FIN 355 HW9

Assume all investors want to hold a portfolio that, for a given level of volatility, has the maximum possible expected return. Explain why, when a risk-free asset exists, all investors will choose to hold exactly the same portfolio of risky stocks. Select one: A. Investors who want to maximize their expected return for a given level of volatility will pick portfolios that maximize their Sharpe ratio. The set of portfolios that does this is a combination of a risk-free asset and the tangent portfolio. B. All investors will do the same thing - that is, they will minimize their volatilities - so they will all hold the same portfolio. C. All investors will do the same thing - that is, they will maximize their expected returns - so they will all hold the same portfolio. D. When a risk-free asset exists, it provides a safe investment opportunity. Given this safe investment opportunity, investor who maximize their expected returns for a given level of volatility will pick the same expected return and hence the same portfolio.

A. Investors who want to maximize their expected return for a given level of volatility will pick portfolios that maximize their Sharpe ratio. The set of portfolios that does this is a combination of a risk-free asset and the tangent portfolio.

The systematic risk of a security is also called its Select one: A. Market risk B. Perceived risk C. Fundamental Risk D. Unique or firm-specific risk

A. Market risk

Which of the following statements regarding short sale and risk-free security is NOT correct? Select one: A. The correlation between the risk-free investment and a risky portfolio is always equal to one. B. A portfolio that consists of a short position in the risk-free investment is known as a levered portfolio. C. A short sale is a transaction in which you sell a stock that you do not own and then buy that stock back in the future. D. Short selling the risk free investment is equivalent to borrowing money at the risk-free interest rate through a loan.

A. The correlation between the risk-free investment and a risky portfolio is always equal to one.

A financial market's security market line (SML) describes Select one: A. The relationship between systematic risk and expected return B. The relationship between unsystematic risk and unexpected return C. The relationship between systematic risk and unexpected return D. The relationship between unsystematic risk and expected return

A. The relationship between systematic risk and expected return

The systematic risk principle states that Select one: A. The reward for bearing risk is independent of the systematic risk of an investment. B. Systematic risk can be essentially eliminated by diversifcation. C. The reward of bearing risk depends only on the systematic risk of an investment. D. Systematic risk doesn't matter investors

C. The reward of bearing risk depends only on the systematic risk of an investment.

According to the CAPM, what is the rate of return of a portfolio with a beta of 1? Select one: A. The risk free rate, Rf B. Beta × (RM - Rf) C. Difference between RM and Rf. D. The return on the market, RM

D. The return on the market, RM

A company announces that its earnings have increased 25 percent from the previous year, but analyst actually expected a 50 percent increase. What is the likely effect on stock price? Select one: A. The stock price will increase. B. The stock price will rise and then fall after an overreaction. C. The stock price will not be affected. D. The stock price will decrease.

D. The stock price will decrease.

What type of risk is essentially eliminated by diversification? Select one: A. Systematic risk B. Market risk C. Perceived risk D. Unsystematic risk

D. Unsystematic risk