Midterm 2

How many diverse securities are required to eliminate the majority of the diversifiable risk from a portfolio? A. 5 B. 10 C. 25 D. 50 E. 75

25

The common stock of United Industries has a beta of 1.34 and an expected return of 14.29 percent. The risk-free rate of return is 3.7 percent. What is the expected market risk premium? A. 7.02 percent B. 7.90 percent C. 10.63 percent D. 11.22 percent E. 11.60 percent

7.90 percent E(r) = 0.1429 = 0.037 + 1.34 M rp ; M rp= 7.90 percent

Systematic risk is measured by: A. the mean. B. beta. C. the geometric average. D. the standard deviation. E. the arithmetic average.

beta

Which one of the following statements related to risk is correct? A. The beta of a portfolio must increase when a stock with a high standard deviation is added to the portfolio. B. Every portfolio that contains 25 or more securities is free of unsystematic risk. C. The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio. D. Adding five additional stocks to a diversified portfolio will lower the portfolio's beta. E. Stocks that move in tandem with the overall market have zero betas.

The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.

Which one of the following is an example of systematic risk? A. investors panic causing security prices around the globe to fall precipitously B. a flood washes away a firm's warehouse C. a city imposes an additional one percent sales tax on all products D. a toymaker has to recall its top-selling toy E. corn prices increase due to increased demand for alternative fuels

investors panic causing security prices around the globe to fall precipitously

Total risk is measured by _____ and systematic risk is measured by _____. A. beta; alpha B. beta; standard deviation C. alpha; beta D. standard deviation; beta E. standard deviation; variance

standard deviation; beta

Which one of the following is a risk that applies to most securities? A. unsystematic B. diversifiable C. systematic D. asset-specific E. total

systematic

Your portfolio has a beta of 1.12. The portfolio consists of 20 percent U.S. Treasury bills, 50 percent stock A, and 30 percent stock B. Stock A has a risk-level equivalent to that of the overall market. What is the beta of stock B? A. 1.47 B. 1.52 C. 1.69 D. 1.84 E. 2.07

2.07 Beta Portfolio = 1.12 = (0.2 x 0) + (0.5 x 1) + (0.3 x B);B = 2.07 The beta of a risk-free asset is zero. The beta of the market is 1.0.

The expected return on JK stock is 15.78 percent while the expected return on the market is 11.34 percent. The stock's beta is 1.62. What is the risk-free rate of return? A. 3.22 percent B. 3.59 percent C. 3.63 percent D. 3.79 percent E. 4.18 percent

4.18 percent E(r) = 0.1578 = r f + 1.62 (0.1134 - r f ); r f = 4.18 percent

Which one of the following statements is correct concerning a portfolio beta? A. Portfolio betas range between -1.0 and +1.0. B. A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio. C. A portfolio beta cannot be computed from the betas of the individual securities comprising the portfolio because some risk is eliminated via diversification. D. A portfolio of U.S. Treasury bills will have a beta of +1.0. E. The beta of a market portfolio is equal to zero.

A portfolio beta is a weighted average of the betas of the individual securities contained in

The expected return on a portfolio: I. can never exceed the expected return of the best performing security in the portfolio. II. must be equal to or greater than the expected return of the worst performing security in the portfolio. III. is independent of the unsystematic risks of the individual securities held in the portfolio. IV. is independent of the allocation of the portfolio amongst individual securities.

I. can never exceed the expected return of the best performing security in the portfolio. II. must be equal to or greater than the expected return of the worst performing security in the portfolio. III. is independent of the unsystematic risks of the individual securities held in the portfolio.

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. asset's standard deviation II. asset's beta III. risk-free rate of return IV. market risk premium

II. asset's beta IV. market risk premium

Unsystematic risk: A. can be effectively eliminated by portfolio diversification. B. is compensated for by the risk premium. C. is measured by beta. D. is measured by standard deviation. E. is related to the overall economy.

can be effectively eliminated by portfolio diversification.

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk? A. capital asset pricing model B. time value of money equation C. unsystematic risk equation D. market performance equation E. expected risk formula

capital asset pricing model

Which one of the following is an example of unsystematic risk? A. income taxes are increased across the board B. a national sales tax is adopted C. inflation decreases at the national level D. an increased feeling of prosperity is felt around the globe E. consumer spending on entertainment decreased nationally

consumer spending on entertainment decreased nationally

If a stock portfolio is well diversified, then the portfolio variance: A. will equal the variance of the most volatile stock in the portfolio. B. may be less than the variance of the least risky stock in the portfolio. C. must be equal to or greater than the variance of the least risky stock in the portfolio. D. will be a weighted average of the variances of the individual securities in the portfolio. E. will be an arithmetic average of the variances of the individual securities in the portfolio.

may be less than the variance of the least risky stock in the portfolio.

Which one of the following is least apt to reduce the unsystematic risk of a portfolio? A. reducing the number of stocks held in the portfolio B. adding bonds to a stock portfolio C. adding international securities into a portfolio of U.S. stocks D. adding U.S. Treasury bills to a risky portfolio E. adding technology stocks to a portfolio of industrial stocks

reducing the number of stocks held in the portfolio

The principle of diversification tells us that: A. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. B. concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. C. spreading an investment across five diverse companies will not lower the total risk. D. spreading an investment across many diverse assets will eliminate all of the systematic risk. E. spreading an investment across many diverse assets will eliminate some of the total risk.

spreading an investment across many diverse assets will eliminate some of the total risk.

The principle of diversification tells us that: A. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. B. concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. C. spreading an investment across five diverse companies will not lower the total risk. D. spreading an investment across many diverse assets will eliminate all of the systematic risk. E. spreading an investment across many diverse assets will eliminate some of the total risk.

spreading an investment across many diverse assets will eliminate some of the total risk.

Which one of the following should earn the most risk premium based on CAPM? A. diversified portfolio with returns similar to the overall market B. stock with a beta of 1.38 C. stock with a beta of 0.74 D. U.S. Treasury bill E. portfolio with a beta of 1.01

stock with a beta of 1.38

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk. A. efficient markets hypothesis B. systematic risk principle C. open markets theorem D. law of one price E. principle of diversification

systematic risk principle

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.7 percent and the market risk premium is 8.8 percent? A. A B. B C. C D. D E. E

0.037 + (1.22 x 0.088) = 0.1444 Stock C is correctly priced.

You have a $12,000 portfolio which is invested in stocks A and B, and a risk-free asset. $5,000 is invested in stock A. Stock A has a beta of 1.76 and stock B has a beta of 0.89. How much needs to be invested in stock B if you want a portfolio beta of 1.10? A. $3,750.00 B. $4,333.33 C. $4,706.20 D. $4,943.82 E. $5,419.27

$4,943.82 Beta Portfolio = 1.10 = ($5,000/$12,000)(1.76) + (x/$12,000)(0.89) + (($12,000 - $5,000 - x)/$12,000)(0); x = $4,943.82

The common stock of Jensen Shipping has an expected return of 16.3 percent. The return on the market is 10.8 percent and the risk-free rate of return is 3.8 percent. What is the beta of this stock? A. .92 B. 1.23 C. 1.33 D. 1.67 E. 1.79

1.79 E(r) = 0.163 = 0.038 + B (0.108 - 0.038); B= 1.79

The risk-free rate of return is 3.9 percent and the market risk premium is 6.2 percent. What is the expected rate of return on a stock with a beta of 1.21? A. 10.92 percent B. 11.40 percent C. 12.22 percent D. 12.47 percent E. 12.79 percent

11.40 percent E(r) = 0.039 + (1.21 x 0.062) = 11.40 percent

Thayer Farms stock has a beta of 1.12. The risk-free rate of return is 4.34 percent and the market risk premium is 7.92 percent. What is the expected rate of return on this stock? A. 8.35 percent B. 9.01 percent C. 10.23 percent D. 13.21 percent E. 13.73 percent

13.21 percent

Which one of the following statements is correct concerning unsystematic risk? A. An investor is rewarded for assuming unsystematic risk. B. Eliminating unsystematic risk is the responsibility of the individual investor. C. Unsystematic risk is rewarded when it exceeds the market level of unsystematic risk. D. Beta measures the level of unsystematic risk inherent in an individual security. E. Standard deviation is a measure of unsystematic risk.

Eliminating unsystematic risk is the responsibility of the individual investor.

The capital asset pricing model (CAPM) assumes which of the following? I. a risk-free asset has no systematic risk. II. beta is a reliable estimate of total risk. III. the reward-to- risk ratio is constant. IV. the market rate of return can be approximated.

I. a risk-free asset has no systematic risk III. the reward-to- risk ratio is constant. IV. the market rate of return can be approximated.

Which one of the following is the best example of a diversifiable risk? A. interest rates increase B. energy costs increase C. core inflation increases D. a firm's sales decrease E. taxes decrease

a firm's sales decrease

The reward-to- risk ratio for stock A is less than the reward-to- risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that: A. stock A is riskier than stock B and both stocks are fairly priced. B. stock A is less risky than stock B and both stocks are fairly priced. C. either stock A is underpriced or stock B is overpriced or both. D. either stock A is overpriced or stock B is underpriced or both. E. both stock A and stock B are correctly priced since stock A is riskier than stock B.

either stock A is overpriced or stock B is underpriced or both.

Which one of the following is most directly affected by the level of systematic risk in a security? A. variance of the returns B. standard deviation of the returns C. expected rate of return D. risk-free rate E. market risk premium

expected rate of return

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock: A. is underpriced. B. is correctly priced. C. will plot below the security market line. D. will plot on the security market line. E. will plot to the right of the overall market on a security market line graph.

is underpriced.

The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly. A. real return B. actual return C. nominal return D. risk premium E. expected return

risk premium

According to CAPM, the expected return on a risky asset depends on which three components?

the risk-free rate of return the market risk premium beta

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent? A. portfolio B. nondiversifiable C. market D. unsystematic E. total

unsystematic

Which one of the following risks is irrelevant to a well-diversified investor? A. systematic risk B. unsystematic risk C. market risk D. nondiversifiable risk E. systematic portion of a surprise

unsystematic risk

Jerilu Markets has a beta of 1.09. The risk-free rate of return is 2.75 percent and the market rate of return is 9.80 percent. What is the risk premium on this stock? A. 6.47 percent B. 7.03 percent C. 7.68 percent D. 8.99 percent E. 9.80 percent

7.68 percent Risk premium = 1.09 (0.098 - 0.0275) = 7.68 percent

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset? A. beta B. reward-to- risk ratio C. risk ratio D. standard deviation E. price-earnings ratio

beta

The primary purpose of portfolio diversification is to: A. increase returns and risks. B. eliminate all risks. C. eliminate asset-specific risk. D. eliminate systematic risk. E. lower both returns and risks.

eliminate asset-specific risk.

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the: A. market risk premium. B. risk premium. C. systematic return. D. total return. E. real rate of return.

risk premium.

Which of the following statements concerning risk are correct? I. Nondiversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for nondiversifiable risk. IV. Diversifiable risks are market risks you cannot avoid.

I. Nondiversifiable risk is measured by beta III. Systematic risk is another name for nondiversifiable risk.

According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the: A. amount of total risk assumed and the market risk premium. B. market risk premium and the amount of systematic risk inherent in the security. C. risk free rate, the market rate of return, and the standard deviation of the security. D. beta of the security and the market rate of return. E. standard deviation of the security and the risk-free rate of return.

market risk premium and the amount of systematic risk inherent in the security.

You want your portfolio beta to be 0.95. Currently, your portfolio consists of $4,000 invested in stock A with a beta of 1.47 and $3,000 in stock B with a beta of 0.54. You have another $9,000 to invest and want to divide it between an asset with a beta of 1.74 and a risk- free asset. How much should you invest in the risk-free asset? A. $4,316.08 B. $4,425.29 C. $4,902.29 D. $4,574.71 E. $4,683.92

$4,574.71 Beta Portfolio = 0.95 = ($4,000/$16,000)(1.47) + ($3,000/$16,000)(0.54) + (x/$16,000)(1.74) + (($9,000 - x)/$16,000)(0); Investment in risk-free asset = $9,000 - $4,425.29 = $4,574.71

Your portfolio is comprised of 40 percent of stock X, 15 percent of stock Y, and 45 percent of stock Z. Stock X has a beta of 1.16, stock Y has a beta of 1.47, and stock Z has a beta of 0.42. What is the beta of your portfolio? A. 0.87 B. 1.09 C. 1.13 D. 1.18 E. 1.21

0.87 Beta Portfolio = (0.40 x 1.16) + (0.15 x 1.47) + (0.45 x 0.42) = 0.87

What is the beta of the following portfolio? Amount Invested/Security Beta A $6700/1.58 B $4900/1.23 C $8500/0.79 A. 1.04 B. 1.07 C. 1.13 D. 1.16 E. 1.23

1.16 Value Portfolio = $6,700 + $4,900 + $8,500 = $20,100 Beta Portfolio = ($6,700/$20,100 x 1.58) + ($4,900/$20,100 x 1.23) + ($8,500/$20,100 x 0.79)

Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas? A. reward-to- risk matrix B. portfolio weight graph C. normal distribution D. security market line E. market real returns

security market line

Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.

I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry.

The common stock of Alpha Manufacturers has a beta of 1.47 and an actual expected return of 15.26 percent. The risk-free rate of return is 4.3 percent and the market rate of return is 12.01 percent. Which one of the following statements is true given this information? A. The actual expected stock return will graph above the Security Market Line. B. The stock is underpriced. C. To be correctly priced according to CAPM, the stock should have an expected return of 21.95 percent. D. The stock has less systematic risk than the overall market. E. The actual expected stock return indicates the stock is currently overpriced.

The actual expected stock return indicates the stock is currently overpriced.

The systematic risk of the market is measured by: A. a beta of 1.0. B. a beta of 0.0. C. a standard deviation of 1.0. D. a standard deviation of 0.0. E. a variance of 1.0.

a beta of 1.0.

Which one of the following indicates a portfolio is being effectively diversified? A. an increase in the portfolio beta B. a decrease in the portfolio beta C. an increase in the portfolio rate of return D. an increase in the portfolio standard deviation E. a decrease in the portfolio standard deviation

a decrease in the portfolio standard deviation