Portfolio Risk and Return: Part 2 EOCQ

Beta (β) of an individual security

β = Ρim * σi/σm Beta = correlation between security and the market * (stnd dev. of the security / stnd dev. of the market)

The portfolio of a risk-free asset and a risky asset has a better risk-return tradeoff than investing in only one asset type because the correlation between the risk-free asset and the risky asset is equal to: a. -1 b. 0 c. 1

b. 0

Portfolio managers, who are maximizing risk-adjusted returns, will seek to invest less in securities with: a. lower values for nonsystematic variance b. values of nonsystematic variance equal to 0 c. higher values for nonsystematic variance

c. higher values for nonsystematic variance

With respect to the capital asset pricing model, which of the following values of beta for an asset is most likely to have an expected return for the asset that is less than the risk-free rate? a. -0.5 b. 0.0 c. 0.5

a. -0.5

Which of the following performance measures is most appropriate for an investor who is not fully diversified? a. M-squared b. Treynor ratio c. Jensen's alpha

a. M-squared When measuring performance of a non fully diversified portfolio we need to look at total risk. When measuring the performance of a well diversified portfolio we look at only systemic risk. Sharpe Ratio and M-squared both use variance/std dev. to measure total risk Jensen's alpha and Treynor ratio both use Beta to measure systematic risk.

With respect to the capital asset pricing model, the primary determinant of expected return of an individual asset is the: a. asset's beta b. market risk premium c. asset's standard deviation

a. asset's beta

The slop of the security characteristic line is an asset's: a. beta b. excess return c. risk premium

a. beta Ri = ⍺ +βRm + ε => Market Model => Return of individual security = alpha + Beta* return of the market + error term Alpha = risk free rate Beta = risk premium Alpha + Beta*(Market return) captures systematic risk Error term captures nonsystematic risk

With respect to return-generating models, which of the following statements is most accurate? Return-generating models are used to directly estimate the: a. expected return of a security b. weights of securities in a portfolio c. parameters of the capital market line

a. expected return of a security E(Ri)= rf + β(Rm-rf)

With respect to capital market theory, the optimal risky portfolio: a. is the market portfolio b. has the highest expected return c. has the lowest expected variance

a. is the market portfolio

With respect to the capital market line, a portfolio on the CML with returns less than the returns on the market portfolio represents a(n): a. lending portfolio b. borrowing portfolio c. unachievable portfolio

a. lending portfolio highly risk-averse investors will lend at the risk-free rate to reduce risk of the portfolio, while reducing expected returns.

Which of the following statements most accurately defines the market portfolio in capital market theory? The market portfolio consists of all: a. risky assets b. tradable assets c. investable assets

a. risky assets risky assets are both tradable and investable. question asks which most accurately defines, and risky assets is the most encompassing definition.

With respect to capital market theory, which of the following statements best describes the effect of the homogeneity assumption? Because all investors have the same economic expectations of future cash flows for all assets, investors will invest in: a. the same optimal risky portfolio b. the Standard and Poor's 500 index c. assets with the same amount of risk

a. the same optimal risky portfolio

How do you identify the security with the highest total risk from a list of securities? a. security with the lowest correlation to the market b. security with the highest expected standard deviation c. security with the highest expected annual return

b. The security with the highest expected standard deviation.

With respect to return-generating models, the intercept term of the market model is the asset's estimated: a. beta b. alpha c. variance

b. alpha Ri = alpha + βRm + Error term

A portfolio on the capital market line (CML) with returns greater than the returns on the market portfolio represents a(n): a. lending portfolio b. borrowing portfolio c. unachievable portfolio

b. borrowing portfolio borrow at the risk free rate to take on an even higher percentage of risky assets than with the market portfolio alone.

The line depicting the total risk and expected return of portfolio combinations of a risk-free asset and any risky asset is the: a. security market line b. capital allocation line c. security characteristic line

b. capital allocation line Security market line measures systematic risk of an asset and expected return of an asset

With respect to capital market theory, the average beta of all assets in the market is: a. less than 1.0 b. equal to 1.0 c. greater than 1.0

b. equal to 1.0

With respect to the capital asset pricing model, the market risk premium is, a. less than the excess market return b. equal to the excess market return c. greater than the excess market return

b. equal to the excess market return

With respect to capital market theory, which of the following assumptions allows for the existence of the market portfolio? All investors: a. are price takers b. have homogeneous expectations c. plan for the same, single holding period

b. have homogeneous expectations

With respect to capital market theory, an investor's optimal portfolio is the combination of a risk-free asset and a risky asset with the highest: a. expected return b. indifference curve c. capital allocation line slope

b. indifference curve

Highly risk-averse investors will most likely invest the majority of their wealth in: a. risky assets b. risk-free assets c. the optimal risky portfolio

b. risk-free assets

With respect to capital market theory, correctly priced individual assets can be plotted on the: a. capital market line b. security market line c. capital allocation line

b. security market line Capital market line is for well diversified portfolios.

The graph of the capital asset pricing model is the: a. capital market line b. security market line c. security characteristic line

b. security market line Capital asset pricing model: E(Ri) = rf + βi [ Rm-rf] When we use β in the model instead of sigma(std deviation), we use the security market line instead of the capital market line

With respect to return-generating models, the slope term of the market model is an estimate of the asset's: a. total risk b. systematic risk c. nonsystematic risk

b. systematic risk Ri = alpha + βRm + Error term β = systematic risk Error term = nonsystematic risk

With respect to the pricing of risk in capital market theory, which of the following statements is most accurate? a. all risk is priced b. systematic risk is priced c. nonsystematic risk is priced

b. systematic risk is priced nonsystematic risk is not priced because it is avoidable by diversification.

The capital market line (CML) is the graph of the risk and return of portfolio combinations consisting of the risk-free asset and: a. any risky portfolio b. the market portfolio c. the leveraged portfolio

b. the market portfolio

Which of the following events is most likely an example of nonsystematic risk? a. a decline in interest rates b. the resignation of chief executive officer c. an increase in the value of the US dollar

b. the resignation of chief executive officer

Analysts who have estimated returns of an asset to be greater than the expected returns generated by the capital asset pricing model should consider the asset to be: a. overvalued. b. undervalued. c. properly valued.

b. undervalued.

Which of the following performance measures is consistent with CAPM? a. M-squared b. Sharpe ratio c. Jensen's alpha

c. Jensen's alpha Sharpe Ratio and M-squared both use variance to measure total risk Jensen's alpha and Treynor ratio both use Beta to measure systematic risk.

Which of the following performance measures does not require the measure to be compared to another value? a. Sharpe ratio b. Treynor ratio c. Jensen's alpha

c. Jensen's alpha Sharpe ratio and Treynor ratio both require the measure to be compared to another value. M squared and Jensen's alpha do not require the measure be compared to another value.

The intercept of the best fit line formed by plotting the excess returns of a manager's portfolio on the excess returns of the market is best described as Jensen's: a. beta. b. ratio. c. alpha.

c. alpha.

Portfolio managers who are maximizing risk-adjusted returns will seek to invest more in securities with: a. lower values of Jensen's alpha b. values of Jensen's alpha equal to 0 c. higher values of Jensen's alpha

c. higher values of Jensen's alpha Jensen's alpha measures the distance above Security Market Line (SML) and the actual return of an individual security given the same level of risk.

Which of the following types of risk is most likely avoided by forming a diversified portfolio? a. Total risk b. systematic risk c. nonsystematic risk

c. nonsystematic risk systematic risk cannot be avoided by diversification. total risk is a function of systematic and nonsystematic risk.

The sum of an asset's systematic variance and its nonsystematic variance of returns is equal to the asset's: a. beta b. total risk c. total variance

c. total variance systematic variance + nonsystematic variance = total variance systematic risk + nonsystematic risk = total risk

Relative to portfolios on the CML, any portfolio that plots above the CML is considered: a. inferior b. inefficient c. unachievable

c. unachievable

How would you identify the security with the least amount of market risk from a list of securities?

the security with the lowest Beta β will have the least amount of market risk.