Chapter eight: risk and rate of return practice quiz

true

The standard deviation is calculated as the weighted average of all the deviations of possible returns from the expected value, and it indicates how far above or below the expected value the actual value is expected to be. True or False

the total risk of an investment is the chance that it will earn a return other than the one that is expected

Which of the following statements gives the best definition/description of the risk that is associated with an investment? a. The total risk of an investment is the chance that it will earn a negative return. b. The total risk of an investment is the chance that it will earn a positive return. c. The total risk of an investment is the chance that it will earn a return other than the one that is expected. d. The total risk of an investment is measured by its beta coefficient. e. The total risk of an investment can be determined by computing its expected return.

inflation risk is a systematic risk

which of the following statements about the various types of risks is true? a. A firm's default risk is a nondiversifiable risk. b. Interest rate risk is an unsystematic risk. c. Inflation risk is a systematic risk. d. Economic risk is a firm-specific risk. e. Political risk is a diversifiable risk.

false

Systematic risk is diversifiable, so it is an investment's relevant risk. Unsystematic risk is nondiversifiable risk and therefore not relevant. True or False

there is a good chance that the firm will experience a long labor strike in the near future

which of the following activities would most likely affect a particular company's systematic risk? a. The company's CEO resigns. b. The firm's sales this year probably will substantially lower than the amount forecasted by senior management. c. According to the U.S. government, inflation is expected to increase during the next five years. d. There is a good chance that the firm will experience a long labor strike in the near future. e. Next year the company plans to introduce a new product line that has a 30 percent chance of failing.

market risk

which of the following is the only risk that is relevant to a rational, diversified investor, because it cannot be eliminated or reduced through diversification? a. Diversifiable risk b. Stand-alone risk c. Market risk d. Unsystematic risk e. Firm-specific risk

systematic risk

which of the following is the relevant risk of an investment, for which investors should be rewarded? a. Firm-specific risk b. Total risk c. Systematic risk d. Unsystematic risk e. Diversifiable risk

a portfolio consisting of two perfectly positively correlated stocks

which of the following portfolios would have no diversification benefits? a. A portfolio consisting of two perfectly positively correlated stocks b. A portfolio consisting of two perfectly negatively correlated stocks c. A portfolio consisting of two uncorrelated stocks d. A portfolio consisting of two stocks with the same standard deviation of returns e. A portfolio consisting of two stocks with the same beta coefficient

treasury bill

which of the following securities generates a return tat is closest to a risk-free rate of return? a. treasury bill b. treasury bond c. commercial paper d. corporate bond e. corporate stock

treasury bill

which of the following securities generates a return that is closest to a risk-free rate of return? a. treasury bill b. treasury bond c. commercial paper d. corporate bond e. corporate stock

interest rate risk is a systematic risk, hence it should be rewarded by the market

which of the following statements about the various kinds of risk is correct? a. Economic risk is a market risk, hence it should not be rewarded by the market. b. A firm's default risk is a diversifiable risk, hence it should be rewarded by the market. c. Exchange rate risk is a diversifiable risk, hence it should not be rewarded by the market. d. Inflation risk is an unsystematic risk, hence it should not be rewarded by the market. e. Interest rate risk is a systematic risk, hence it should be rewarded by the market.

false

A stock's standard deviation indicates how the stock affects the riskiness of a diversified portfolio. Therefore, the standard deviation is a better measure of a stock's relevant risk than its beta coefficient, which measures total, or stand-alone, risk. True or False

1.50

Isabel invested in four-stock portfolio; she invested 20 percent of her money in Stock A, 30 percent of her money in Stock B, 25 percent of her money in Stock C, and 25 percent of her money in Stock D. The betas for Stock A, B, C, and D are 0.4, 1.2, 2.5, and 1.75, respectively, and their expected returns are 12 percent, 24 percent, 30 percent, and 28 percent, respectively. What is the beta of Isabel's portfolio? a. 1.82 b. 1.96 c. 1.50 d. 1.43 e. 1.38

The risk premium associated with Stock A, RPA, should be three times the risk premium associated with Stock B, RPB

Stock A has a beta coefficient (β) equal to 2.1, and Stock B has a beta coefficient (β) equal to 0.7. According to the capital asset pricing model (CAPM), which of the following statements is correct? a. The required rate of return for Stock A, rA, should be 2.1 times the required rate of return for Stock B, rB. b. The risk premium associated with Stock A, RPA, should be 2.1 times the risk premium associated with Stock B, RPB. c. The required rate of return for Stock A, rA, should be three times the required rate of return for Stock B, rB. d. The risk premium associated with Stock A, RPA, should be three times the risk premium associated with Stock B, RPB. e. The required rate of return for Stock A, rA, should be three times the risk premium associated with Stock A, RPA.

an investor should not buy Stock A because its expected rate of return is less than the required rate of return

The beta of Stock A is 2.1. The risk-free rate is 6 percent, and the market return is 13 percent. The expected rate of return of Stock A is 15.5 percent. Based on the above information, which of the following statements is true? a. An investor should buy Stock A because its expected rate of return is less than the required rate of return. b. An investor should buy Stock A because its expected rate of return is greater than the required rate of return. c. An investor should not buy Stock A because its expected rate of return is greater than the required rate of return. d. An investor should not buy Stock A because its expected rate of return is less than the required rate of return. e. An investor should be indifferent towards buying or selling the stock.

greater the chance that its realized return will differ significantly from its expected return

The larger the standard deviation of returns on an investment, the ______. a. greater the chance that it will provide regular return to its investors b. lower the chance that its realized return will be negative c. greater the chance that its realized return will be equal to its expected return d. lower the chance that its expected return will differ significantly from its market return e. greater the chance that its realized return will differ significantly from its expected return

an investor should buy this stock because its expected rate of return, 11.69 percent, is greater than its required rate of return, 9.6 percent

The next expected dividend for Stock P is $2.50, the current price of the stock is $32.50, and the firm is expected to grow at a constant rate of 4 percent per year forever. The risk free rate is 3 percent, the market risk premium is 5.5 percent, and the stock's beta is 1.2. Based on the given information, which of the following statements is correct? a. An investor should buy this stock because its expected rate of return, 11.69 percent, is greater than its required rate of return, 9.6 percent. b. An investor should not buy this stock because its expected rate of return, 9.6 percent, is greater than its required rate of return, 11.69 percent. c. An investor should not buy this stock because its intrinsic value, $44.64, is greater than its current price of $32.50. d. An investor should not buy this stock because its current price, $32.50, is not equal to its intrinsic value, $44.64. e. An investor should be indifferent toward buying or selling the stock because its required rate of return is equal to its expected rate of return, 11.69 percent.

19.80%

The risk-free rate is 5 percent and the market risk premium is 8 percent. Stock Y's beta is 1.85 and the standard deviation of its returns is 62.5 percent. What should be the stock's expected rate of return for the stock price to be considered in equilibrium? a. 10.55% b. 12.82% c. 15.54% d. 14.80% e. 19.80%

D

The risk-free rate of return is 4 percent, and the market return is 10 percent. The betas of Stocks A, B, C, D, and E are 0.85, 0.95, 1.20, 1.35, and 0.5, respectively. The expected rates of return for Stocks A, B, C, D, and E are 8 percent, 9 percent, 10 percent, 14 percent, and 6 percent, respectively. Which stock should a rational investor purchase? a. A b. B c. C d. D e. E

Stock E

The risk-free rate of return is 5 percent, and the market return is 8 percent. The betas of Stocks A, B, C, D, and E are 0.75, 0.50, 0.25, 1.50, and 1.25, respectively. The expected rates of return for Stocks A, B, C, D, and E are 8 percent, 6.5 percent, 7 percent, 11 percent, and 7 percent, respectively. Suppose an investor holds all of these stocks in a single portfolio. Based on the information given here, if the investor wants to sell one of the stocks so that only four stocks remain in the portfolio, which stock should be sold? a. Stock A b. Stock B c. Stock C d. Stock D e. Stock E

when two perfectly positively correlated stocks with the same risk are combined, the portfolio risk is equal to the risk associated with the individual stocks

Which of the following statements about diversification is correct? a. Portfolio diversification reduces the variability of returns on an individual stock. b. When the company specific risk has been diversified, the inherent risk that remains is the market risk, which is constant for all securities in the market. c. A stock with a beta of −1.0 has maximum nondiversifiable risk. d. When two perfectly correlated stocks with the same risk are combined, the portfolio risk is equal to the risk associated with the individual stocks. e. The systematic risk of a stock with a beta of zero is equal to its unsystematic risk.

an increase in the expected inflation rate would lead to an increase in the required return on all the risky assets by the same amount, assuming all other things were held constant

Which of the following statements about the risk-return relationship observed in investing is correct? a. An increase in the expected inflation rate would lead to an increase in the required return on all the risky assets by the same amount, assuming all other things were held constant. b. A graph of the SML shows required rates of return on the vertical axis and standard deviations of returns on the horizontal axis. c. If investors' risk attitudes change, the required rates of return on low-beta stocks will be impacted more than the required rates of return on high-beta stocks. d. If investors became more averse to risk, then the slope of the SML would become less steep. e. The market risk premium is lower for high-beta stocks than it is for low-beta stocks.

risk premium

the difference between the expected rate of return on a given risky asset and the expected rate of return on a less risky asset is known as the _____. a. standard deviation of returns b. variance of returns c. actual rate of return d. risk premium e. risk-adjusted return

is the mean value of the probability distribution of possible outcomes

the expected rate of return of an investment _____. a. equals one of the possible rates of return for that investment b. equals the required rate of return for the investment c. is the mean value of the probability distribution of possible outcomes d. is the median value of the probability distribution of possible outcomes e. is the mode value of the probability distribution of possible outcomes

the riskier the investment

the greater the variability of the possible returns on an investment, _____. a. the lesser the expected return b. the lower the standard deviation of the investment c. the higher the actual return on the investment d. the riskier the investment e. the lower the beta of the investment

unsystematic risk

the part of a security's risk associated with random outcomes generated by events or behaviors specific to the firm is known as _____. a. nondiversifiable risk b. unsystematic risk c. market risk d. systematic risk e. relevant risk

market risk and relevant risk

which of the following pairs of terms are names for the same risk? a. Market risk and unsystematic risk b. Market risk and relevant risk c. Firm-specific risk and nondiversifiable risk d. Firm-specific risk and systematic risk e. Firm-specific risk and market risk

a stock that is perfectly positively correlated with the market cannot have a beta coefficient equal to 1.0

which of the following statements about beta is correct? a. If the returns on a stock vary widely, then its standard deviation is large, and as a result, the stock will also have a high beta coefficient. b. A stock's standard deviation of returns is a measure of the stock's stand-alone risk, while its beta measures its unsystematic risk. c. A portfolio that contains 100 high-beta stocks will not be riskier than a portfolio containing 100 low-beta stocks. d. A stock that is perfectly positively correlated with the market cannot have a beta coefficient equal to 1.0. e. A stock with a negative beta has very high firm-specific risk.

the weaker the positive correlation two stocks exhibit, the more risk can be reduced when they are combined in a portfolio

which of the following statements about correlation is correct? a. If the returns from two stocks are perfectly positively correlated and the two stocks have equal variance, an equally weighted portfolio of the two stocks will have a variance that is less than that of the individual stocks. b. If a stock has a negative correlation with market, its systematic risk is more than the market risk. c. Stocks that have correlation coefficients equal to zero will have minimum diversification benefits. d. The weaker the positive correlation two stocks exhibit, the more risk can be reduced when they are combined in a portfolio. e. Risk is reduced when positively-related stocks are combined to form portfolios, especially when the correlation coefficients are equal to +1.

market risk is the relevant risk, whereas firm-specific risk is an irrelevant risk

which of the following statements about market risk and firm-specific risk is true? a. Market risk is an unsystematic risk, whereas firm-specific risk is systematic risk. b. Investors are not rewarded for taking market risk, whereas they are rewarded for taking firm-specific risk. c. Market risk is a diversifiable risk, whereas firm-specific risk is a nondiversifiable risk. d. Market risk is the relevant risk, whereas firm-specific risk is an irrelevant risk e. Market risk includes a firm's default risk, whereas firm-specific risk includes economic risk.

the steeper the slope of the line, the greater the average investor's risk aversion, and thus the greater the return investors require as compensation for risk

which of the following statements about the security market line (SML) and investor's risk aversion is correct? a. The steeper the slope of the line, the lower the average investor's risk aversion, and thus the greater the return investors require as compensation for risk. b. The steeper the slope of the line, the greater the average investor's risk aversion, and thus the greater the return investors require as compensation for risk. c. The steeper the slope of the line, the lower the average investor's risk aversion, and thus the lower the return investors require as compensation for risk. d. The steeper the slope of the line, the greater the average investor's risk aversion, and thus the lower the return investors require as compensation for risk. e. The less steep the slope of the line, the greater the average investor's risk aversion, and thus the lower the return investors require as compensation for risk.

economic risk and political risk are systematic risks

which of the following statements about the various kinds of risk is true? a. Interest rate risk and inflation risk are diversifiable risks. b. Economic risk and political risk are systematic risks. c. Business risk and exchange rate risk are firm-specific risks. d. Financial risk and default risk are market risks. e. Default risk and economic risk are relevant risks.

if the beta of a stock is three, the stock's relevant risk is three times as volatile as the market portfolio

which of the following statements is true about the beta of a portfolio? a. If the beta of a portfolio doubles, its required return also doubles. b. If a stock included in the portfolio has a negative beta, the portfolio's required return is negative. c. Portfolios that contain higher beta stocks have more company-specific risk, but do not necessarily have more market risk. d. If a portfolio's beta increases from 1.2 to 1.5, its actual rate of return will decrease by 1.5 times the market risk premium. e. If the beta of a stock is three, the stock's relevant risk is three times as volatile as the market portfolio.

false

A firm can affect its beta risk by changing the composition of its assets and by modifying its use of debt financing, but external factors do not have any bearing on a firm's beta. True or False

true

A probability distribution consists of a listing of all possible outcomes, or events, with the chance of occurrence assigned to each. True or False

15.8%

A stock has a beta coefficient, β, equal to 1.20. The risk premium associated with the market is 9 percent, and the risk-free rate is 5 percent. Application of the capital asset pricing model indicates that the stock's appropriate return should be _____. a. 9.8% b. 5.2% c. 12.5% d. 15.8% e. 17.2%

true

A stock might be quite risky if held by itself, but if much of this total (stand-alone) risk can be eliminated through diversification, then its relevant risk—that is, its contribution to the portfolio's risk—is much smaller than its total risk. True or False

investors should expect to be rewarded for only the systematic risk associated with an individual investment, which is measured by the beta coefficient

According to the capital asset pricing model (CAPM), ______. a. investors should expect to be rewarded for the total risk associated with an individual investment, which is measured by the standard deviation of returns on the investment b. investors should expect to be rewarded for only the unsystematic risk associated with an individual investment, which is measured by the standard deviation of returns c. investors should expect to be rewarded only for the systematic risk associated with an individual investment, which is measured by the standard deviation of returns d. investors should expect to be rewarded for only the unsystematic risk associated with an individual investment, which is measured by the beta coefficient e. investors should expect to be rewarded for only the systematic risk associated with an individual investment, which is measured by the beta coefficient

15.95%; 16.35%

Darren has the option of investing in either Stock A or Stock B. There is a 45 percent chance that the return on Stock A will be 25 percent, a 25 percent chance it will be 14 percent, and a 30 percent chance it will be 4 percent. There is a 45 percent chance that the return on Stock B will be 30 percent, a 25 percent chance it will be 9 percent, and a 30 percent chance it will be2 percent. What is the expected rates of return on Stock A and Stock B? a. 13.65%; 12.85% b. 14.75%; 13.75% c. 15.95%; 16.35% d. 16.80%; 11.45% e. 14.33%; 13.67%

false

Economic risk is an unsystematic risk that can be diversified by the investors. True or False

9.0%

For Investment A, the probability of the return being 20 percent is 0.5, 10 percent is 0.4, and -10 percent is 0.1. Compute the standard deviation for the investment with the given information. a. 85.0% b. 15..0% c. 34.0% d. 17.0% e. 9.0%

2.0

If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected return on Security J is 13 percent, what is the beta of Security J? a. 1.0 b. 1.5 c. 2.0 d. 2.5 e. 3.0

true

Other things held constant, a risk-averse investor requires a higher return to invest in securities with higher risks, which means they will pay lower prices for such investments. True or False

down and have a steeper slope

Other things held constant, if the expected inflation rate decreases at the same time investors become more risk averse, the Security Market Line (SML) would shift _____. a. down and have a steeper slope b. up and have a less steep slope c. up and keep the same slope d. down and keep the same slope e. down and have a less steep slope

true

Risk is indicated by variability of returns, whether the variability is considered positive or negative. Both the positive and negative outcomes must be evaluated when considering risk. True or False

1.6

Steve Brickson currently has an investment portfolio that contains four stocks with a total value equal to $80,000. The portfolio has a beta (β) equal to 1.4. To earn higher returns, Steve wants to invest an additional $20,000 in a stock that has β equal to 2.4. After Steve adds the new stock to his portfolio, what will the portfolio's beta be? a. 1.6 b. 1.8 c. 1.9 d. 2.0 e. 2.1

the required returns on all stocks will increase

The Security Market Line (SML) relates the risks of individual securities to their required rate of return. If investors conclude that the inflation rate is going to increase, which of the following change would occur? a. The market risk premium will increase. b. The beta of a stock will increase. c. The slope of the SML will become steeper. d. The standard deviation of a stock will increase. e. The required returns on all stock will increase.

10.83%

The beta coefficient of Zed Corporation is equal to 0.7 and the required rate of return on the stock equals 12 percent. If the expected return on the market is 12.5 percent, what is the risk-free rate of return? a. 11.56% b. 10.83% c. 9.52% d. 12.25% e. 8.89%

E

The expected returns for Stocks A, B, C, D, and E are 7 percent, 10 percent, 12 percent, 25 percent, and 18 percent, respectively. The corresponding standard deviations for these stocks are 12 percent, 18 percent, 15 percent, 23 percent, and 15 percent, respectively. Which one of the securities should a risk-averse investor purchase if the investment will be held in isolation (by itself)? a. A b. B c. C d. D e. E

false

The market portfolio contains only unsystematic risk, therefore the market risk premium represents the return that investors require to be compensated for taking an average amount of relevant, or unsystematic, risk. True or False

Stock A has a tighter probability distribution than Stock B, and hence lower total risk

The standard deviation of the returns of Stock A is 45.9 percent, and the standard deviation of the returns of Stock B is 52.7 percent. Which of the following statements about the stocks is correct? a. Stock A has a wider (more dispersed) probability distribution than Stock B, and hence lower total risk. b. Stock A has a tighter probability distribution than Stock B, and hence lower total risk. c. Stock B has a wider (more dispersed) probability distribution than Stock A, and hence lower total risk. d. Stock B has a tighter probability distribution than Stock A, and hence lower total risk. e. Stock B has a lower risk than Stock A, but nothing can be said about their probability distributions.

true

Two stocks can be combined to form a portfolio that is risk free (i.e., has no risk) if the stocks are perfectly negatively correlated (r = −1.0) with each other. True or False

coefficient of variation

Which of the following measures captures the effects of both risk and return, which makes it a better measure than standard deviation for evaluating stand-alone risk in situations where investments differ with respect to both their amounts of total risk and their expected returns? a. Probability distribution of the investment's returns b. Expected average rate of returns of the investment c. Correlation coefficient of one investment with another investment d. Coefficient of variation e. Beta coefficient

true

a stock's beta coefficient measures the tendency of its returns to move with the returns on the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and it will have a beta greater than 1.0. True or False

10.0%

an investment's possible payoffs are -10 percent, 10 percent, and 30 percent. The probabilities that these payoffs will occur are 0.30, 0.40, and 0.30, respectively. What is the expected rate of return on the investment? a. 10.0% b. 9.5% c. 15.0% d. 12.5% e. 13.0%

the stocks have correlation coefficient equal to -1

combining two stocks to form a portfolio offer maximum diversification benefits when_____. a. the stocks have a correlation coefficient equal to 0 b. the stocks have a correlation coefficient equal to +1 c. the stocks have a correlation coefficient equal to -1 d. the both stocks have a coefficients of variation of 0 e. both stocks have a coefficients of variation of -1

the stocks have a correlation coefficient equal to -1

combining two stocks to form a portfolio offers maximum diversification benefits when _____. a. the stocks have a correlation coefficient equal to 0 b. the stocks have a correlation coefficient equal to +1 c. the stocks have a correlation coefficient equal to -1 d. the both stocks have a coefficient of variation of 0 e. both stocks have a coefficient of variation of -1

business risk

diversifiable risk includes _____. a. reinvestment rate risk b. economic risk c. business risk d. political risk e. interest rate risk

coefficient of variation

dividing the standard deviation of the returns of a stock by the stock's expected return gives us the stock's _____. a. variance b. risk premium c. coefficient of variation d. beta e. correlation coefficient

there is no risk associated with the investment; that is, the investment is risk free, because there is only one possible payoff

if the standard deviation of returns from an investment is zero, then: a. the risk associated with the investment is more than that of the investments that provide risk-free return. b. the expected return from the investment is higher than that of those investments whose standard deviation is greater than zero. c. the scatter of the possible outcome from the investment is high and its investors demand higher return. d. the scatter of the possible outcome from the investment is low and its investors demand higher return. e. there is no risk associated with the investment; that is, the investment is risk free, because there is only one possible payoff.

a decrease in the required rate of return of the portfolio

in a given portfolio, replacing an existing investment with a lower beta investment results in _____. a. an increase in the expected rate of return of the portfolio b. a decrease in the actual rate of return of the portfolio c. a decrease in the required rate of return of the portfolio d. an increase in the systemic risk of the portfolio e. the portfolio beta moving toward 1.0

have a less steep slope

other things held constant, if investors become less risk averse, the new security market line (SML) would _____. a. not be affected b. shift down c. shift up d. have a steeper slope e. have a less steep slope

false

risk refers to the chance that no unfavorable event will occur. True or False

false

short-term investments have higher maturity risks than long-term investments. True or False

standard deviation of the returns

the _____ of an investment is a measure of the tightness, or variability, of its set of returns. a. correlation coefficient b. standard deviation of the returns c. beta coefficient d. coefficient of variation e. expected return

market risk

the part of a security's risk associated with economic factors that affect all firms to some extent is known as the _____. a. diversifiable risk b. unsystematic risk c. stand-alone risk d. market risk e. business risk

listing of all possible outcomes with a chance of occurrence assigned to each outcome

the probability distribution of the payoffs on an investment consists of a _____. a. listing of all possible outcomes with a chance of occurrence assigned to each outcome b. measure of the relationship of one investment with another investment c. standardized measure of the risk per percentage return d. listing of the degree of relationship between the probabilities of two payoffs e. measure of the extent to which the payoffs move with the capital market

true

the relevant risk, which is the risk for which investors should be compensated, is the portion of the total risk that cannot be diversified away. True or False

unsystematic risk

the risk that is limited to a particular firm is also known as _____. a. unsystematic risk b. non-diversifiable risk c. market risk d. relevant risk e. combined risk

market risk and firm-specific risk

the total risk associated with an investment can be divided into _____. a. systematic risk and nondiversifiable risk b. firm-specific risk and unsystematic risk c. market risk and firm-specific risk d. market risk and nondiversifiable risk e. firm-specific risk and total risk

0.44

the variance of the returns of Stock X is 62.5 percent, and the expected return from the stock is 18 percent. Calculate the coefficient of variation of the stock. a. 3.47 b. 0.44 c. 40.98 d. 0.29 e. 1.86

beta coefficient

which of the following is a measure of the extent to which the returns on a given stock move with the stock market? a. Beta coefficient b. Standard deviation c. Coefficient of variation d. Correlation coefficient e. Probability distribution of expected returns