Finance Chapter 12
T/F: If two stocks are perfectly negatively correlated, a portfolio with equal weighting in each stock will always have a volatility (standard deviation) of 0.
False
T/F: If you build a large enough portfolio, you can diversify away all the risks of a portfolio
False
T/F: Stocks have both diversifiable risk and undiversifiable risk, but only diversifiable risk is rewarded with higher expected returns
False
T/F: 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
The price of Microsoft is $37 per share and that of Apple is $43 per share. The price of Microsoft increases to $42 per share after one year and to $47 after two years. Also, shares of Apple increase to $49 after one year and to $59 after two years. If your portfolio comprises 100 shares of each security, what is your portfolio return in year 1 and year 2? Assume no dividends are paid. a) 13.06 %, 14.84 % b) 10.31 %, 18.96 % c) 13.75 %, 16.48 % d) 11.69 %, 19.78 %
c) 13.75 %, 16.48 % Year 0 initial portfolio value = 100 x $37 + 100 x $43 = $8,000 Year 1 portfolio value = 100 x $42 + 100 x $49 = $9,100 Year 2 portfolio value = 100 x $47 + 100 x $59 = $10,600 Year 1 expected portfolio return = ($9,100 - $8,000) / $8,000 = 13.75% Year 2 expected portfolio return = ($10,600 - $9,100) / $9,100 = 16.48%
Your estimate of the market risk premium is 9%. The risk-free rate of return is 3.8% and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return? a) 14.8% b) 15.6% c) 16.4% d) 17.2%
c) 16.4% Expected Return = 3.8% + (1.4 x 9%) = 16.4%
UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal -Mart? a) 14.96 % b) 15.79 % c) 16.62% d) 18.28 %
c) 16.62% (0.4 x 1.6) + (0.6 x 0.9) = 1.18 6% + (1.18 x 9%) = 16.62%
Suppose you invest in 110 shares of Merck (MRK) at $40 per share and 120 shares of Yahoo (YHOO)at $25 per share. If the price of Merck increases to $45 and the price of Yahoo decreases to $22 per share, what is the return on your portfolio? a) 7.70% b) 4.11% c) 2.57% d) 3.47%
c) 2.57% Initial portfolio value = 110 x $40 + 120 x $25 = $7,400 Final portfolio value = 110 x $45 + 120 x $22 = $7,590 Portfolio return = $7,590 / $7,400 - 1 = 2.57%
Suppose you invest $15,000 by purchasing 200 shares of Abbott Labs (ABT) at $40 per share, 200 shares of Lowes (LOW) at $20 per share, and 100 shares of Ball Corporation (BLL) at $30 per share. The weight of Ball Corporation in your portfolio is ________. a) 50.00% b) 40.00% c) 20.00% d) 30.00%
c) 20.00% Value of portfolio = 200 x $40 + 200 x $20 + 100 x $30 = $15,000 xi = value of security / value of portfolio = (100 x $30) / $15,000 = 0.2 or 20.00%
A portfolio has three stocks 300 shares of Yahoo (YHOO), 300 Shares of General Motors (GM), and 80 shares of Standard and Poorʹs Index Fund (SPY). If the price of YHOO is $20, the price of GM is $30, and the price of SPY is $150, calculate the portfolio weight of YHOO and GM. a) 11.1%, 20.0% b) 16.7%, 28.3% c) 22.2%, 33.3% d) 22.2%, 43.3%
c) 22.2%, 33.3% Total portfolio value = 300 x $20 + 300 x $30 + 80 x $150 = $27,000 Weight of YHOO = $6,000 / $27,000 = 22.2% Weight of GM = $9,000 / $27,000 = 33.3%
21) Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share. Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 21%, and Abbott Labs has a return of -10%. The return on your portfolio over the year is ________. a) 0% b) 7.6% c) 3.8% d) 5.7%
c) 3.8% ABT - Weight: 0.5 - Return: -0.1 - W x R: -0.05 LOW - Weight: 0.3 - Return: 0.21 - W x R: 0.063 BLL - Weight: 0.2 - Return: 0.125 - W x R: 0.025 Rp = 0.038
Duke Energy - Expected Return: 13% - Standard Deviation: 6% - Correlation with Duke Energy: 1.0 - Correlation with Microsoft: -1.0 - Correlation with Wal-Mart: 0.0 Microsoft - Expected Return: 47% - Standard Deviation: 24% - Correlation with Duke Energy: -1.0 - Correlation with Microsoft: 1.0 - Correlation with Wal-Mart: 0.7 Wal-Mart - Expected Return: 23% - Standard Deviation: 14% - Correlation with Duke Energy: 0.0 - Correlation with Microsoft: 0.7 - Correlation with Wal-Mart: 1.0 The expected return of a portfolio that is equally invested in Duke Energy and Microsoft is closest to _____ a) 15% b) 14% c) 30% d) 45%
c) 30% .5 x 0.13 + .5 x 0.47 = 0.3 = 30%
2000 - Lowes Realized Return: 20.3% - Home Depot Realized Return: -14.6% - IBM Realized Return: 0.2% 2001 - Lowes Realized Return: 72.7% - Home Depot Realized Return: 4.8% - IBM Realized Return: -3.2% 2002 - Lowes Realized Return: -25.7% - Home Depot Realized Return: -58.1% - IBM Realized Return: -27.0% 2003 - Lowes Realized Return: 56.3% - Home Depot Realized Return: 71.7% - IBM Realized Return: 27.9% 2004 - Lowes Realized Return: 6.7% - Home Depot Realized Return: 17.3% - IBM Realized Return: -5.1% 2005 - Lowes Realized Return: 17.9% - Home Depot Realized Return: 0.9% - IBM Realized Return: -11.3% The volatility on Home Depot's returns is closest to _____ a) 35% b) 32% c) 42% d) 17%
c) 42%
Duke Energy - Expected Return: 14% - Standard Deviation: 6% - Correlation with Duke Energy: 1.0 - Correlation with Microsoft: -1.0 - Correlation with Wal-Mart: 0.0 Microsoft - Expected Return: 44% - Standard Deviation: 24% - Correlation with Duke Energy: -1.0 - Correlation with Microsoft: 1.0 - Correlation with Wal-Mart: 0.7 Wal-Mart - Expected Return: 23% - Standard Deviation: 12% - Correlation with Duke Energy: 0.0 - Correlation with Microsoft: 0.7 - Correlation with Wal-Mart: 1.0 The volatility of a portfolio that is equally invested in Wal-Mart and Duke Energy is closest to _____ a) 4.0% b) 0.7% c) 6.7% d) 20.1%
c) 6.7% 0.5^2(0.12)^2 + 0.5^2(0.06)^2 + 2(0.5)(0.5)(0)(0.12)(0.06) = 0.0045 stdev = sqrrt(0.0045) = 0.06708204
Week 1 - AT&T return: 0.005 - S&P 500 return: 0.001 Week 2 - AT&T return: 0.010 - S&P 500 return: 0.005 Week 3 - AT&T return: -0.003 - S&P 500 return: -0.005 Week 4 - AT&T return: -0.005 - S&P 500 return: -0.001 If this pattern of stock returns is typical of AT&T stock, and you calculated a beta against the S&P 500, which of the following is true? a) AT&Tʹs beta is negative. b) AT&Tʹs beta is zero. c) AT&Tʹs beta is positive. d) Cannot be determined from information given.
c) AT&Tʹs beta is positive.
T/F: A portfolio comprises two stocks, A and B, with equal amounts of money invested in each. If stock A's stock price increases and that of stock B decreases, the weight of stock A in the portfolio will increase
True
T/F: Correlation is the degree to which the returns of two stocks share common risks.
True
T/F: 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
T/F: The market or equity risk premium can be estimated by computing the historical average excess return on the market portfolio.
True
T/F: The security market line is a graph of the expected return of a stock as a function of its beta with the market.
True
T/F: The volatility of an individual stock is more than the volatility of a well-diversified portfolio of stocks
True
T/F: 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
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. (Almost all of the correlations between stocks are positive, illustrating the general tendency of stocks to move together)
Which of the following equations is INCORRECT? a) Cov(Ri,Rj) = 1 / (T - 1)E(Ri - Ri)(Rj - Rj) b) Var(Rp) = w1^2 SD(R1) + w2^2 SD(R2) + 2w1w2Corr(R1,R2)SD(R1)SD(R2) c) Corr(Ri,Rj) = (Cov(Ri,Rj) / (Var(Ri)Var(Rj) d) Cov(Ri,Rj) = E[(Ri - E[Ri])(Rj - E[Rj])]
c) Corr(Ri,Rj) = (Cov(Ri,Rj) / (Var(Ri)Var(Rj) Corr(Ri,Rj) = (Cov(Ri,Rj) / (SD(Ri)SD(Rj))
We can reduce volatility by investing in less than perfectly 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
Duke Energy - Expected Return: 14% - Standard Deviation: 6% - Correlation with Duke Energy: 1.0 - Correlation with Microsoft: -1.0 - Correlation with Wal-Mart: 0.0 Microsoft - Expected Return: 44% - Standard Deviation: 24% - Correlation with Duke Energy: -1.0 - Correlation with Microsoft: 1.0 - Correlation with Wal-Mart: 0.7 Wal-Mart - Expected Return: 23% - Standard Deviation: 14% - Correlation with Duke Energy: 0.0 - Correlation with Microsoft: 0.7 - Correlation with Wal-Mart: 1.0 Which of the following combinations of two stocks would give you the biggest reduction in risk? a) Duke Energy and Wal-Mart b) Wal-Mart and Microsoft c) Microsoft and Duke Energy d) No combination will reduce risk
c) Microsoft and Duke Energy
The volatility of Home Depot share prices is 30% and that of General Motors shares is 15%. When I hold both stocks in my portfolio and the stocks returns have a correlation of 1, the overall volatility of returns of the portfolio is ________. a) More than 15% b) Less than 30% c) Unchanged at 30% d) Equal to 15%
c) Unchanged at 30%
You expect General Motors (GM) to have a beta of 1 over the next year and the beta of Exxon Mobil (XOM) to be 1.2 over the next year. Also, you expect the volatility of General Motors to be 30% and that of Exxon Mobil to be 40% over the next year. Which stock has more systematic risk? Which stock has more total risk? a) GM, GM b) GM, XOM c) XOM, XOM d) XOM, GM
c) XOM, XOM
The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%. When I hold both stocks in my portfolio with an equal amount in each, and the stocks returns have a correlation of minus 1, the overall volatility of returns of the portfolio is ________. a) More than 30% b) Unchanged at 30% c) Zero d) Equal to 60%
c) Zero
Historically, the average excess return of the S&P 500 over the return of U.S. Treasury bonds has been ________ and is proxy for the market risk premium. a) between 10% and 12% b) between 14% and 16% c) between 5% and 7% d) between 11% and 13%
c) between 5% and 7%
The market portfolio is the portfolio of all risky investments held ________. a) in descending weights b) in ascending weights c) in proportion to their value d) based on previous year performance
c) in proportion to their value
A stock market comprises 1500 shares of stock A and 3000 shares of stock B. The share prices for stocks A and B are $24 and $34 , respectively. What is the capitalization of the market portfolio? a) $138,000 b) $117,300 c) $110,400 d) $151,800
a) $138,000 (1,500 x $24) + (3,000 x $34) = $138,000
A stock market comprises 4600 shares of stock A and 2000 shares of stock B. Assume the share prices for stocks A and B are $25 and $35 , respectively. What is the capitalization of the market portfolio? a) $185,000 b) $157,250 c) $175,750 d) $203,500
a) $185,000 (4,600 x $25) + (2000 x $35) = $185,000
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% Initial portfolio value = 100 x $40 + 230 x $25 = $9,750 Final portfolio value = 100 x $50 + 230 x $20 = $9,600 Portfolio return = $9,600 / $9,750 - 1 = -1.54%
2000 - Lowes Realized Return: 20.1% - Home Depot Realized Return: -14.6% - IBM Realized Return: 0.2% 2001 - Lowes Realized Return: 72.7% - Home Depot Realized Return: 4.5% - IBM Realized Return: -3.2% 2002 - Lowes Realized Return: -25.7% - Home Depot Realized Return: -58.1% - IBM Realized Return: -27.0% 2003 - Lowes Realized Return: 56.9% - Home Depot Realized Return: 71.8% - IBM Realized Return: 27.9% 2004 - Lowes Realized Return: 6.7% - Home Depot Realized Return: 17.3% - IBM Realized Return: -5.1% 2005 - Lowes Realized Return: 17.9% - Home Depot Realized Return: 0.9% - IBM Realized Return: -11.3% The covariance between Lowes' and Home Depot's returns is closest to _____ a) 0.10 b) 0.31 c) 0.12 d) 0.73
a) 0.10
A portfolio comprises Coke (beta of 1.6) and Wal-Mart (beta of 0.6). The amount invested in Coke is $10,000 and in Wal-Mart is $20,000. What is the beta of the portfolio? a) 0.93 b) 0.84 c) 1.03 d) 0.98
a) 0.93 1.6 x ($10,000) / ($10,000 + $20,000) + 0.6 x ($20,000) / ($10,000 + $20,000) = 0.93
A portfolio comprises Coke (beta of 1.4) and Wal-Mart (beta of 0.8). The amount invested in Coke is $20,000 and in Wal-Mart is $30,000. What is the beta of the portfolio? a) 1.04 b) 1.20 c) 1.35 d) 1.25
a) 1.04 1.4 x ($20,000) / ($20,000 + $30,000) + 0.8 x ($30,000) / ($20,000 + $30,000) = 1.04
UPS, a delivery services company, has a beta of 1.4, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 4% and the market risk premium is 6%. What is the expected return on a portfolio with 50% of its money in UPS and the balance in Wal -Mart? a) 10.9% b) 10.4% c) 12.0% d) 13.1%
a) 10.9% (0.5 x 1.4) + (0.5 x 0.9) = 1.15 4% + (1.15 x 6%) = 10.9%
The price of Microsoft is $30 per share and that of Apple is $58 per share. The price of Microsoft increases to $39 per share after one year and to $42 after two years. Also, shares of Apple increase to $66 after one year and to $71 after two years. If your portfolio comprises 100 shares of each security, what is your portfolio return over year 1 and year 2? Assume no dividends are paid. a) 19.32%, 7.62% b) 28.01%, 8.38% c) 23.18%, 11.43% d) 22.22%, 13.71%
a) 19.32%, 7.62% Year 0 initial portfolio value = 100 x $30 + 100 x $58 = $8,800 Year 1 portfolio value = 100 x $39 + 100 x $66 = $10,500 Year 2 portfolio value = 100 x $42 + 100 x $71 = $11,300 Year 1 expected portfolio return = ($10,500 - $8,800) / $8,800 = 19.32% Year 2 expected portfolio return = ($11,300 - $10,500) / $10,500 = 7.62%
2000 - Lowes Realized Return: 20.0% - Home Depot Realized Return: -14.6% - IBM Realized Return: 0.2% 2001 - Lowes Realized Return: 72.7% - Home Depot Realized Return: 4.4% - IBM Realized Return: -3.2% 2002 - Lowes Realized Return: -25.7% - Home Depot Realized Return: -58.1% - IBM Realized Return: -27.0% 2003 - Lowes Realized Return: 56.2% - Home Depot Realized Return: 71.3% - IBM Realized Return: 27.9% 2004 - Lowes Realized Return: 6.7% - Home Depot Realized Return: 17.3% - IBM Realized Return: -5.1% 2005 - Lowes Realized Return: 17.9% - Home Depot Realized Return: 0.9% - IBM Realized Return: -11.3% The volatility on Lowes' returns is closest to _____ a) 35% b) 11% c) 14% d) 42%
a) 35%
A portfolio has three stocks 240 shares of Yahoo (YHOO), 150 Shares of General Motors (GM), and 40 shares of Standard and Poorʹs 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% Total portfolio value = 240 x $30 + 150 x $30 + 40 x $130 = $16,900 Weight of YHOO = $7,200 / $16,900 = 42.6% Weight of GM = $4,500 / $16,900 = 26.6%
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 Abbott Labs in your portfolio is ________. a) 48.89% b) 39.11% c) 29.33% d) 19.56%
a) 48.89% Value of portfolio = 200 x $55 + 200 x $35 + 100 x $45 = $22,500 xi = value of security / value of portfolio = (200 x $55) / $22,500 = 0.48888889 or 48.89%
A stock market comprises 4700 shares of stock A and 2300 shares of stock B. Assume the share prices for stocks A and B are $25 and $30 , respectively. What proportion of the market portfolio is comprised of stock A? a) 63.0% b) 62.0% c) 61.3% d) 79%
a) 63.0% (4,700 x $25) + (2,300 x $30) = $186,500 Stock A is worth 4,700 x $25 = $117,500 $117,500 / $186,500 = 63.0%
Your retirement portfolio comprises 100 shares of the Standard & Poorʹs 500 fund (SPY) and 100 shares of iShares Barclays Aggregate Bond Fund (AGG). The price of SPY is $118 and that of AGG is $97. If you expect the return on SPY to be 11% in the next year and the return on AGG to be 6%, what is the expected return for your retirement portfolio? a) 8.74% b) 10.06% c) 7.43% d) 7.87%
a) 8.74% Initial portfolio value = 100 x $118 + 100 x $97 = $21,500 Final portfolio value = 100 x $118 x (1 + 0.11) + 100 x $97 x (1 + 0.06) = $23,380 Expected portfolio return = ($23,380 - $21,500) / $21,500 = 8.74%
UPS, a delivery services company, has a beta of 1.1, and Wal-Mart has a beta of 0.7. The risk-free rate of interest is 4% and the market risk premium is 7%. What is the expected return on a portfolio with 30% of its money in UPS and the balance in Wal -Mart? a) 9.74% b) 10.23 % c) 9.25% d) 9.55%
a) 9.74% (0.3 x 1.1) + (0.7 x 0.7) = 0.82 4% + (0.82 x 7%) = 9.74%
A stock market comprises 2100 shares of stock A and 2100 shares of stock B. The share prices for stocks A and B are $25 and $15 , respectively. What proportion of the market portfolio is comprised of each stock? a) Stock A is 62.5% and Stock B is 37.5%. b) Stock A is 37.5% and Stock B is 62.5%. c) Stock A is 50% and Stock B is 50%. d) Stock A is 200% and Stock B is 100%.
a) Stock A is 62.5% and Stock B is 37.5%. (2,100 x $25) + (2,100 x $15) = $84,000 Stock A = $52,500 / $84,000 = 62.5% Stock B = $31,500 / $84,000 = 37.5%
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 statements is FALSE? a) We say a portfolio is an efficient portfolio whenever it is possible to find another portfolio that is better in terms of both expected return and volatility. b) We can rule out inefficient portfolios because they represent inferior investment choices. c) The volatility of the portfolio will differ, depending on the correlation between the securities in the portfolio. d) Correlation has no effect on the expected return on a portfolio.
a) We say a portfolio is an efficient portfolio whenever it is possible to find another portfolio that is better in terms of both expected return and volatility. (We say a portfolio is an efficient portfolio whenever it is not possible to find another portfolio that is better in terms of both expected return and volatility.)
Which of the following statements is FALSE? a) While the sign of a correlation is easy to interpret, its magnitude is not b) Independent risks are uncorrelated c) When the covariance equals 0, the returns are uncorrelated d) To find the risk of a portfolio, we need to know more than the risk and return of the component stocks; we need to know the degree to which the stocks' returns move together
a) While the sign of a correlation is easy to interpret, its magnitude is not
The beta of the market portfolio is ________. a) 0 b) -1 c) 2 d) 1
d) 1
Your estimate of the market risk premium is 7%. The risk-free rate of return is 4%, and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return? a) 10.4% b) 11.7% c) 13.1% d) 13.8%
d) 13.8% Expected Return = 4% + (1.4 x 7%) = 13.8%
A portfolio has three stocks 110 shares of Yahoo (YHOO), 210 Shares of General Motors (GM), and 70 shares of Standard and Poorʹs Index Fund (SPY). If the price of YHOO is $20, the price of GM is $20, and the price of SPY is $130, calculate the portfolio weight of YHOO and GM. a) 10.6%, 13.5% b) 9.9%, 25.7% c) 13.5%, 24.4% d) 14.2%, 27.1%
d) 14.2%, 27.1% Total portfolio value = 110 x $20 + 210 x $20 + 70 x $130 = $15,500 Weight of YHOO = $2,200 / $15,500 = 14.2% Weight of GM = $4,200 / $15,500 = 27.1%
A portfolio has 40% of its value in IBM shares and the rest in Microsoft (MSFT). The volatility of IBM and MSFT are 40% and 30%, respectively, and the correlation between IBM and MSFT is -0.3. What is the standard deviation of the portfolio? a) 19.17% b) 18.16% c) 22.20% d) 20.18%
d) 20.18% (0.4)^2 x (0.40)^2 + (0.6)^2 x (0.3)^2 - 2 x 0.4 x 0.3 x 0.4 + 0.6 x -0.3 = 0.040720 Square root of 0.040720 to get standard deviation = 20.18%
A portfolio has 45% of its value in IBM shares and the rest in Microsoft (MSFT). The volatility of IBM and MSFT are 33% and 35%, respectively, and the correlation between IBM and MSFT is 0. What is the standard deviation of the portfolio? a) 19.45% b) 27.96% c) 34.04% d) 24.31%
d) 24.31% (0.45)^2 x (0.33)^2 + (0.55)^2 x (0.35)^2 + 2 x 0.33 x 0.35 x 0.45 x 0.55 x 0 = 0.0591085 Square root of 0.0591085 to get standard deviation = 24.31%
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% Value of portfolio = 200 x $55 + 200 x $35 + 100 x $45 = $22,500 xi = value of security / value of portfolio = (200 x $35) / $22,500 = 0.31111111 or 31.11%
Your retirement portfolio comprises 200 shares of the S&P 500 fund (SPY) and 100 shares of iShares Barclays Aggregate Bond Fund (AGG). The price of SPY is $134 and that of AGG is $110 . If you expect the return on SPY to be 10 % in the next year and the return on AGG to be 8%, what is the expected return for your retirement portfolio? a) 8.48% b) 154.10% c) 9.89% d) 9.42%
d) 9.42% Initial portfolio value = 200 x $134 + 100 x $110 = $37,800 Final portfolio value = 200 x $134 x (1 + 0.1) + 100 x $110 x (1 + 0.08) = $41,360 Expected portfolio return = ($41,360 - $37,800) / $37,800 = 9.42%
As we add more uncorrelated stocks to a portfolio where the stocks are held in equal weights, the benefit of diversification is most dramatic ________. a) After 20 stocks have been added b) When there are more than 500 stocks c) When there are more than 1,000 stocks d) At the outset
d) At the outset
Which of the following statements is FALSE? a) When stocks are perfectly positively correlated, the set of portfolios is identified graphically by a straight line between them. b) An investor seeking high returns and low volatility should only invest in an efficient portfolio. c) When the correlation between securities is less than 1, the volatility of the portfolio is reduced due to diversification. d) Efficient portfolios can be easily ranked, because investors will choose from among them those with the highest expected returns.
d) Efficient portfolios can be easily ranked, because investors will choose from among them those with the highest expected returns.
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) Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return. b) The expected return of a portfolio is simply the weighted average of the expected returns of the investments within the portfolio. c) Portfolio weights add up to 1 so that they represent the way we have divided our money between the different individual investments in the portfolio. d) A portfolio weight is the fraction of the total investment in the portfolio held in an individual investment in the portfolio.
a) Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return. (Without trading, the portfolio weights will increase for the stocks in the portfolio whose returns are above the overall portfolio return)
The volatility of Home Depot share prices is 20% and that of General Motors shares is 20%. When I hold both stocks in my portfolio, the overall volatility of the portfolio is ________. a) 20% b) 16% c) 18% d) Not possible to calculate as information is inadequate
d) Not possible to calculate as information is inadequate
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. (The correlation allows us to gauge the strength of the relationship between stocks)
Which of the following statements is FALSE? a) A stockʹs 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 variance of a portfolio depends on the variance and correlations of the individual stocks)
The amount of a stockʹs risk that is diversified away ________. a) is independent of the portfolio that you add it to b) depends on market risk premium c) depends on risk-free rate of interest d) depends on the portfolio that you add it to
d) depends on the portfolio that you add it to
You expect General Motors (GM) to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM) to be 1.9 over the next year. Also, you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year. Which stock has more systematic risk? Which stock has more total risk? a) XOM, GM b) GM, XOM c) GM, GM d) XOM, XOM
a) XOM, GM
For each 1% change in the market portfolioʹs excess return, the investmentʹs excess return is expected to change by ________ due to risks that it has in common with the market. a) beta b) alpha c) 0% d) 1%
a) beta
The systematic risk (beta) of a portfolio is ________ by holding more stocks, even if they each had the same systematic risk. a) unchanged b) increased c) decreased d) turned to 0
a) unchanged
The S&P 500 index traditionally is a(n) ________ portfolio of the 500 largest U.S. stocks. a) value weighted b) equally weighted c) chain weighted d) price weighted
a) value weighted
Which of the following equations is INCORRECT? a) xi = total value of portfolio / value of investment i b) Rp = EixiPi c) Rp = x1P1 + x2P2 + ... + xnPn d) E[Rp] = E[EixiRi]
a) xi = total value of portfolio / value of investment i (xi = value of investment i / total value of portfolio)
A stock market comprises 2400 shares of stock A and 2400 shares of stock B. The share prices for stocks A and B are $15 and $5, respectively. What is the capitalization of the market portfolio? a) $43,200 b) $48,000 c) $55,200 d) $52,800
b) $48,000 (2,400 x $15) + (2,400 x $5) = $48,000
A stock market comprises 4600 shares of stock A and 1600 shares of stock B. Assume the share prices for stocks A and B are $15 and $30 , respectively. If you have $15,000 to invest and you want to hold the market portfolio, how much of your money will you invest in Stock A? a) $10,615.38 b) $8846.15 c) $6153.85 d) $5307.69
b) $8846.15 (4,600 x $15) + (1,600 x $30) = $117,000 Stock A is worth = 4,600 x $15 = $69,000 Proportion of stock A in the market portfolio = $69,000 / $117,000 = 58.974359% Value of stock A in portfolio = 58.974359% x 15,000 = $8,846.15
The price of Microsoft is $25 per share and that of Apple is $50 per share. The price of Microsoft increases to $36 per share after one year and to $41 after two years. Also, shares of Apple increase to $56 after one year and to $66 after two years. If your portfolio comprises 100 shares of each security, what is your portfolio return over year 1 and year 2? Assume no dividends are paid. a) 21.53 %, 14.67 % b) 22.67 %, 16.30 % c) 24.93 %, 18.75 % d) 22.21 %, 18.26 %
b) 22.67%, 16.30% Year 0 initial portfolio value = 100 x $25 + 100 x $50 = $7,500 Year 1 portfolio value = 100 x $36 + 100 x $56 = $9,200 Year 2 portfolio value = 100 x $41 + 100 x $66 = $10,700 Year 1 expected portfolio return = ($9,200 - $7,500) / $7,500 = 22.67% Year 2 expected portfolio return = ($10,700 - $9,200) / $9,200 = 16.30%
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% (0.3)^2 x (0.35)^2 + (0.7)^2 x (0.3)^2 + 2 x 0.3 x 0.7 x 0.35 x 0.3 x 0.5 = 0.077175 Square root of 0.077175 to get standard deviation = 27.78%
Suppose you invest in 220 shares of Johnson and Johnson (JNJ) at $70 per share and 240 shares of Yahoo (YHOO) at $20 per share. If the price of Johnson and Johnson increases to $80 and the price of Yahoo decreases to $18 per share, what is the return on your portfolio? a) 12.77% b) 8.51% c) 9.37% d) 10.22%
b) 8.51% Initial portfolio value = 220 x $70 + 240 x $20 = $20,200 Final portfolio value = 220 x $80 + 240 x $18 = $21,920 Portfolio return = $21,920 / $20,200 - 1 = 8.51%
Duke Energy - Expected Return: 14% - Standard Deviation: 6% - Correlation with Duke Energy: 1.0 - Correlation with Microsoft: -1.0 - Correlation with Wal-Mart: 0.0 Microsoft - Expected Return: 44% - Standard Deviation: 24% - Correlation with Duke Energy: -1.0 - Correlation with Microsoft: 1.0 - Correlation with Wal-Mart: 0.7 Wal-Mart - Expected Return: 23% - Standard Deviation: 14% - Correlation with Duke Energy: 0.0 - Correlation with Microsoft: 0.7 - Correlation with Wal-Mart: 1.0 The volatility of a portfolio that is equally invested in Duke Energy and Microsoft is closest to _____ a) 8.1% b) 9.0% c) 10.8% d) 5.4%
b) 9.0% = 0.5^2(0.06)^2 + 0.5^2(0.24)^2 + 2(0.5)(0.5)(-1)(0.06)(0.24) = 0.0081 stdev = sqrrt(0.0081) = 0.09
A linear regression to estimate the relation between General Motorsʹ stock returns and the marketʹs return gives the best fitting line that represents the relation between the stock and the market. The slope of this line is our estimate of ________. a) Alpha b) Beta c) Risk-free rate d) Volatility
b) Beta
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
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
The volatility of Home Depot Share prices is 50% and that of General Motors shares is 50%. When I hold both stocks in my portfolio and the stocks returns have zero correlation, the overall volatility of returns of the portfolio is ________. a) More than 25% b) Less than 50% c) More than 50% d) Less than 25%
b) Less than 50%
A linear regression was done to estimate the relation between Sprintʹs stock returns and the marketʹs return. The intercept of the line was found to be 0.23 and the slope was 1.47. Which of the following statements is true regarding Sprintʹs stock? a) Sprintʹs beta is 0.23. b) Sprintʹs beta is 1.47. c) The risk-free rate is 1.47%. d) The standard deviation of Sprintʹs excess returns is 23%.
b) Sprintʹs beta is 1.47.
The expected return is usually ________ the baseline risk-free rate of return that we demand to compensate for inflation and the time value of money. a) lower than b) higher than c) similar to d) none of the above
b) higher than
The Capital Asset Pricing Model asserts that the expected return ________. a) is equal to the risk-free rate plus a risk premium for unsystematic risk b) is equal to the risk-free rate plus a risk premium for systematic risk c) is equal to the risk premium plus a risk-free rate for systematic risk d) is equal to the risk premium plus a risk-free rate for unsystematic risk
b) is equal to the risk-free rate plus a risk premium for systematic risk
Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away. These stocks tend to have ________ betas. a) high b) low c) negative d) infinite
b) low
If you build a large enough portfolio, you can diversify away all ________ risk, but you will be left with ________ risk. a) diversifiable, unsystematic b) unsystematic, systematic c) systematic, undiversifiable d) undiversifiable, diversifiable
b) unsystematic, systematic
Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a(n) 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange -traded fund (ETF) with a 11% expected return and a 20% volatility. The expected return on your of your investment is closest to ________. A) 7% B) 8% C) 4% D) 9.1%
A) 7% E[Rxp] = rf + x(E[Rp] - rf) = 6% + 20%(11% - 6%) = 7%
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share. Suppose over the next year Ball has a return of 12.3%, Lowes has a return of 23%, and Abbott Labs has a return of -10%. The value of your portfolio over the year is ________. a) $21,916 b) $19,828 c) $20,872 d) $22,959
c) $20,872 ABT - Weight: 0.5 - Return: -0.1 - W x R: -0.05 LOW - Weight: 0.3 - Return: 0.23 - W x R: 0.069 BLL - Weight: 0.2 - Return: 0.123 - W x R: 0.0246 Rp = 0.0436 Value of portfolio = $20,000 x (1 + 0.0436) = $20,872
Which of the following statements is FALSE? A) The risk premium of a security is equal to the market risk premium divided by the amount of market risk present in the securityʹs returns measured by its beta with the market. B) The beta of a portfolio is the weighted average beta of the securities in the portfolio. C) There is a linear relationship between a stockʹs beta and its expected return. D) A security with a negative beta has a negative correlation with the market, which means that this security tends to perform well when the rest of the market is doing poorly.
A) The risk premium of a security is equal to the market risk premium divided by the amount of market risk present in the securityʹs returns measured by its beta with the market. (The risk premium of a security is equal to the market risk premium (the amount by which the marketʹs expected return exceeds the risk-free rate) multiplied by the amount of market risk present in the securityʹs returns measured by its beta with the market.)
A portfolio comprises Coke (beta of 1.3) and Wal-Mart (beta of 0.7). The amount invested in Coke is $20,000 and in Wal-Mart is $20,000. What is the beta of the portfolio? a) 0.9 b) 0.95 c) 1.00 d) 1.10
c) 1.00 1.3 x ($20,000) / ($20,000 + $20,000) + 0.7 x ($20,000) / ($20,000 + $20,000) = 1.00
Which of the following statements is FALSE? A) The expected return of a portfolio should correspond to the portfolioʹs beta. B) Graphically, the line through the risk-free investment and the market portfolio is called the capital market line (CML). C) The beta of a portfolio is the weighted average beta of the securities in the portfolio. D) By holding a negative-beta security, an investor can reduce the overall market risk of her portfolio.
B) Graphically, the line through the risk-free investment and the market portfolio is called the capital market line (CML). (Graphically, the line through the risk-free investment and the market portfolio is called the security market line (SML).)
Your retirement portfolio comprises 300 shares of the S&P 500 fund (SPY) and 100 shares of iShares Barclays Aggregate Bond Fund (AGG). The price of SPY is $136 and that of AGG is $97 . If you expect the return on SPY to be 11% in the next year and the return on AGG to be 10%, what is the expected return for your retirement portfolio? a) 9.73% b) 8.65% c) 10.81% d) 10.27%
c) 10.81% Initial portfolio value = 300 x $136 + 100 x $97 = $50,500 Final portfolio value = 300 x $136 x (1 + 0.11) + 100 x $97 x (1 + 0.1) = $55,958 Expected portfolio return = ($55,958 - $50,500) / $50,500 = 10.81%
Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM), what is its expected return? a) 12.2% b) 12.9% c) 13.6% d) 14.3%
c) 13.6% Expected Return = 4% + (1.6 x 6%) = 13.6%
Which of the following statements is FALSE? A) Because all investors should hold risky securities in the same proportions as the efficient portfolio, their combined portfolio will also reflect the same proportions as the efficient portfolio. B) The Capital Asset Pricing Model (CAPM) assumptions hold that the return on any portfolio is the combination of the risk-free rate of return plus a risk premium proportional to the amount of systematic risk in the investment. C) Graphically, when the tangent line goes through the market portfolio, it is called the security market line (SML). D) A portfolioʹs risk premium and volatility are determined by the fraction that is invested in the market.
C) Graphically, when the tangent line goes through the market portfolio, it is called the security market line (SML). (Graphically, when the tangent line goes through the risk-free investment (with a beta of zero) and the market (with a beta of one), it is called the security market line (SML).)
Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a(n) 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange -traded fund (ETF) with a 10% expected return and a 20% volatility. Assume that the ETF you invested in returns -10%. Then the realized return on your investment is closest to ________. A) -18% B) -10% C) -23% D) -26%
D) -26% Value of portfolio = $20,000 (1 + -0.10) = $18,000 - $10,600 = $7,400 Return = ($7,400 - $10,000) / $10,000 = -26%
