VEE Accounting and Finance 2

Which of the following statements is/are true? I. The volatility of a stock is the square root of the variance of the return on that stock. II. Volatility increases when the size of a portfolio increases. III. Volatility differentiates between upside and downside risk.

Only (I)

Which of the following statements is/are true? I. The volatility of an investment portfolio that is balanced evenly between two stocks is not greater than the average volatility of the two individual stocks. II. Full diversification of an investment portfolio eliminates market risk. III. The total risk of an individual stock held in isolation determines its contribution to the risk of a well-diversified portfolio.

Only (I)

Which of the following risk is diversifiable? (A) The risk that the government raises corporate tax rate (B) The risk that a key official in the government of the United States is kidnapped (C) The risk that a key employee in a start-up computer software firm would be hired away by a another similar start-up company (D) The risk that an asteroid would hit the earth (E) The risk that the oil reserve would be depleted in 20 years

C

Which of the following statements is false? (A) It is mathematically possible for beta to be negative. (B) A company with a beta of 1.20 will expect to have a 12 percent increases in returns if the market rises by 10%. (C) Beta is a measure of systematic risk. (D) Beta would be affected by business and financial risk. (E) Research shows that individual stock's alphas are stable over time.

E a - since cov can be negative, beta can be negative b - SML = e(r) = rf + beta(Erm-rf) c - true d - true

Which of the following is/are assumption(s) of the capital asset pricing model? I. The market is frictionless. II. Investors care about only mean and variance of returns. III. Investors have homogeneous risk preference.

I and II only III. The CAPM assumes that investors have homogeneous beliefs in volatilities, correlation and mean returns.

An industry is likely to have a low beta if (i) the stream of revenues is stable and less volatile than the market. (ii) the economy is in a recession. (iii) market for their goods is unaffected by the market cycle.

I and III Beta is a measure of risk in terms of the responsiveness to movements in the market portfolio. When the cash flow stream is less volatile than the market, beta would be low. When the market for the goods is unaffected by the market cycle, the cash flow stream would be less volatile than the market and hence the beta would also tend to be lower.

Which of the following statements concerning arithmetic mean return and geometric mean return is/are correct? (i) It can happen that for a set of historical data, the geometric mean return is -100% while the arithmetic mean average is 100%. (ii) Arithmetic mean return is not a good measure of return for investment purposes. (iii) Geometric mean return is no greater than arithmetic mean return.

I, II and III For statement (i), let R1 = 300% and R2 = -100%. Then the arithmetic mean return is 100%. The geometric return is ((1 + 3)(1 - 1))0.5 - 1= -100%. Statements (ii) and (iii) are correct. While arithmetic mean return is the one that is widely reported, it over-estimates the return of an investment.

Which of the following statement is/are false? I. Another name of undiversifiable risk is idiosyncratic risk II. Investors would be rewarded for holding firm-specific risk III. The risk premium of an asset is related to its unsystematic risk

I, II, and III

Which of the following statements concerning Sharpe ratio is/are correct? (i) Sharpe ratio is defined as mean return per unit volatility. (ii) Sharpe ratio is a measure of risk-adjusted return. (iii) Investors use Sharpe ratio to select stocks.

II and III For (i), Sharpe ratio is defined as excess return per unit volatility. For (iii), the higher is the Sharpe ratio, the better is the excess return (and hence return) for the same volatility. So it can be used by investors to select stocks.

Which of the following statement(s) concerning a market with a risk-free asset and two risky assets is / are false? I. The optimal risky portfolio is a portfolio with the largest possible Sharpe ratio. II. The efficient frontier is hyperbolic. III. Risk adverse investors would hold more in the stock that has a smaller volatility when compared to risk seeking investors in their portfolios of risky assets.

II and III only II. While the opportunity set formed by the two stocks alone (without the risk-free asset) is hyperbolic, the efficient frontier obtained by incorporating the risk-free asset would be a straight line (this is the capital market line). III. Every investor would the same optimal risky portfolio. The ratio of risk-free assets to the optimal risky portfolio is dependent on the level of risk aversion.

Which of the following statement is/are true? I. A zero-beta stock has no risk II. Utility stocks have low betas III. High-tech stocks have low betas

II only I. Zero beta means that no sensitivity to market fluctuation only. The stock may still have its own specific risk III. High-tech stocks have high betas because high-tech products sell well when the economy is good.

Which of the following statement(s) is/are true? I. Volatility measures total risk, while beta measures firm-specific risk II. A portfolio that is inefficient does not lie on the security market line III. A portfolio that is efficient lies on the security market line

III only I. Beta measures market risk. II. Every portfolio lies on the security market line. Only efficient portfolios lie on the efficient market frontier, though.

If CAPM holds, the stock with the _______ mean return must have a larger ______.

greater, beta

Which of the following statement(s) is / are false? I. The opportunity set formed by two stocks in the mean-standard deviation diagram is parabolic. II. The efficient portfolios formed by a stock and a risk-free asset in the mean-standard deviation diagram lies on a straight line. III. A portfolio is efficient if there exists no portfolio in the opportunity set lying on the northwest of it in the mean-standard deviation diagram.

only (I) (it is hyperbolic)

the capital market line

passes through the optimal risky portfolio