R2, R3, and R4 each quarter, then the holding period return is calculated as ________. A) Rannual = (1 + R1) (1 + R2) (1 + R3)( 1 + R4) - 1 B) Rannual = R1 + R2 + R3 + R4 C) Rannual = (1 + R1) (1 + R2)( 1 + R3)( 1 + R4)

A) Rannual = (1 + R1) (1 + R2) (1 + R3)( 1 + R4) - 1

Because investors can eliminate unsystematic risk "for free" by diversifying their portfolios, they ________. A) do not require a risk premium for bearing it B) require a risk premium for bearing it C) are indifferent about credit spread and risk premium D) do not require a credit spread

A) do not require a risk premium for bearing it

Stocks with high returns are expected to have ________. A) high variability B) low variability C) no relation to variability D) inverse relationship with variability

A) high variability

Historically, stocks have delivered a ________ return on average compared to Treasury bills but have experienced ________ fluctuations in values. A) higher, higher B) higher, lower C) lower, higher D) lower, lower

A) higher, higher

A portfolio of stocks can achieve diversification benefits if the stocks that comprise the portfolio are ________. A) not perfectly positively correlated B) perfectly correlated C) susceptible to common risks only D) both B and C

A) not perfectly positively correlated

Diversification reduces the risk of a portfolio because ________, and some of the risks are averaged out of the portfolio. A) stocks do not move identically B) stocks have common risks C) stocks are fully predictable D) stocks are not affected by the market

A) stocks do not move identically

Which of the following is NOT a diversifiable risk? A) the risk that oil prices rise, increasing production costs B) the risk that the CEO is killed in a plane crash C) the risk of a key employee being hired away by a competitor D) the risk of a product liability lawsuit

A) the risk that oil prices rise, increasing production costs

In general, it is possible to eliminate ________ risk by holding a large portfolio of assets. A) unsystematic B) systematic C) unsystematic and systematic D) market specific

A) unsystematic

Many former employees at Alpha Energy, an energy trading and supply company, had a large part of their portfolio invested in Alpha Energy's stock. These employees were bearing a high degree of ________ risk. A) unsystematic B) systematic C) market-specific D) non-diversifiable

A) unsystematic

If asset A's return is exactly two times asset B's return, then following risk return tradeoff, the standard deviation of asset A should be ________ times the standard deviation of asset B. A) 3 B) 2 C) 1 D) 4

B) 2

A portfolio has 30% of its value in IBM shares and the rest in Microsoft (MSFT). The volatility of IBM and MSFT are 35% and 30%, respectively, and the correlation between IBM and MSFT is 0.5. What is the standard deviation of the portfolio? A) 23.61% B) 27.78% C) 31.95% D) 30.56%

B) 27.78%

Which of the following statements is FALSE? A) The covariance and correlation allow us to measure the co-movement of returns. B) Correlation is the expected product of the deviations of two returns. C) Because the stocks' prices do not move identically, some of the risk is averaged out in a portfolio. D) The amount of risk that is eliminated in a portfolio depends on the degree to which the stocks face common risks and their prices move together.

B) Correlation is the expected product of the deviations of two returns.

Stocks tend to move together if they are affected by ________. A) company specific events B) common economic events C) events unrelated to the economy D) idiosyncratic shocks

B) common economic events

The risk that is linked across outcomes is called ________. A) diversifiable risk B) common risk C) uncorrelated risk D) independent risk

B) common risk

Fluctuations of a stock's return that are due to market-wide news representing common risk is the ________. A) idiosyncratic risk B) systematic risk C) unique risk D) unsystematic risk

B) systematic risk

The risk premium of a security is determined by its ________ risk and does not depend on its ________ risk. A) systematic, undiversifiable B) systematic, unsystematic C) undiversifiable, diversifiable D) diversifiable, undiversifiable

B) systematic, unsystematic

A company's stock price dropped when it announced that its revenue had decreased because of the quality issues of its products. This is an example of ________. A) market risk B) unsystematic risk C) systematic risk D) undiversifiable risk

B) unsystematic risk

The average annual return for the S&P 500 from 1886 to 2006 is 5%, with a standard deviation of 15%. Based on these numbers, what is a 95% confidence interval for 2007's returns? A) -12.5%, 17.5% B) -15%, 25% C) -25%, 35% D) -25%, 25%

C) -25%, 35%

Which of the following statements is FALSE? A) Stock returns will tend to move together if they are affected similarly by economic events. B) Stocks in the same industry tend to have more highly correlated returns than stocks in different industries. C) Almost all of the correlations between stocks are negative, illustrating the general tendency of stocks to move together. D) With a positive amount invested in each stock, the more the stocks move together and the higher their covariance or correlation, the more volatile the portfolio will be

C) Almost all of the correlations between stocks are negative, illustrating the general tendency of stocks to move together.

Which of the following statements is FALSE? A) Expected return should rise proportionately with volatility. B) Investors would not choose to hold a portfolio that is more volatile unless they expected to earn a higher return. C) Smaller stocks have lower volatility than larger stocks. D) The largest stocks are typically more volatile than a portfolio of large stocks.

C) Smaller stocks have lower volatility than larger stocks.

As we increase the number of stocks in a portfolio, the standard deviation of returns of the portfolio ________. A) increases B) remains unchanged C) decreases D) doubles

C) decreases

We can reduce volatility by investing in less than perfectly positively correlated assets through diversification because the expected return of a portfolio is the weighted average of the expected returns of its stocks, but the volatility of a portfolio ________. A) is higher than the weighted average volatility B) is independent of weights in the stocks C) is less than the weighted average volatility D) depends on the expected return

C) is less than the weighted average volatility

Which of the following is NOT a systematic risk? A) the risk that oil prices rise, increasing production costs B) the risk that the economy slows, reducing demand for your firm's products C) the risk that your new product will not receive regulatory approval D) the risk that the Federal Reserve raises interest rates

C) the risk that your new product will not receive regulatory approval

Suppose that a stock gave a realized return of 20% over a two-year time period and a 10% return over the third year. The geometric average annual return is ________. A) 8.28% B) 12.43% C) 14.08% D) 16.57%

D) 16.57%

Suppose you invest $22,500 by purchasing 200 shares of Abbott Labs (ABT) at $55 per share, 200 shares of Lowes (LOW) at $35 per share, and 100 shares of Ball Corporation (BLL) at $45 per share. The weight of Lowes in your portfolio is ________. A) 40.44% B) 21.78% C) 49.78% D) 31.11%

D) 31.11%

The probability mass between two standard deviations around the mean for a normal distribution is ________. A) 66% B) 90% C) 75% D) 95%

D) 95%

You expect General Motors (GM) to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM) to be 0.9 over the next year. Also, you expect the volatility of General Motors to be 40% and that of Exxon Mobil to be 30% over the next year. Which stock has more systematic risk? Which stock has more total risk? A) XOM, GM B) XOM, XOM C) GM, XOM D) GM, GM

D) GM, GM

Which of the following statements is FALSE? A) If two stocks move in opposite directions, the covariance will be negative. B) The correlation between two stocks has the same sign as their covariance, so it has a similar interpretation. C) The covariance of a stock with itself is simply its variance. D) The covariance allows us to gauge the strength of the relationship between stocks.

D) The covariance allows us to gauge the strength of the relationship between stocks.

Which of the following statements is FALSE? A) A stock's return is perfectly positively correlated with itself. B) When the covariance equals 0, the stocks have no tendency to move either together or in opposition of one another. C) The closer the correlation is to -1, the more the returns tend to move in opposite directions. D) The variance of a portfolio depends only on the variance of the individual stocks.

D) The variance of a portfolio depends only on the variance of the individual stocks.

The risk premium of a stock is NOT affected by its ________. A) undiversifiable risk B) market risk C) systematic risk D) unsystematic risk

D) unsystematic risk

A stock whose return does not depend on overall economic conditions has a high systematic risk.

FALSE

If you build a large enough portfolio, you can diversify away all the risks of a portfolio.

FALSE

Investors should earn a risk premium for bearing unsystematic risk.

FALSE

Rational investors may be willing to choose an investment that has additional risk but does not offer additional reward

FALSE

Stocks have both diversifiable risk and undiversifiable risk, but only diversifiable risk is rewarded with higher expected returns.

FALSE

When we form an equally weighted portfolio of stocks and keep increasing the number of stocks in the portfolio, the volatility of the portfolio also increases.

FALSE

A portfolio of stocks where each stock has a large component of independent risk benefits when such stocks are held in a portfolio, because the independent risks are averaged out. This is also referred to as diversification of risks.

TRUE

Historical evidence on the returns of large portfolios of stock and bonds shows that investments with higher volatility have rewarded investors with higher returns.

TRUE

Independent risks can be diversified by holding a large number of uncorrelated assets with independent risks.

TRUE

The Capital Asset Pricing Model (CAPM) says that the risk premium on a stock is equal to its beta times the market risk premium.

TRUE

The risk that inflation rates are likely to increase in the next year is an example of common risk.

TRUE

The security market line is a graph of the expected return of a stock as a function of its beta with the market.

TRUE

The volatility of an individual stock is more than the volatility of a well-diversified portfolio of stocks.

TRUE

When we combine stocks in a portfolio, the amount of risk that is eliminated depends on the degree to which the stocks face common risks and move together.

TRUE