Investments Test 2

According to the capital asset pricing model, a security with a _________.

positive alpha is considered underpriced

Empirical results estimated from historical data indicate that betas _________.

seem to regress toward one over time

Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______.

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

The values of beta coefficients of securities are __________.

usually positive, but are not restricted in any way

According to the capital asset pricing model, fairly priced securities have _________.

zero alphas

The standard deviation of return on investment A is .10 while the standard deviation of return on investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is _________.

-0.0020 Covariance = -.50(.10)(.04)

Which of the following correlation coefficients will produce the most diversification benefits?

-0.9

In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________.

-1.0

Asset A has an expected return of 20% and a standard deviation of 25%. The risk free rate is 10%. What is the reward-to-variability ratio?

.4 (20-10)/25

The expected return of portfolio is 8.9% and the risk free rate is 3.5%. If the portfolio standard deviation is 12.0%, what is the reward to variability ratio of the portfolio?

.45 (.089 - .035)/.12

A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24% while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient between the returns on A and B is _________.

0.583 0.0380 = (.6^2)(.24^2) + (.4^2)(.18^2) + 2(.6)(.4)(.24)(.18) ρ; ρ = 0.583

Which of the following correlations coefficients will produce the least diversification benefit?

0.8

Research has revealed that regardless of what the current estimate of a firm's beta is, it will tend to move closer to ______ over time.

1

The market value weighted average beta of firms included in the market index will always be _____________.

1

The market portfolio has a beta of _________.

1.0

What is the most likely correlation coefficient between a stock index mutual fund and the S&P 500?

1.0

You have a $50,000 portfolio consisting of Intel, GE and Con Edison. You put $20,000 in Intel, $12,000 in GE and the rest in Con Edison. Intel, GE and Con Edison have betas of 1.3, 1.0 and 0.8 respectively. What is your portfolio beta?

1.048 (20/50)(1.3+(12/50)(1.0)+(18/50)(0.8)

Consider the CAPM. The risk-free rate is 5% and the expected return on the market is 15%. What is the beta on a stock with an expected return of 17%?

1.2

What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard deviation of 30%. Stock B has a standard deviation of 18%. The portfolio contains 60% of stock A and the correlation coefficient between the two stocks is -1.0.

10.8%

An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20% while the standard deviation on stock B is 15%. The correlation coefficient between the return on A and B is 0%. The standard deviation of return on the minimum variance portfolio is _________.

12%

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.4. The risk-free rate of return is 5%. The expected return on the optimal risky portfolio is _________.

16% E(rp)=(.29)(.21) + (.71)(.14)

A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35% while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is _________.

19.76% σ2p =(.40^2)(.35^2) + (.60^2)(.15^2) + (2)(.4)(.6)(.35)(.15)(.45) = .39046 σp = 19.76%

Stock A has a beta of 1.2 and Stock B has a beta of 1. The returns of Stock A are ______ sensitive to changes in the market as the returns of Stock B.

20% more

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.4. The risk-free rate of return is 5%. The standard deviation of the returns on the optimal risky portfolio is _________.

21.4% σ^2rp = (.292)(.392) + (.712)(.202) + 2(.29)(.71)(.39)(.20).4 = .045804 σrp = 21.4%

Consider the CAPM. The risk-free rate is 6% and the expected return on the market is 18%. What is the expected return on a stock with a beta of 1.3?

21.6%

A project has a 50% chance of doubling your investment in one year and a 50% chance of losing half your money. What is the expected return on this investment project?

25% (.5)(100)+(.5)(-50)

Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate of return of 16% and a standard deviation of return of 20%. B has an expected rate of return of 10% and a standard deviation of return of 30%. The weight of security B in the minimum variance portfolio is _________.

40%

You find that the annual standard deviation of a stock's returns is equal to 25%. For a 3 year holding period the standard deviation of your total return would equal _______.

43% (.25)(3^1/2)

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is 0.50. The risk-free rate of return is 10%. The standard deviation of return on the optimal risky portfolio is _________.

5%

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.4. The risk-free rate of return is 5%. The proportion of the optimal risky portfolio that should be invested in stock B is approximately _________.

71%

A project has a 60% chance of doubling your investment in one year and a 40% chance of losing half your money. What is the standard deviation of this investment?

73%

Consider the CAPM. The expected return on the market is 18%. The expected return on a stock with a beta of 1.2 is 20%. What is the risk-free rate?

8%

Which one of the following stock return statistics fluctuates the most over time?

Average return

The part of a stock's return that is systematic is a function of which of the following variables? I. Volatility in excess returns of the stock market II. The sensitivity of the stock's returns to changes in the stock market III. The variance in the stock's returns that is unrelated to the overall stock market

I and II only

Which risk can be diversified away as additional securities are added to a portfolio? I. Total risk II. Systematic risk III. Firm specific risk

I and III

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

I, II, III, and IV

Which of the following statements is true regarding time diversification? I. The standard deviation of the average annual rate of return over several years will be smaller than the one-year standard deviation. II. For a longer time horizon, uncertainty compounds over a greater number of years. III. Time diversification does not reduce risk.

I, II, and III

You are considering adding a new security to your portfolio. In order 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

I, II, and III

Which of the following are assumptions of the simple CAPM model? I. Individual trades of investors do not affect a stock's price II. All investors plan for one identical holding period III. All investors analyze securities in the same way and share the same economic view of the world IV. All investors have the same level of risk aversion

I, II, and III only

Which of the following provides the best example of a systematic risk event?

The Federal Reserve increases interest rates 50 basis points

Investing in two assets with a correlation coefficient of -0.5 will reduce what kind of risk?

Unique risk

Risk that can be eliminated through diversification is called ______ risk.

Unique, firm-specific, and diversifiable

Which of the following statistics cannot be negative?

Variance

The capital asset pricing model was developed by _________.

William Sharpe

According to the capital asset pricing model, a fairly priced security will plot _________.

along the security market line

You are recalculating the risk of ACE stock in relation to the market index and you find the ratio of the systematic variance to the total variance has risen. You must also find that the ____________.

correlation coefficient between ACE and the market has risen

Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum variance portfolio has a standard deviation that is always _________.

equal to 0

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

The risk that can be diversified away is __________.

firm specific risk

Decreasing the number of stocks in a portfolio from 50 to 10 would likely _________________________.

increase the unsystematic risk of the portfolio

A security's beta coefficient will be negative if ____________.

its returns are negatively correlated with market index returns

On a standard expected return vs. standard deviation graph investors will prefer portfolios that lie to the _____________ of the current investment opportunity set.

left and above

Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is _____________.

less than 1

You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation of 24%. You put the rest of you money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard deviation of the resulting portfolio will be ________________.

more than 12% but less than 18% σ2p = 0.02592 = (.52)(.242) + (.52)(.122) + 2(.5)(.5)(.24)(.12)0.55; σ = 16.1%

To eliminate the bias in calculating the variance and covariance of returns from historical data the average squared deviation must be multiplied by _________.

n/(n-1)

Diversification is most effective when security returns are _________.

negatively correlated

Diversification can reduce or eliminate __________ risk.

non-systematic

An investor's degree of risk aversion will determine his or her ______.

optimal mix of the risk-free asset and risky asset

If an investor does not diversify their portfolio and instead puts all of their money in one stock, the appropriate measure of security risk for that investor is the ________.

stock's standard deviation

A portfolio of stocks fluctuates when the treasury yields change. Since this risk can not be eliminated through diversification, it is called __________.

systematic risk

Investors require a risk premium as compensation for bearing ______________.

systematic risk

Market risk is also called __________ and _________.

systematic, nondiversifiable risk

Harry Markowitz is best known for his Nobel prize winning work on _____________.

techniques used to identify efficient portfolios of risky assets

The expected rate of return of a portfolio of risky securities is _________.

the weighted sum of the securities expected returns

Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron collapsed because ___.

their 401k accounts were not well diversified

The correlation coefficient between two assets equals to _________.

their covariance divided by the product of their standard deviations

Firm specific risk is also called __________ and __________.

unique risk, diversifiable risk

In a well diversified portfolio, __________ risk is negligible.

unsystematic

The term "complete portfolio" refers to a portfolio consisting of _________________.

the risk-free asset combined with at least one risky asset

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______.

up, left

Which of the following is a correct expression concerning the formula for the standard deviation of returns of a two asset portfolio where the correlation coefficient is positive?

σ^2(rp) < (W12σ12 + W22σ22)

The standard deviation of return on investment A is .10 while the standard deviation of return on investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is _________.

.60 .0030/(.10 x .05)

A stock has a correlation with the market of 0.45. The standard deviation of the market is 21% and the standard deviation of the stock is 35%. What is the stock's beta?

.75 (.45)(.35)(.21)/(.21^2)

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is 0.50. The risk-free rate of return is 10%. The proportion of the optimal risky portfolio that should be invested in stock A is _________.

0%

An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20% while the standard deviation on stock B is 15%. The expected return on stock A is 20% while on stock B it is 10%. The correlation coefficient between the return on A and B is 0%. The expected return on the minimum variance portfolio is approximately _________.

13.60%

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is 0.50. The risk-free rate of return is 10%. The expected return on the optimal risky portfolio is _________.

14% E(rp)=1.00(.14)= .1400

Semitool Corp has an expected excess return of 6% for next year. However for every unexpected 1% change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out the economy and the stock market do better than expected by 1.5% and Semitool's products experience more rapid growth than anticipated, pushing up the stock price by another 1%. Based on this information what was Semitool's actual excess return?

8.8% 6% + (1.5%)(1.2) + 1%

An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 24% while the standard deviation on stock B is 14%. The correlation coefficient between the return on A and B is 0.35. The expected return on stock A is 25% while on stock B it is 11%. The proportion of the minimum variance portfolio that would be invested in stock B is approximately _________.

85%

What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard deviation of 18%. Stock B has a standard deviation of 14%. The portfolio contains 40% of stock A and the correlation coefficient between the two stocks is -.23.

9.7%

As you lengthen the time horizon of your investment period and decide to invest for multiple years you will find that ________. I. the average risk per year may be smaller over longer investment horizons II. the overall risk of your investment will compound over time III. your overall risk on the investment will fall

I and II only

Fama and French claim that after controlling for firm size and the ratio of firm's book value to market value, beta is ______________. I. highly significant in predicting future stock returns II. relatively useless in predicting future stock returns III. a good predictor of firm's specific risk

II only

The optimal risky portfolio can be identified by finding ____________. I. the minimum variance point on the efficient frontier II. the maximum return point on the efficient frontier the minimum variance point on the efficient frontier III. the tangency point of the capital market line and the efficient frontier IV. the line with the steepest slope that connects the risk free rate to the efficient frontier

III and IV only

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

SML

The arbitrage pricing theory was developed by _________.

Stephen Ross

Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk?

With a correlation of 1.0, no risk will be reduced

You are constructing a scatter plot of excess returns for Stock A versus the market index. If the correlation coefficient between Stock A and the index is -1 you will find that the points of the scatter diagram ______________________ and the line of best fit has a ______________.

all fall on the line of best fit; negative slope

Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ______.

asset A

The _______ decision should take precedence over the _____ decision.

asset allocation, stock selection

Arbitrage is based on the idea that _________.

assets with identical risks must have the same expected rate of return

In the context of the capital asset pricing model, the systematic measure of risk is captured by _________.

beta

If you want to know the portfolio standard deviation for a three stock portfolio you will have to

calculate three covariances

An adjusted beta will be ______ than the unadjusted beta.

closer to 1

The ________ is equal to the square root of the systematic variance divided by the total variance.

correlation coefficient

If all investors become more risk averse the SML will _______________ and stock prices will _______________.

have the same intercept with a steeper slope; fall

When all investors analyze securities in the same way and share the same economic view of the world we say they have ____________________.

homogenous expectations

Rational risk-averse investors will always prefer portfolios _____________.

located on the capital market line to those located on the efficient frontier

Reward-to-variability ratios are ________ on the ________ capital market line.

lower; steeper

Beta is a measure of security responsiveness to _________.

market risk

A measure of the riskiness of an asset held in isolation is ____________.

standard deviation

The term excess-return refers to ______________.

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