MBA702 Module 3

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true? A. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. B. The beta of the portfolio is less than the weighted average of the betas of the individual stocks. C. The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. D. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.

A

Inflation, recession, and high interest rates are economic events that are best characterized as being A. systematic risk factors that can be diversified away. B. company-specific risk factors that can be diversified away. C. among the factors that are responsible for market risk. D. irrelevant except to governmental authorities like the Federal Reserve.

C

Which of the following statements is CORRECT? A. An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. B. It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock. C. Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. D. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

D

A stock with a beta equal to -1.0 has zero systematic (or market) risk.

False

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

False

A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

False

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

False

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

False

An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.

False. Market risk is measured by beta. Market risk cannot be lowered by adding more stocks to the portfolio in which the stock is held.

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

False. The expected return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

True

Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

True

Diversification will normally reduce the riskiness of a portfolio of stocks

True

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

True

The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

True

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

True