FIN-421 Exam 2

27. A security has an expected rate of return of 0.10 and a beta of 1.1. The market expected rate of return is 0.08, and the risk-free rate is 0.05. The alpha of the stock is A. 1.7%. B. -1.7%. C. 8.3%. D. 5.5%.

A. 1.7%. 10% - [5% +1.1(8% - 5%)] = 1.7%.

42. An analyst estimates the index model for a stock using regression analysis involving total returns. The estimated intercept in the regression equation is 6% and the β is 0.5. The risk-free rate of return is 12%. The true β of the stock is A. 0%. B. 3%. C. 6%. D. 9%.

A.0%. 6% = a+ 12% (1 - 0.5); a= 0%.

3. As diversification increases, the firm-specific risk of a portfolio approaches A. 0. B. 1. C. infinity. D. (n- 1) × n.

A.0.

66. Given an optimal risky portfolio with expected return of 16%, standard deviation of 20%, and a risk-free rate of 4%, what is the slope of the best feasible CAL? A. 0.60 B. 0.14 C. 0.08 D. 0.36 E. 0.31

A.0.60 Slope = (16 - 4)/20 = .6.

27. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 100 stocks in order to construct a mean-variance efficient portfolio constrained by 100 investments. They will need to calculate _____________ expected returns and ___________ variances of returns. A. 100; 100 B. 100; 4950 C. 4950; 100 D. 4950; 4950

A.100; 100

35. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected market rate of return is 11%. Your company has a beta of 1.4, and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 13.8%. B. 7%. C. 15%. D. 4%. E. 1.4%.

A.13.8%. he hurdle rate should be the required return from CAPM, or R = 4% + 1.4(11% - 4%) = 13.8%.

37. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected market rate of return is 11%. Your company has a beta of 0.67, and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 4%. B. 8.69%. C. 15%. D. 11%. E. 0.75%.

B. 8.69% The hurdle rate should be the required return from CAPM, or R = 4% + 0.67(11% - 4%) = 8.69%

33. Your opinion is that Boeing has an expected rate of return of 0.08. It has a beta of 0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security Is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.

B. overpriced. 8.0% - [4% + 0.92(10% - 4%)] = -1.52%; therefore, the security is overpriced

5. As diversification increases, the unique risk of a portfolio approaches A. 1. B. 0. C. infinity. D. (n- 1) × n.

B.0.

46.The index model has been estimated for stocks A and B with the following results: RA= 0.01 + 0.5RM+ eA. RB= 0.02 + 1.3RM+ eB. σM= 0.25; σ(eA) = 0.20; σ(eB) = 0.10. The covariance between the returns on stocks A and B is A. 0.0384. B. 0.0406. C. 0.1920. D. 0.0050. E. 0.4000.

B.0.0406. Cov(RA, RB) = bAbBs2M= 0.5(1.3)(0.25)2= 0.0406

48. The index model has been estimated for stock A with the following results: RA= 0.01 + 0.8RM+ eA. σM= 0.20; σ(eA) = 0.10. The standard deviation of the return for stock A is A. 0.0356. B. 0.1887. C. 0.1600. D. 0.6400.

B.0.1887. σB= [(0.8)2(0.2)2+ (0.1)2]1/2= 0.1887

61. The beta of a stock has been estimated as 1.8 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of A. 1.20. B. 1.53. C. 1.13. D. 1.0.

B.1.53. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.8) + 1/3 = 1.53

73. Consider two perfectly negatively correlated risky securities, K and L. K has an expected rate of return of 13% and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%. The risk-free portfolio that can be formed with the two securities will earn _____ rate of return. A. 9.5% B. 11.4% C. 10.9% D. 9.9% E. None of the options are correct.

B.11.4% E(RP) = 0.46(13%) + 0.54(10%) = 11.38%.

63. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 40 stocks in order to construct a mean-variance efficient portfolio constrained by 40 investments. They will need to calculate ____________ covariances. A. 45 B. 780 C. 4,950 D. 10,000

B.780 (n2- n)/2 = (1,600 - 40)/2 = 780 covariances must be calculated.

52. An overpriced security will plot A. on the security market line. B.below the security market line. C. above the security market line. D. either above or below the security market line depending on its covariance with the market. E. either above or below the security-market line depending on its standard deviation.

B.below the security market line.

1. In the context of the Capital Asset Pricing Model (CAPM), the relevant measure of risk is A. unique risk. B.beta. C. standard deviation of returns. D. variance of returns.

B.beta. Once a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.

3. In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is A. unique risk. B.market risk. C. standard deviation of returns. D. variance of returns.

B.market risk.

20. The presence of risk means that A. investors will lose money. B. more than one outcome is possible. C. the standard deviation of the payoff is larger than its expected value. D. final wealth will be greater than initial wealth. E. terminal wealth will be less than initial wealth.

B.more than one outcome is possible.

15. According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal To A. r f + [E(r M)]. B. r f + [E(r M) - r f ]. C. [E(rM) - r f ]. D. E(r M) + r f .

B.r f + [E(r M) - r f ]. The expected rate of return on any security is equal to the risk-free rate plus the systematic risk of the security (beta) times the market risk premium, E(rM - rf ).

73. You invest $200 in security A with a beta of 1.4 and $800 in security B with a beta of 0.3. The beta of the resulting portfolio is A. 1.40. B. 1.00. C. 0.52. D. 1.08. E. 0.80.

C. 0.52. 0.2(1.4) + 0.8(0.3) = 0.52.

38. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 5%, and the expected market rate of return is 10%. Your company has a beta of 0.67, and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 10%. B. 5%. C. 8.35%. D. 28.35%. E. 0.67%.

C. 8.35% The hurdle rate should be the required return from CAPM, or R = 5% + 0.67(10% - 5%) = 8.35%

45. According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases A. directly with alpha. B. inversely with alpha. C. directly with beta. D. inversely with beta. E. in proportion to its standard deviation.

C. directly with beta

68. Your opinion is that security A has an expected rate of return of 0.145. It has a beta of 1.5. The risk-free rate is 0.04, and the market expected rate of return is 0.11. According to the Capital Asset Pricing Model, this security Is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.

C. fairly priced. 4.5% = 4% + 1.5(11% - 4%) = 14.5%; therefore, the security is fairly priced.

32. Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of 0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security Is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided

C. fairly priced. 9.52% - [4% + 0.92(10% - 4%)] = 0.0%; therefore, the security is fairly priced

19. According to the Capital Asset Pricing Model (CAPM), overpriced securities have A. positive betas. B. zero alphas. C. negative alphas. D. positive alphas.

C. negative alphas.

44. Capital asset pricing theory asserts that portfolio returns are best explained by A. reinvestment risk. B. specific risk. C. systematic risk. D. diversification.

C. systematic risk. The risk remaining in diversified portfolios is systematic risk; thus, portfolio returns are commensurate with systematic risk.

59. If investors do not know their investment horizons for certain, A. the CAPM is no longer valid. B. the CAPM underlying assumptions are not violated. C. the implications of the CAPM are not violated as long as investors' liquidity needs are not priced. D. the implications of the CAPM are no longer useful

C. the implications of the CAPM are not violated as long as investors' liquidity needs are not priced.

30. An investor invests 40% of his wealth in a risky asset with an expected rate of return of 0.17 and a variance of 0.08 and 60% in a T-bill that pays 4.5%. His portfolio's expected return and standard deviation are __________ and __________, respectively. A. 0.114; 0.126 B. 0.087; 0.068 C. 0.095; 0.113 D. 0.087; 0.124 E. None of the options are correct.

C.0.095; 0.113 E(r P) = 0.4(17%) + 0.6(4.5%) = 9.5%; sP = 0.4(0.08)1/2 = 11.31%

43. The index model for stock A has been estimated with the following result: RA= 0.01 + 0.9RM+ eA. If σM= 0.25 and R2A= 0.25, the standard deviation of return of stock A is A. 0.2025. B. 0.2500. C. 0.4500. D. 0.8100.

C.0.4500. R2= b2s2M/s2; 0.25 = [(0.81)(0.25)2]/s2; s= 0.4500.

8. Beta books typically rely on the __________ most recent monthly observations to calculate regression parameters. A. 12 B. 36 C. 60 D. 120

C.60 Most published betas and other regression parameters are based on five years of monthly return data.

33. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a portfolio with a standard deviation of 0.06? A. 30% and 70% B. 50% and 50% C. 60% and 40% D. 40% and 60% E. Cannot be determined.

C.60% and 40% 0.06 = x(0.15); x = 40% in risky asset.

64. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 60 stocks in order to construct a mean-variance efficient portfolio constrained by 60 investments. They will need to calculate ________ estimates of expected returns and ________ estimates of sensitivity coefficients to the macroeconomic factor. A. 200; 19,900 B. 200; 200 C. 60; 60 D. 19,900; 19.900 E. None of the options are correct.

C.60; 60

21. If a firm's beta was calculated as 0.8 in a regression equation, a commonly-used adjustment technique would provide an adjusted beta of A. less than 0.8 but greater than zero. B. between 1.0 and 1.8. C. between 0.8 and 1.0. D. greater than 1.8. E. zero or less.

C.between 0.8 and 1.0.

11. The standard deviation of a portfolio of risky securities is A. the square root of the weighted sum of the securities' variances. B. the square root of the sum of the securities' variances. C. the square root of the weighted sum of the securities' variances and covariances. D. the square root of the sum of the securities' covariances.

C.the square root of the weighted sum of the securities' variances and covariances.

26. You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta of the resulting portfolio is A. 1.40. B. 1.00. C. 0.36. D. 1.08. E. 0.80.

D. 1.08. 0.6(1.2) + 0.4(0.90) = 1.08.

55. The capital asset pricing model assumes A. all investors are price takers. B. all investors have the same holding period. C. investors pay taxes on capital gains. D. all investors are price takers and have the same holding period. E. all investors are price takers, have the same holding period, and pay taxes on capital gains

D. all investors are price takers and have the same holding period.

39. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two risky securities, X and Y. The weights of Xand Y in P are 0.60 and 0.40, respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081. What would be the dollar values of your positions in Xand Y, respectively, if you decide to hold 40% of your money in the risky portfolio and 60% in T-bills? A. $240; $360 B. $360; $240 C. $100; $240 D. $240; $160 E. Cannot be determined.

D.$240; $160 $400(0.6) = $240 in X; $400(0.4) = $160 in Y

75. Security X has expected return of 7% and standard deviation of 14%. Security Y has expected return of 11% and standard deviation of 22%. If the two securities have a correlation coefficient of 0.45, what is their covariance? A. 0.0388 B. -0.0108 C. 0.0184 D. -0.0139 E. -0.1512

D.-0.0139 Cov(r X, r Y) = (-0.45)(0.14)(0.22) = -.01386

32. Given an optimal risky portfolio with expected return of 6%, standard deviation of 23%, and a risk free rate of 3%, what is the slope of the best feasible CAL? A. 0.64 B. 0.39 C. 0.08 D. 0.13 E. 0.36

D.0.13 Slope = (6 - 3)/23 = 0.1304

63. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12% and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%. The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively. A. 0.24; 0.76 B. 0.50; 0.50 C. 0.57; 0.43 D. 0.45; 0.55 E. 0.76; 0.24

D.0.45; 0.55 wA = 14/(17 + 14) = 0.45; wB = 1 0.45 = 0.55.

40. Suppose the following equation best describes the evolution of β over time: βt= 0.31 + 0.82βt- 1. If a stock had a β of 0.88 last year, you would forecast the β to be _______ in the coming year. A. 0.88 B. 0.82 C. 0.31 D. 1.03

D.1.03 0.31 + 0.82(0.88) = 1.0316.

32. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 125 stocks in order to construct a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate ________ estimates of expected returns and ________ estimates of sensitivity coefficients to the macroeconomic factor. A. 125; 15,225 B. 15,625; 125 C. 7,750; 125 D. 125; 125

D.125; 125

18. Which of the following statement(s) is(are) false regarding the variance of a portfolio of two risky securities? I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance. II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance. III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. A. I only B. II only C. III only D. I and II E. I and III

D.I and II

6. The index model was first suggested by A. Graham. B. Markowitz. C. Miller. D. Sharpe.

D.Sharpe.

26. Which of the following statements regarding the capital allocation line (CAL) is false? A. The CAL shows risk-return combinations. B. The slope of the CAL equals the increase in the expected return of the complete portfolio per unit of additional standard deviation. C. The slope of the CAL is also called the reward-to-volatility ratio. D. The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset.

D.The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset.

19. Rosenberg and Guy found that ___________ helped to predict firms' betas. A. debt/asset ratios B. market capitalization C. variance of earnings D. all of the options E. None of the options are correct.

D.all of the options

18. If the index model is valid, _________ would be helpful in determining the covariance between assets Kand L. A. βk B. βL C. σM D. all of the options E. None of the options are correct.

D.all of the options If the index model is valid βk, βL, and σMare determinants of the covariance between K and L

48. The line representing all combinations of portfolio expected returns and standard deviations that can be constructed from two available assets is called the A. risk/reward tradeoff line. B. capital allocation line. C. efficient frontier. D. portfolio opportunity set. E. Security Market Line.

D.portfolio opportunity set.

13. Other things equal, diversification is most effective when A. securities' returns are uncorrelated. B. securities' returns are positively correlated. C. securities' returns are high. D. securities' returns are negatively correlated. E. securities' returns are positively correlated and high.

D.securities' returns are negatively correlated.

4. Diversifiable risk is also referred to as A. systematic risk or unique risk. B. systematic risk or market risk. C. unique risk or market risk. D. unique risk or firm-specific risk

D.unique risk or firm-specific risk

42. You invest 55% of your money in security A with a beta of 1.4 and the rest of your money in security B with a beta of 0.9. The beta of the resulting portfolio is A. 1.466. B. 1.157. C. 0.968. D. 1.082. E. 1.175.

E. 1.175 0.55(1.4) + 0.45(0.90) = 1.175.

58. The capital asset pricing model assumes A. all investors are fully informed. B. all investors are rational. C. all investors are mean-variance optimizers. D. taxes are an important consideration. E. all investors are fully informed, are rational, and are mean-variance optimizers.

E. all investors are fully informed, are rational, and are mean-variance optimizers.

63. The CAPM applies to A. portfolios of securities only. B. individual securities only. C. efficient portfolios of securities only. D. efficient portfolios and efficient individual securities only. E. all portfolios and individual securities.

E. all portfolios and individual securities.

57. Given an optimal risky portfolio with expected return of 13%, standard deviation of 26%, and a risk free rate of 5%, what is the slope of the best feasible CAL? A. 0.60 B. 0.14 C. 0.08 D. 0.36 E. 0.31

E.0.31 Slope = (13 - 5)/26 = 0.31

13. Which statement is true regarding the capital market line (CML)? I) The CML is the line from the risk-free rate through the market portfolio. II) The CML is the best attainable capital allocation line. III) The CML is also called the security market line. IV) The CML always has a positive slope. A. I only B. II only C. III only D. IV only E.I, II, and IV

E.I, II, and IV

62. One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does this mean? A. They plan for one identical holding period. B. They are price takers who can't affect market prices through their trades. C. They are mean-variance optimizers. D. They have the same economic view of the world. E. They pay no taxes or transactions costs.

A. They plan for one identical holding period Myopic behavior is shortsighted, with no concern for medium-term or long-term implications

54. In equilibrium, the marginal price of risk for a risky security must be A. equal to the marginal price of risk for the market portfolio. B. greater than the marginal price of risk for the market portfolio. C. less than the marginal price of risk for the market portfolio. D. adjusted by its degree of nonsystematic risk. E. None of the options are true.

A. equal to the marginal price of risk for the market portfolio.

65. The expected return-beta relationship of the CAPM is graphically represented by A. the security-market line. B. the capital-market line. C. the capital-allocation line. D. the efficient frontier with a risk-free asset. E. the efficient frontier without a risk-free asset

A. the security-market line. The security market line shows expected return on the vertical axis and beta on the horizontal axis. It has an intercept of rf and a slope of E(RM) rf .

31. Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of 0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security Is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided

A. underpriced 11.2% - [4% + 0.92(10% - 4%)] = 1.68%; therefore, the security is underpriced.

30. Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided. E. None of the options are correct.

A. underpriced. 15% - [4% + 1.3(11.5% - 4%)] = 1.25%; therefore, the security is underpriced

40. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two risky securities, X and Y. The weights of Xand Y in P are 0.60 and 0.40, respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081. What would be the dollar value of your positions in X,Y, and the T-bills, respectively, if you decide to hold a portfolio that has an expected outcome of $1,120? A. $568; $378; $54 B. $568; $54; $378 C. $378; $54; $568 D. $108; $514; $378 E. Cannot be determined.

A.$568; $378; $54 ($1,120 - $1,000)/$1,000 = 12%; (0.6)14% + (0.4)10% = 12.4%; 12% = w5% + 12.4%(1 - w); w = 0.054; 1-w = 0.946; w = 0.054($1,000) = $54 (T-bills); 1 - w= 1 - 0.054 = 0.946($1,000) = $946; $946 × 0.6 = $568 in X; $946 × 0.4 = $378 inY.

54. An investor invests 35% of his wealth in a risky asset with an expected rate of return of 0.18 and a variance of 0.10 and 65% in a T-bill that pays 4%. His portfolio's expected return and standard deviation are __________ and __________, respectively. A. 0.089; 0.111 B. 0.087; 0.063 C. 0.096; 0.126 D. 0.087; 0.144

A.0.089; 0.111 E(r P) = 0.35(18%) + 0.65(4%) = 8.9%; sP = 0.35(0.10)1/2 = 11.07%.

9. The risk-free rate and the expected market rate of return are 0.056 and 0.125, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.25 is equal to A.0.142. B. 0.144. C. 0.153. D. 0.134. E. 0.117.

A.0.142. E(R) = 5.6% + 1.25(12.5 - 5.6) = 14.225%.

61. You invest $1,000 in a risky asset with an expected rate of return of 0.17 and a standard deviation of 0.40 and a T-bill with a rate of return of 0.04. The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to A. 0.325. B. 0.675. C. 0.912. D. 0.407. E. Cannot be determined.

A.0.325 (0.17 - 0.04)/0.40 = 0.325

69. Suppose the following equation best describes the evolution of β over time: βt= 0.3 + 0.2βt- 1 If a stock had a β of 0.8 last year, you would forecast the β to be _______ in the coming year. A. 0.46 B. 0.60 C. 0.70 D. 0.94

A.0.46 0.3 + 0.2(0.8) = 0.46.

35. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to A. 0.4667. B. 0.8000. C. 2.14. D. 0.41667. E. Cannot be determined.

A.0.4667. (0.12 - 0.05)/0.15 = 0.4667.

38. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.18 and σMwas 0.24, the β of the portfolio would be approximately A. 0.75. B. 0.56. C. 0.07. D. 1.03.

A.0.75. s2p/s2m= b2; (0.18)2/(0.24)2= 0.5625; b= 0.75.

41. Suppose the following equation best describes the evolution of β over time: t= 0.18 + 0.63βt- 1. If a stock had a β of 1.09 last year, you would forecast the β to be _______ in the coming year. A. 0.87 B. 0.18 C. 0.63 D. 0.81

A.0.87 0.18 + 0.63(1.09) = 0.8667.

74. The beta of a stock has been estimated as 1.4 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of A. 1.27. B. 1.32. C. 1.13. D. 1.0.

A.1.27. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.4) + 1/3 = 1.27.

65. Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 10%. The risk-free rate of return is 3%. The stock earns a return that exceeds the risk-free rate by 11%, and there are no firm-specific events affecting the stock performance. The β of the stock is A. 1.57. B. 0.75. C. 1.17. D. 1.33. E. 1.50.

A.1.57. 11% = 0% + b(7%); b= 1.571.

76. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 125 stocks in order to construct a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate _____________ expected returns and ___________ variances of returns. A.125; 125 B. 125; 15,625 C. 15,625; 125 D. 15,625; 15,625 E. None of the options are correct.

A.125; 125 The expected returns of each of the 125 securities must be calculated. In addition, the 125 variances around these returns must be calculated.

62. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a T-bill with a rate of return of 0.045. What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a portfolio with an expected return of 0.13? A. 130.77% and -30.77% B. -30.77% and 130.77% C. 67.67% and 33.33% D. 57.75% and 42.25% E. Cannot be determined.

A.130.77% and -30.77% 13% = w1(11%) + (1 - w1)(4.5%); 13% = 11%w1 + 4.5% - 4.5%w1; 8.5% = 6.5%w1; w1 = 1.3077; 1 - w1 = 0.3077; 1.308(11%) + (-0.3077)(4.5%) = 13.00%.

26. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 150 stocks in order to construct a mean-variance efficient portfolio constrained by 150 investments. They will need to calculate _____________ expected returns and ___________ variances of returns. A. 150; 150 B. 150; 22500 C. 22500; 150 D. 22500; 22500

A.150; 150

34. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 500 stocks in order to construct a mean-variance efficient portfolio constrained by 500 investments. They will need to calculate ________ estimates of firm-specific variances and ________ estimate/estimates for the variance of the macroeconomic factor. A. 500; 1 B. 500; 500 C. 124,750; 1 D. 124,750; 500 E. 250,000; 500

A.500; 1

12. According to the mean-variance criterion, which one of the following investments dominates all others? A. E(r) = 0.15; Variance = 0.20 B. E(r) = 0.10; Variance = 0.20 C. E(r) = 0.10; Variance = 0.25 D. E(r) = 0.15; Variance = 0.25 E. None of these options dominates the other alternatives

A.E(r) = 0.15; Variance = 0.20

21. Which of the following statement(s) is(are) false regarding the selection of a portfolio from those that lie on the capital allocation line? I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. III) Investors choose the portfolio that maximizes their expected utility. A. I only B. II only C. III only D. I and II E. I and III

A.I only

21. According to the Capital Asset Pricing Model (CAPM), which one of the following statements is false? A.The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate. B. The expected rate of return on a security increases as its beta increases. C. A fairly priced security has an alpha of zero. D. In equilibrium, all securities lie on the security market line. E. All of the statements are true

A.The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate.

7. A single-index model uses __________ as a proxy for the systematic risk factor. A. a market index, such as the S&P 500 B. the current account deficit C. the growth rate in GNP D. the unemployment rate.

A.a market index, such as the S&P 500 The single-index model uses a market index, such as the S&P 500, as a proxy for the market and thus for systematic risk.

43. The first major step in asset allocation is A .assessing risk tolerance. B. analyzing financial statements. C. estimating security betas. D. identifying market anomalies.

A.assessing risk tolerance.

5. According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function Of A.beta risk. B. unsystematic risk. C. unique risk. D. reinvestment risk. E. None of the options are correct.

A.beta risk.

8. The risk that can be diversified away is A. firm-specific risk. B. beta. C. systematic risk. D. market risk.

A.firm-specific risk.

25. The capital allocation line can be described as the A. investment opportunity set formed with a risky asset and a risk-free asset. B. investment opportunity set formed with two risky assets. C. line on which lie all portfolios that offer the same utility to a particular investor. D. line on which lie all portfolios with the same expected rate of return and different standard deviations.

A.investment opportunity set formed with a risky asset and a risk-free asset.

12. The expected return of a portfolio of risky securities A. is a weighted average of the securities' returns. B. is the sum of the securities' returns. C. is the weighted sum of the securities' variances and covariances. D. is a weighted average of the securities' returns and the weighted sum of the securities' variances and covariances. E. None of the options are correct.

A.is a weighted average of the securities' returns.

2. Systematic risk is also referred to as A. market risk or nondiversifiable risk. B. market risk or diversifiable risk. C. unique risk or nondiversifiable risk. D. unique risk or diversifiable risk. E. None of the options are correct.

A.market risk or nondiversifiable risk.

4. According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function Of A.market risk. B. unsystematic risk. C. unique risk. D. reinvestment risk. E. None of the options are correct.

A.market risk. With a diversified portfolio, the only risk remaining is market, or systematic, risk. This is the only risk that influences return according to the CAPM.

6. According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function Of A.systematic risk. B. unsystematic risk. C. unique risk. D. reinvestment risk.

A.systematic risk.

14. The market risk, beta, of a security is equal to A.the covariance between the security's return and the market return divided by the variance of the market's returns. B. the covariance between the security and market returns divided by the standard deviation of the market's returns. C. the variance of the security's returns divided by the covariance between the security and market returns. D. the variance of the security's returns divided by the variance of the market's returns.

A.the covariance between the security's return and the market return divided by the variance of the market's returns. Beta is a measure of how a security's return covaries with the market returns, normalized by the market variance.

58. The separation property refers to the conclusion that A. the determination of the best risky portfolio is objective, and the choice of the best complete portfolio is subjective. B. the choice of the best complete portfolio is objective, and the determination of the best risky portfolio is objective. C. the choice of inputs to be used to determine the efficient frontier is objective, and the choice of the best CAL is subjective. D. the determination of the best CAL is objective, and the choice of the inputs to be used to determine the efficient frontier is subjective. E. investors are separate beings and will, therefore, have different preferences regarding the risk-return tradeoff.

A.the determination of the best risky portfolio is objective, and the choice of the best complete portfolio is subjective.

41. The individual investor's optimal portfolio is designated by A. the point of tangency with the indifference curve and the capital allocation line. B. the point of highest reward to variability ratio in the opportunity set. C. the point of tangency with the opportunity set and the capital allocation line. D. the point of the highest reward to variability ratio in the indifference curve. E. None of the options are correct.

A.the point of tangency with the indifference curve and the capital allocation line.

14. The efficient frontier of risky assets is A. the portion of the minimum-variance portfolio that lies above the global minimum variance portfolio. B. the portion of the minimum-variance portfolio that represents the highest standard deviations. C. the portion of the minimum-variance portfolio that includes the portfolios with the lowest standard deviation. D. the set of portfolios that have zero standard deviation.

A.the portion of the minimum-variance portfolio that lies above the global minimum variance portfolio.

22. The certainty equivalent rate of a portfolio is A. the rate that a risk-free investment would need to offer with certainty to be considered equally attractive as the risky portfolio. B. the rate that the investor must earn for certain to give up the use of his money. C. the minimum rate guaranteed by institutions such as banks. D. the rate that equates "A" in the utility function with the average risk aversion coefficient for all risk-averse investors. E. represented by the scaling factor "-.005" in the utility function

A.the rate that a risk-free investment would need to offer with certainty to be considered equally attractive as the risky portfolio.

13. Analysts may use regression analysis to estimate the index model for a stock. When doing so, the intercept of the regression line is an estimate of A. the α of the asset. B. the β of the asset. C. the σ of the asset. D. the δ of the asset

A.the α of the asset.

74. Security A has an expected rate of return of 0.10 and a beta of 1.3. The market expected rate of return is 0.10, and the risk-free rate is 0.04. The alpha of the stock is A. 1.7%. B. -1.8%. C. 8.3%. D. 5.5%.

B. -1.8%. 10% - [4% + 1.3(10% - 4%)] = -1.8%.

72. You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in security B with a beta of 0.7. The beta of the resulting portfolio is A. 1.40. B. 1.15. C. 0.36. D. 1.08. E. 0.80.

B. 1.15. 0.5(1.6) + 0.5(0.70) = 1.15.

60. Assume that a security is fairly priced and has an expected rate of return of 0.17. The market expected rate of return is 0.11, and the risk-free rate is 0.04. The beta of the stock is A. 1.25. B. 1.86. C. 1. D. 0.95.

B. 1.86. 17% = [4% + (11% - 4%)]; 13% = (7%); = 1.86.

50. Studies of liquidity spreads in security markets have shown that A. liquid stocks earn higher returns than illiquid stocks. B. illiquid stocks earn higher returns than liquid stocks. C. both liquid and illiquid stocks earn the same returns. D. illiquid stocks are good investments for frequent, short-term traders.

B. illiquid stocks earn higher returns than liquid stocks.

66. A "fairly-priced" asset lies A. above the security-market line. B. on the security-market line. C. on the capital-market line. D. above the capital-market line. E. below the security-market line

B. on the security-market line.

47. Standard deviation and beta both measure risk, but they are different in that beta measures A. both systematic and unsystematic risk. B. only systematic risk, while standard deviation is a measure of total risk. C. only unsystematic risk, while standard deviation is a measure of total risk. D. both systematic and unsystematic risk, while standard deviation measures only systematic risk. E. total risk, while standard deviation measures only nonsystematic risk

B. only systematic risk, while standard deviation is a measure of total risk.

39. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 10%, you should A. buy CAT because it is overpriced. B. sell short CAT because it is overpriced. C. sell short CAT because it is underpriced. D. buy CAT because it is underpriced. E. None of the options, as CAT is fairly priced

B. sell short CAT because it is overpriced. 10% < 4% + 1.0(11% - 4%) = 11.0%; therefore, CAT is overpriced and should be shorted

70. The risk-free rate is 4%. The expected market rate of return is 12%. If you expect stock X with a beta of 1.0 to offer a rate of return of 10%, you should A. buy stock X because it is overpriced. B. sell short stock X because it is overpriced. C. sell short stock X because it is underpriced. D. buy stock X because it is underpriced. E. None of the options, as the stock is fairly priced.

B. sell short stock X because it is overpriced. 10% < 4% + 1.0(12% - 4%) = 12.0%; therefore, stock is overpriced and should be shorted

71. The risk-free rate is 5%. The expected market rate of return is 11%. If you expect stock X with a beta of 2.1 to offer a rate of return of 15%, you should A. buy stock X because it is overpriced. B. sell short stock X because it is overpriced. C. sell short stock X because it is underpriced. D. buy stock X because it is underpriced. E. None of the options, as the stock is fairly priced.

B. sell short stock X because it is overpriced. 15% < 5% + 2.1(11% - 5%) = 17.6%; therefore, stock is overpriced and should be shorted

4. As diversification increases, the unsystematic risk of a portfolio approaches A. 1. B. 0. C. infinity. D. (n- 1) ×n

B.0.

65. Security X has expected return of 14% and standard deviation of 22%. Security Y has expected return of 16% and standard deviation of 28%. If the two securities have a correlation coefficient of 0.8, what is their covariance? A. 0.038 B. 0.049 C. 0.018 D. 0.013 E. 0.054

B.0.049 Cov(r X, r Y) = (0.8)(0.22)(0.28) = 0.04928

55. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.11 and a variance of 0.12 and 70% in a T-bill that pays 3%. His portfolio's expected return and standard deviation are __________ and __________, respectively. A. 0.086; 0.242 B. 0.054; 0.104 C. 0.295; 0.123 D. 0.087; 0.182 E. None of the options are correct.

B.0.054; 0.104 E(r P) = 0.3(11%) + 0.7(3%) = 5.4%; sP = 0.3(0.12)1/2 = 10.4%

28. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________ and __________, respectively. A. 0.114; 0.12 B. 0.087; 0.06 C. 0.295; 0.06 D. 0.087; 0.12 E. None of the options are correct.

B.0.087; 0.06 E(r P) = 0.3(15%) + 0.7(6%) = 8.7%; sP = 0.3(0.04)1/2 = 6%.

37. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two risky securities, X and Y. The weights of Xand Y in P are 0.60 and 0.40, respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081. If you want to form a portfolio with an expected rate of return of 0.11, what percentages of your money must you invest in the T-bill and P, respectively? A. 0.25; 0.75 B. 0.19; 0.81 C. 0.65; 0.35 D. 0.50; 0.50 E. Cannot be determined.

B.0.19; 0.81 E(r p) = 0.6(14%) + 0.4(10%) = 12.4%; 11% = 5x + 12.4(1 - x); x = 0.189 (T-bills)(1-x) = 0.811 (risky asset).

49. Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of 5%, what is the slope of the best feasible CAL? A. 0.64 B. 0.27 C. 0.08 D. 0.33 E. 0.36

B.0.27 Slope = (12 - 5)/26 = 0.2692

7. The market portfolio has a beta of A. 0. B.1. C. -1. D. 0.5.

B.1.

37. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.22 and σMwas 0.19, the β of the portfolio would be approximately A. 1.34. B. 1.16. C. 1.25. D. 1.56.

B.1.16. s2p/s2m= b2; (0.22)2/(0.19)2= 1.34; b= 1.16

66. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.25 and σMwas 0.21, the β of the portfolio would be approximately ________. A. 0.64 B. 1.19 C. 1.25 D. 1.56

B.1.19 s2p/s2m= b2; (0.25)2/(0.21)2= 1.417; b= 1.19

24. The beta of Apple stock has been estimated as 2.3 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of A. 2.20. B. 1.87. C. 2.13. D. 1.66.

B.1.87. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(2.3) + 1/3 = 1.867

64. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12% and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%. The risk-free portfolio that can be formed with the two securities will earn _____ rate of return. A. 9.5% B. 10.4% C. 10.9% D. 9.9%

B.10.4% E(RP) = 0.45(12%) + 0.55(9%) = 10.35%.

31. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 175 stocks in order to construct a mean-variance efficient portfolio constrained by 175 investments. They will need to calculate ________ estimates of expected returns and ________ estimates of sensitivity coefficients to the macroeconomic factor. A. 175; 15,225 B. 175; 175 C. 15,225; 175 D. 15,225; 15,225

B.175; 175

33. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 200 stocks in order to construct a mean-variance efficient portfolio constrained by 200 investments. They will need to calculate ________ estimates of expected returns and ________ estimates of sensitivity coefficients to the macroeconomic factor. A. 200; 19,900 B. 200; 200 C. 19,900; 200 D. 19,900; 19.900

B.200; 200

78. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 217 stocks in order to construct a mean-variance efficient portfolio constrained by 217 investments. They will need to calculate ________ estimates of expected returns and ________ estimates of sensitivity coefficients to the macroeconomic factor. A. 217; 47,089 B. 217; 217 C. 47,089; 217 D. 47,089; 47,089 E. None of the options are correct.

B.217; 217

62. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 40 stocks in order to construct a mean-variance efficient portfolio constrained by 40 investments. They will need to calculate _____________ expected returns and ___________ variances of returns. A. 100; 100 B. 40; 40 C. 4950; 100 D. 4950; 4950 E. None of the options are correct.

B.40; 40

60. You invest $1,000 in a risky asset with an expected rate of return of 0.17 and a standard deviation of 0.40 and a T-bill with a rate of return of 0.04. What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a portfolio with a standard deviation of 0.20? A. 30% and 70% B. 50% and 50% C. 60% and 40% D. 40% and 60% E. Cannot be determined.

B.50% and 50% 0.20 = x(0.40); x = 50% in risky asset.

29. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 125 stocks in order to construct a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate ____________ covariances. A. 125 B. 7,750 C. 15,625 D. 11,750

B.7,750 (n2- n)/2 = (15,625 - 125)/2 = 7,750 covariances must be calculated

36. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected market rate of return is 11%. Your company has a beta of 0.75, and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 4%. B. 9.25%. C. 15%. D. 11%. E. 0.75%.

B.9.25% The hurdle rate should be the required return from CAPM, orR = 4% + 0.75(11% - 4%) = 9.25%.

24. Steve is more risk-averse than Edie. On a graph that shows Steve and Edie's indifference curves, which of the following is true? Assume that the graph shows expected return on the vertical axis and standard deviation on the horizontal axis. I) Steve and Edie's indifference curves might intersect. II) Steve's indifference curves will have flatter slopes than Edie's. III) Steve's indifference curves will have steeper slopes than Edie's. IV) Steve and Edie's indifference curves will not intersect. V) Steve's indifference curves will be downward sloping, and Edie's will be upward sloping. A. I and V B. I and III C. III and IV D. I and II E. II and IV

B.I and III

20. If a firm's beta was calculated as 0.6 in a regression equation, a commonly-used adjustment technique would provide an adjusted beta of A. less than 0.6 but greater than zero. B. between 0.6 and 1.0. C. between 1.0 and 1.6. D. greater than 1.6. E. zero or less.

B.between 0.6 and 1.0. Betas, on average, equal one; thus, betas over time regress toward the mean, or 1. Therefore, if historic betas are less than 1, adjusted betas are between 1 and the calculated beta

42. The change from a straight to a kinked capital allocation line is a result of A. reward-to-volatility ratio increasing. B. borrowing rate exceeding lending rate. C. an investor's risk tolerance decreasing. D. increase in the portfolio proportion of the risk-free asset.

B.borrowing rate exceeding lending rate.

16. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global-minimum variance portfolio has a standard deviation that is always A. greater than zero. B. equal to zero. C. equal to the sum of the securities' standard deviations. D. equal to 1.

B.equal to zero.

19. Efficient portfolios of N risky securities are portfolios that A. are formed with the securities that have the highest rates of return regardless of their standard deviations. B. have the highest rates of return for a given level of risk. C. are selected from those securities with the lowest standard deviations regardless of their returns. D. have the highest risk and rates of return and the highest standard deviations. E. have the lowest standard deviations and the lowest rates of return.

B.have the highest rates of return for a given level of risk.

28. Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.

B.overpriced. 13% - [4% + 1.3(11.5% - 4%)] = -0.75%; therefore, the security is overpriced.

39. The unsystematic risk of a specific security A. is likely to be higher in an increasing market. B. results from factors unique to the firm. C. depends on market volatility. D. cannot be diversified away.

B.results from factors unique to the firm. Unsystematic (or diversifiable or firm-specific) risk refers to factors unique to the firm. Such risk may be diversified away; however, market risk will remain.

53. In words, the covariance considers the probability of each scenario happening and the interaction between A. securities' returns relative to their variances. B. securities' returns relative to their mean returns. C. securities' returns relative to other securities' returns. D. the level of return a security has in that scenario and the overall portfolio return. E. the variance of the security's return in that scenario and the overall portfolio variance.

B.securities' returns relative to their mean returns.

25. The risk-free rate is 7%. The expected market rate of return is 15%. If you expect a stock with a beta of 1.3 to offer a rate of return of 12%, you should A. buy the stock because it is overpriced. B. sell short the stock because it is overpriced. C. sell the stock short because it is underpriced. D. buy the stock because it is underpriced. E. None of the options, as the stock is fairly priced.

B.sell short the stock because it is overpriced. 2% < 7% + 1.3(15% - 7%) = 17.40%; therefore, stock is overpriced and should be shorted.

37. The measure of risk in a Markowitz efficient frontier is A. specific risk. B. standard deviation of returns. C. reinvestment risk. D. beta.

B.standard deviation of returns.

3. Nondiversifiable risk is also referred to as A. systematic risk or unique risk. B. systematic risk or market risk. C. unique risk or market risk. D. unique risk or firm-specific risk.

B.systematic risk or market risk.

1. Market risk is also referred to as A. systematic risk or diversifiable risk. B. systematic risk or nondiversifiable risk. C. unique risk or nondiversifiable risk. D. unique risk or diversifiable risk.

B.systematic risk or nondiversifiable risk. Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that can be eliminated from the portfolio by diversification.

2. In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is A. unique risk. B.systematic risk. C. standard deviation of returns. D. variance of returns.

B.systematic risk.

46. In the mean-standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called A. the security market line. B. the capital allocation line. C. the indifference curve. D. the investor's utility line.

B.the capital allocation line. The capital allocation line (CAL) illustrates the possible combinations of a risk-free asset and a risky asset available to the investor

36. Portfolio theory as described by Markowitz is most concerned with A. the elimination of systematic risk. B. the effect of diversification on portfolio risk. C. the identification of unsystematic risk. D. active portfolio management to enhance returns.

B.the effect of diversification on portfolio risk.

54. In the single-index model represented by the equation ri= E(ri) + βiF+ ei, the term ei represents A. the impact of unanticipated macroeconomic events on security i's return. B. the impact of unanticipated firm-specific events on security i's return. C. the impact of anticipated macroeconomic events on security i's return. D. the impact of anticipated firm-specific events on security i's return. E. the impact of changes in the market on security i's return.

B.the impact of unanticipated firm-specific events on security i's return.

47. When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio, A. the portfolio standard deviation will be greater than the weighted average of the individual security standard deviations. B. the portfolio standard deviation will be less than the weighted average of the individual security standard deviations. C. the portfolio standard deviation will be equal to the weighted average of the individual security standard deviations. D. the portfolio standard deviation will always be equal to the securities' covariance

B.the portfolio standard deviation will be less than the weighted average of the individual security standard deviations.

43. In a two-security minimum variance portfolio where the correlation between securities is greater than 1.0, A. the security with the higher standard deviation will be weighted more heavily. B. the security with the higher standard deviation will be weighted less heavily. C. the two securities will be equally weighted. D. the risk will be zero. E. the return will be zero.

B.the security with the higher standard deviation will be weighted less heavily.

12. Analysts may use regression analysis to estimate the index model for a stock. When doing so, the slope of the regression line is an estimate of A. the α of the asset. B. the β of the asset. C. the σ of the asset. D. the δ of the asset.

B.the β of the asset. The slope of the regression line, β, estimates the volatility of the stock versus the volatility of the market, and the α estimates the intercept.

41. A reward-to-volatility ratio is useful in A. measuring the standard deviation of returns. B. understanding how returns increase relative to risk increases. C. analyzing returns on variable-rate bonds. D. assessing the effects of inflation. E. None of the options are correct.

B.understanding how returns increase relative to risk increases

17. According to the Capital Asset Pricing Model (CAPM), fairly-priced securities have A. positive betas. B. zero alphas. C. negative betas. D. positive alphas.

B.zero alphas. A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).

52. The expectedimpact of unanticipated macroeconomic events on a security's return during the period is A. included in the security's expected return. B. zero. C. equal to the risk-free rate. D. proportional to the firm's beta. E. infinite.

B.zero.

77. Assume that a security is fairly priced and has an expected rate of return of 0.13. The market expected rate of return is 0.13, and the risk-free rate is 0.04. The beta of the stock is A. 1.25. B. 1.7. C. 1. D. 0.95.

C. 1. 13% = [4% + (13% - 4%)]; 9% = (9%); = 1.

64. Which of the following statements about the mutual-fund theorem is true? I) It is similar to the separation property. II) It implies that a passive investment strategy can be efficient. III) It implies that efficient portfolios can be formed only through active strategies. IV) It means that professional managers have superior security-selection strategies. A. I and IV B. I, II, and IV C. I and II D. III and IV E. II and IV

C. I and II

51. An underpriced security will plot A. on the security market line. B. below the security market line. C. above the security market line. D. either above or below the security market line depending on its covariance with the market. E. either above or below the security-market line depending on its standard deviation.

C. above the security market line.

69. Your opinion is that security C has an expected rate of return of 0.106. It has a beta of 1.1. The risk-free rate is 0.04, and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security Is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.

C. fairly priced. 4% + 1.1(10% - 4%) = 10.6%; therefore, the security is fairly priced.

67. For the CAPM that examines illiquidity premiums, if there is correlation among assets due to common systematic risk factors, the illiquidity premium on asset i is a function of A. the market's volatility. B. asset i's volatility. C. the trading costs of security i. D. the risk-free rate. E. the money supply.

C. the trading costs of security i.

74. Security M has expected return of 17% and standard deviation of 32%. Security S has expected return of 13% and standard deviation of 19%. If the two securities have a correlation coefficient of 0.78, what is their covariance? A. 0.038 B. 0.049 C. 0.047 D. 0.045 E. 0.054

C.0.047 Cov(r X, r Y) = (0.78)(0.32)(0.19) = 0.0474

47. The index model has been estimated for stocks A and B with the following results: RA= 0.01 + 0.8RM+ eA. RB= 0.02 + 1.2RM+ eB. σM= 0.20; σ(eA) = 0.20; σ(eB) = 0.10. The standard deviation for stock A is A. 0.0656. B. 0.0676. C. 0.2561. D. 0.2600.

C.0.2561. σA= [(0.8)2(0.2)2+ (0.2)2]1/2= 0.2561.

38. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two risky securities, X and Y. The weights of Xand Y in P are 0.60 and 0.40, respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081. If you want to form a portfolio with an expected rate of return of 0.10, what percentages of your money must you invest in the T-bill, X, and Y, respectively, if you keep X and Y in the same proportions to each other as in portfolio P? A. 0.25; 0.45; 0.30 B. 0.19; 0.49; 0.32 C. 0.32; 0.41; 0.27 D. 0.50; 0.30; 0.20 E. Cannot be determined.

C.0.32; 0.41; 0.27 10 = 5w + 12.4(1 - w); w = 0.32 (weight of T-bills); as composition of X and Y are 0.6 and 0.4 ofP, respectively, then for 0.68 weight in P, the respective weights must be 0.41 and 0.27; .6(0.68) = 41%; .4(0.68) = 27%.

72. Consider two perfectly negatively correlated risky securities, K and L. K has an expected rate of return of 13% and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%. The weights of K and L in the global minimum variance portfolio are _____ and _____, respectively. A. 0.24; 0.76 B. 0.50; 0.50 C. 0.46; 0.54 D. 0.45; 0.55 E. 0.76; 0.24

C.0.46; 0.54 wK = 16/(19 + 16) = 0.46; wB = 1 0.46 = 0.54.

39. Suppose the following equation best describes the evolution of β over time: βt= 0.25 + 0.75βt- 1. If a stock had a β of 0.6 last year, you would forecast the β to be _______ in the coming year. A. 0.45 B. 0.60 C. 0.70 D. 0.75

C.0.70 0.25 + 0.75(0.6) = 0.70.

67. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.18 and σMwas 0.22, the β of the portfolio would be approximately A. 0.64. B. 1.19. C. 0.82. D. 1.56.

C.0.82. s2p/s2m= b2; (0.18)2/(0.22)2= 0.669; b= 0.82

35. Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 16%. The risk-free rate of return is 5%. The stock earns a return that exceeds the risk-free rate by 11%, and there are no firm-specific events affecting the stock performance. The β of the stock is A. 0.67. B. 0.75. C. 1.0. D. 1.33. E. 1.50.

C.1.0. 11% = 0% + b(11%);b= 1.0

25. The beta of JCP stock has been estimated as 1.2 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of A. 1.20. B. 1.32. C. 1.13. D. 1.0.

C.1.13. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.2) + 1/3 = 1.13.

36. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.20 and σMwas 0.16, the β of the portfolio would be approximately A. 0.64. B. 0.80. C. 1.25. D. 1.56.

C.1.25. s2p/s2m= b2; (0.2)2/(0.16)2= 1.56; b= 1.25.

9. Assume an investor with the following utility function: U = E(r) - 3/2(s2). To maximize her expected utility, she would choose the asset with an expected rate of return of _______ and a standard deviation of ________, respectively. A. 12%; 20% B. 10%; 15% C. 10%; 10% D. 8%; 10%

C.10%; 10% U = 0.10 - 3/2(0.10) 2 = 8.5%; highest utility of choices

30. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 100 stocks in order to construct a mean-variance efficient portfolio constrained by 100 investments. They will need to calculate ____________ covariances. A. 45 B. 100 C. 4,950 D. 10,000

C.4,950 (n2- n)/2 = (10,000 - 100)/2 = 4,950 covariances must be calculated.

57. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a T-bill with a rate of return of 0.03. What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a portfolio with a standard deviation of 0.08? A. 30% and 70% B. 50% and 50% C. 60% and 40% D. 40% and 60% E. Cannot be determined.

C.60% and 40% 0.08 = x(0.20); x = 40% in risky asset.

56. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a T-bill with a rate of return of 0.03. What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a portfolio with an expected return of 0.08? A. 85% and 15% B. 75% and 25% C. 62.5% and 37.5% D. 57% and 43% E. Cannot be determined.

C.62.5% and 37.5% 8% = w1(11%) + (1 w1)(3%); 8% = 11%w1 + 3% 3%w1; 5% = 8%w1; w1 = 0.625; 1 w1= 0.375; 0.625(11%) + 0.375(3%) = 8.0%.

31. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10% and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%. The risk-free portfolio that can be formed with the two securities will earn a(n) _____ rate of return. A. 8.5% B. 9.0% C. 8.9% D. 9.9%

C.8.9% E(RP) = 0.43(10%) + 0.57(8%) = 8.86%.

10. To maximize her expected utility, which one of the following investment alternatives would she choose? Assume an investor with the following utility function: U= E(r) 3/2(s2). A. A portfolio that pays 10% with a 60% probability or 5% with 40% probability. B. A portfolio that pays 10% with 40% probability or 5% with a 60% probability. C. A portfolio that pays 12% with 60% probability or 5% with 40% probability. D. A portfolio that pays 12% with 40% probability or 5% with 60% probability.

C.A portfolio that pays 12% with 60% probability or 5% with 40% probability. U(c) = 9.02%; highest utility of possibilities

13. Consider a risky portfolio, A, with an expected rate of return of 0.15 and a standard deviation of 0.15, that lies on a given indifference curve. Which one of the following portfolios might lie on the same indifference curve for a risk averse investor? A. E(r) = 0.15; Standard deviation = 0.20 B. E(r) = 0.15; Standard deviation = 0.10 C. E(r) = 0.10; Standard deviation = 0.10 D. E(r) = 0.20; Standard deviation = 0.15 E. E(r) = 0.10; Standard deviation = 0.20

C.E(r) = 0.10; Standard deviation = 0.10

2. Which of the following statements is(are) true? I) Risk-averse investors reject investments that are fair games. II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A. I only B. II only C. I and II only D. II and III only E. II, III, and IV only

C.I and II only Risk-averse investors consider a risky investment only if the investment offers a risk premium. Risk-neutral investors look only at expected returns when making an investment decision.

17. Which of the following statement(s) is(are) true regarding the variance of a portfolio of two risky securities? I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance. II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance. III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. A. I only B. II only C. III only D. I and II E. I and III

C.III only

5. In the mean-standard deviation graph, which one of the following statements is true regarding the indifference curve of a risk-averse investor? A. It is the locus of portfolios that have the same expected rates of return and different standard deviations. B. It is the locus of portfolios that have the same standard deviations and different rates of return. C. It is the locus of portfolios that offer the same utility according to returns and standard deviations. D. It connects portfolios that offer increasing utilities according to returns and standard deviations. E. None of the options are correct.

C.It is the locus of portfolios that offer the same utility according to returns and standard deviations. Indifference curves plot trade-off alternatives that provide equal utility to the individual (in this case, the tradeoffs are the risk-return characteristics of the portfolios).

44. Which of the following is not a source of systematic risk? A. The business cycle B. Interest rates C. Personnel changes D. The inflation rate E. Exchange rates

C.Personnel changes Personnel changes are a firm-specific event that is a component of nonsystematic risk. The others are all sources of systematic risk.

12. Which statement is not true regarding the capital market line (CML)? A. The CML is the line from the risk-free rate through the market portfolio. B. The CML is the best attainable capital allocation line. C.The CML is also called the security market line. D. The CML always has a positive slope. E. The risk measure for the CML is standard deviation

C.The CML is also called the security market line.

36. Consider a T-bill with a rate of return of 5% and the following risky securities: Security A: E(r) = 0.15; Variance = 0.04 Security B: E(r) = 0.10; Variance = 0.0225 Security C: E(r) = 0.12; Variance = 0.01 Security D: E(r) = 0.13; Variance = 0.0625 From which set of portfolios, formed with the T-bill and any one of the four risky securities, would a risk-averse investor always choose his portfolio? A. The set of portfolios formed with the T-bill and security A. B. The set of portfolios formed with the T-bill and security B. C. The set of portfolios formed with the T-bill and security C. D. The set of portfolios formed with the T-bill and security D. E. Cannot be determined.

C.The set of portfolios formed with the T-bill and security C.

1. Which of the following statements regarding risk-averse investors is true? A. They only care about the rate of return. B. They accept investments that are fair games. C.They only accept risky investments that offer risk premiums over the risk-free rate. D. They are willing to accept lower returns and high risk. E. They only care about the rate of return, and they accept investments that are fair games.

C.They only accept risky investments that offer risk premiums over the risk-free rate. Risk-averse investors only accept risky investments that offer risk premiums over the risk-free rate.

22. If a firm's beta was calculated as 1.3 in a regression equation, a commonly-used adjustment technique would provide an adjusted beta of A. less than 1.0 but greater than zero. B. between 0.3 and 0.9. C. between 1.0 and 1.3. D. greater than 1.3. E. zero or less.

C.between 1.0 and 1.3.

73. If a firm's beta was calculated as 1.35 in a regression equation, a commonly-used adjustment technique would provide an adjusted beta of A. equal to 1.35. B. between 0.0 and 1.0. C. between 1.0 and 1.35. D. greater than 1.35. E. zero or less.

C.between 1.0 and 1.35.

60. If a firm's beta was calculated as 1.6 in a regression equation, a commonly-used adjustment technique would provide an adjusted beta of A. less than 0.6 but greater than zero. B. between 0.6 and 1.0. C. between 1.0 and 1.6. D. greater than 1.6. E. zero or less.

C.between 1.0 and 1.6.

34. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. A portfolio that has an expected outcome of $115 is formed by A. investing $100 in the risky asset. B. investing $80 in the risky asset and $20 in the risk-free asset. C. borrowing $43 at the risk-free rate and investing the total amount ($143) in the risky asset. D. investing $43 in the risky asset and $57 in the riskless asset. E. Such a portfolio cannot be formed.

C.borrowing $43 at the risk-free rate and investing the total amount ($143) in the risky asset. For $100: (115 - 100)/100 = 15%; .15 = w1(0.12) + (1 w1)(0.05); .15 = 0.12w1 + 0.05 - 0.05w1; 0.10 = 0.07w1; w1 = 1.43($100) = $143; (1 - w1)$100 = -$43.

24. Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.

C.fairly priced 11% = 5% + 1.5(9% - 5%) = 11.0%; therefore, the security is fairly priced.

29. Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security Is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.

C.fairly priced. 13.75% - [4% + 1.3(11.5% - 4%)] = 0.0%; therefore, the security is fairly priced.

10. The variance of a portfolio of risky securities A. is a weighted sum of the securities' variances. B. is the sum of the securities' variances. C. is the weighted sum of the securities' variances and covariances. D. is the sum of the securities' covariances. E. None of the options are correct.

C.is the weighted sum of the securities' variances and covariances.

4. In the mean-standard deviation graph, an indifference curve has a ________ slope. A. negative B. zero C. positive D. vertical E. Cannot be determined.

C.positive The risk-return trade-off is one in which greater risk is taken if greater returns can be expected, resulting in a positive slope.

53. Covariances between security returns tend to be A. positive because of SEC regulations. B. positive because of Exchange regulations. C. positive because of economic forces that affect many firms. D. negative because of SEC regulations. E. negative because of economic forces that affect many firms.

C.positive because of economic forces that affect many firms.

15. The capital allocation line provided by a risk-free security and N risky securities is A. the line that connects the risk-free rate and the global minimum-variance portfolio of the risky securities. B. the line that connects the risk-free rate and the portfolio of the risky securities that has the highest expected return on the efficient frontier. C. the line tangent to the efficient frontier of risky securities drawn from the risk-free rate. D. the horizontal line drawn from the risk-free rate.

C.the line tangent to the efficient frontier of risky securities drawn from the risk-free rate.

57. The security characteristic line (SCL) associated with the single-index model is a plot of A. the security's returns on the vertical axis and the market index's returns on the horizontal axis. B. the market index's returns on the vertical axis and the security's returns on the horizontal axis. C. the security's excess returns on the vertical axis and the market index's excess returns on the horizontal axis. D. the market index's excess returns on the vertical axis and the security's excess returns on the horizontal axis. E. the security's returns on the vertical axis and Beta on the horizontal axis.

C.the security's excess returns on the vertical axis and the market index's excess returns on the horizontal axis.

1. As diversification increases, the total variance of a portfolio approaches A. 0. B. 1. C. the variance of the market portfolio. D. infinity. E. None of the options are correct.

C.the variance of the market portfolio. As more and more securities are added to the portfolio, unsystematic risk decreases and most of the remaining risk is systematic, as measured by the variance of the market portfolio.

22. In a well-diversified portfolio, A. market risk is negligible. B. systematic risk is negligible. C. unsystematic risk is negligible. D. nondiversifiable risk is negligible.

C.unsystematic risk is negligible.

11. The intercept in the regression equations calculated by beta books is equal to A. α in the CAPM. B. α + rf(1 + β). C. α + rf(1 - β). D. 1 - α.

C.α + rf(1 - β). The intercept that beta books call alpha is really, using the parameters of the CAPM, an estimate of a+ rf(1 - b). The apparent justification for this procedure is that, on a monthly basis, rf(1 - b) is small and is apt to be swamped by the volatility of actual stock returns.

11. A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15. The risk-free rate is 6%. An investor has the following utility function: U = E(r) (A/2)s2. Which value of A makes this investor indifferent between the risky portfolio and the risk-free asset? A. 5 B. 6 C. 7 D. 8

D. 8 0.06 = 0.15 - A/2(0.15)2; 0.06 - 0.15 = A/2(0.0225); 0.09 = -0.01125A; A = 8; U= 0.15 8/2(0.15)2 = 6%; U(Rf ) = 6%.

48. The expected return-beta relationship A. is the most familiar expression of the CAPM to practitioners. B. refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta. C. assumes that investors hold well-diversified portfolios. D. All of the options are true. E. None of the options are true.

D. All of the options are true.

61. The amount that an investor allocates to the market portfolio is negatively related to I) the expected return on the market portfolio. II) the investor's risk aversion coefficient. III) the risk-free rate of return. IV) the variance of the market portfolio. A. I and II. B. II and III. C. II and IV. D. II, III, and IV. E. I, III, and IV.

D. II, III, and IV. The optimal proportion is given by y = (E(RM) - rf )/(0.01 × A 2 M). This amount will decrease as rf , A, and 2Mdecrease

46. What is the expected return of a zero-beta security? A. The market rate of return B. Zero rate of return C. A negative rate of return D. The risk-free rate

D. The risk-free rate E(RS) = rf + 0(RM - rf) = rf.

57. The capital asset pricing model assumes A. all investors are rational. B. all investors have the same holding period. C. investors have heterogeneous expectations. D. all investors are rational and have the same holding period. E. all investors are rational, have the same holding period, and have heterogeneous expectations.

D. all investors are rational and have the same holding period.

23. Empirical results regarding betas estimated from historical data indicate that betas A. are constant over time. B. are always greater than one. C. are always near zero. D. appear to regress toward one over time. E. are always positive.

D. appear to regress toward one over time. Betas vary over time, betas may be negative or less than one, and betas are not always near zero; however, betas do appear to regress toward one over time

41. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 13%, you should A. buy CAT because it is overpriced. B. sell short CAT because it is overpriced. C. sell short CAT because it is underpriced. D. buy CAT because it is underpriced. E. None of the options, as CAT is fairly priced.

D. buy CAT because it is underpriced 13% > 4% + 1.0(11% - 4%) = 11.0%; therefore, CAT is underpriced

49. The security market line (SML) A. can be portrayed graphically as the expected return-beta relationship. B. can be portrayed graphically as the expected return-standard deviation of market-returns relationship. C. provides a benchmark for evaluation of investment performance. D. can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance. E. can be portrayed graphically as the expected return-standard deviation of market-returns relationship and provides a benchmark for evaluation of investment performance.

D. can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance.

20. According to the Capital Asset Pricing Model (CAPM), a security with a A. positive alpha is considered overpriced. B. zero alpha is considered to be a good buy. C. negative alpha is considered to be a good buy. D. positive alpha is considered to be underpriced.

D. positive alpha is considered to be underpriced.

18. According to the Capital Asset Pricing Model (CAPM), underpriced securities have A. positive betas. B. zero alphas. C. negative betas. D. positive alphas. E. None of the options are correct.

D. positive alphas.

53. The risk premium on the market portfolio will be proportional to A. the average degree of risk aversion of the investor population. B. the risk of the market portfolio as measured by its variance. C. the risk of the market portfolio as measured by its beta. D. the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its variance. E. the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its beta.

D. the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its variance.

45. The global minimum variance portfolio formed from two risky securities will be riskless when the correlation coefficient between the two securities is A. 0.0. B. 1.0. C. 0.5. D. -1.0. E. any negative number.

D.-1.0. The global minimum variance portfolio will have a standard deviation of zero whenever the two securities are perfectly negatively correlated.

42. For a two-stock portfolio, what would be the preferred correlation coefficient between the two stocks? A. +1.00 B. +0.50 C. 0.00 D. -1.00 E. None of the options are correct.

D.-1.00 The correlation coefficient of -1.00 provides the greatest diversification benefits

46. Security X has expected return of 12% and standard deviation of 18%. Security Y has expected return of 15% and standard deviation of 26%. If the two securities have a correlation coefficient of 0.7, what is their covariance? A. 0.038 B. 0.070 C. 0.018 D. 0.033 E. 0.054

D.0.033 Cov(r X, r Y) = (0.7)(0.18)(0.26) = 0.0327

9. The index model has been estimated for stocks A and B with the following results: RA= 0.03 + 0.7RM+ eA. RB= 0.01 + 0.9RM+ eB. σM= 0.35; σ(eA) = 0.20; σ(eB) = 0.10. The covariance between the returns on stocks A and B is A. 0.0384. B. 0.0406. C. 0.1920. D. 0.0772. E. 0.4000.

D.0.0772. Cov(RA, RB) = bAbBs2M= 0.7(0.9)(0.35)2= 0.0772.

29. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.13 and a variance of 0.03 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________ and __________, respectively. A. 0.114; 0.128 B. 0.087; 0.063 C. 0.295; 0.125 D. 0.081; 0.052

D.0.081; 0.052 E(r P) = 0.3(13%) + 0.7(6%) = 8.1%; sP = 0.3(0.03)1/2 = 5.19%.

8. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to A. 0.06. B. 0.144. C. 0.12. D.0.132. E. 0.18.

D.0.132 E(R) = 6% + 1.2(12 - 6) = 13.2%.

67. Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of 3%, what is the slope of the best feasible CAL? A. 0.64 B. 0.14 C. 0.08 D. 0.35 E. 0.36

D.0.35 Slope = (12 - 3)/26 = 0.346

58. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a T-bill with a rate of return of 0.03. The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to A. 0.47. B. 0.80. C. 2.14. D. 0.40. E. Cannot be determined.

D.0.40. (0.11 - 0.03)/0.20 = 0.40.

30. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10% and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%. The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively. A. 0.24; 0.76 B. 0.50; 0.50 C. 0.57; 0.43 D. 0.43; 0.57 E. 0.76; 0.24

D.0.43; 0.57 wA = 12/(16 + 12) = 0.4286; wB = 1 0.4286 = 0.5714.

75. The beta of a stock has been estimated as 0.85 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of A. 1.01. B. 0.95. C. 1.13. D. 0.90.

D.0.90. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(0.85) + 1/3 = 0.90

68. Suppose the following equation best describes the evolution of β over time: βt= 0.4 + 0.6βt- 1. If a stock had a β of 0.9 last year, you would forecast the β to be _______ in the coming year. A. 0.45 B. 0.60 C. 0.70 D. 0.94

D.0.94 0.4 + 0.6(0.9) = 0.94.

23. The beta of Exxon stock has been estimated as 1.6 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of A. 1.20. B. 1.32. C. 1.13. D. 1.40.

D.1.40. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.6) + 1/3 = 1.40

34. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected market rate of return is 11%. Your company has a beta of 1.0, and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 4%. B. 7%. C. 15%. D. 11%. E. 1%.

D.11% he hurdle rate should be the required return from CAPM, or R = 4% + 1.0(11% - 4%) = 11%

28. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 150 stocks in order to construct a mean-variance efficient portfolio constrained by 150 investments. They will need to calculate ____________ covariances. A. 12 B. 150 C. 22,500 D. 11,175

D.11,175 (n2- n)/2 = (22,500 - 150)/2 = 11,175 covariances must be calculated.

71. Suppose you forecast that the market index will earn a return of 12% in the coming year. Treasury bills are yielding 4%. The unadjusted β of Mobil stock is 1.50. A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a common method to derive adjusted betas. A. 15.0% B. 15.5% C. 16.0% D. 14.7%

D.14.7% Adjusted beta = 2/3(1.5) + 1/3 = 1.33; E(rM) = 4% + 1.33(8%) = 14.66%.

45. Suppose you forecast that the market index will earn a return of 15% in the coming year. Treasury bills are yielding 6%. The unadjusted β of Mobil stock is 1.30. A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a common method to derive adjusted betas. A. 15.0% B. 15.5% C. 16.0% D. 16.8%

D.16.8% Adjusted beta = 2/3(1.3) + 1/3 = 1.20; E(rM) = 6% + 1.20(9%) = 16.8%.

32. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a portfolio with an expected return of 0.09? A. 85% and 15% B. 75% and 25% C. 67% and 33% D. 57% and 43% E. Cannot be determined.

D.57% and 43% 9% = w1(12%) + (1 - w1)(5%); 9% = 12%w1 + 5% - 5%w1; 4% = 7%w1; w1 = 0.57; 1 - w1 = 0.43; 0.57(12%) + 0.43(5%) = 8.99%.

63. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a T-bill with a rate of return of 0.045. What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a portfolio with a standard deviation of 0.08? A. 30.1% and 69.9% B. 50.5% and 49.50% C. 60.0% and 40.0% D. 61.9% and 38.1% E. Cannot be determined.

D.61.9% and 38.1% 0.08 = x(0.21); x = 38.1% in risky asset.

51. The security characteristic line (SCL) A. plots the excess return on a security as a function of the excess return on the market. B. allows one to estimate the beta of the security. C. allows one to estimate the alpha of the security. D. All of the options. E. None of the options are correct.

D.All of the options.

51. The risk that can be diversified away in a portfolio is referred to as ___________. I) diversifiable risk II) unique risk III) systematic risk IV) firm-specific risk A. I, III, and IV B. II, III, and IV C. III and IV D. I, II, and IV E. I, II, III, and IV

D.I, II, and IV

6. In a return-standard deviation space, which of the following statements is(are) true for risk-averse investors? (The vertical and horizontal lines are referred to as the expected return-axis and the standard deviation-axis, respectively.) I) An investor's own indifference curves might intersect. II) Indifference curves have negative slopes. III) In a set of indifference curves, the highest offers the greatest utility. IV) Indifference curves of two investors might intersect. A. I and II only B. II and III only C. I and IV only D. III and IV only E. None of the options are correct.

D.III and IV only

52. As the number of securities in a portfolio is increased, what happens to the average portfolio standard deviation? A. It increases at an increasing rate. B. It increases at a decreasing rate. C. It decreases at an increasing rate. D. It decreases at a decreasing rate. E. It first decreases, then starts to increase as more securities are added

D.It decreases at a decreasing rate.

10. Which statement is not true regarding the market portfolio? A. It includes all publicly-traded financial assets. B. It lies on the efficient frontier. C. All securities in the market portfolio are held in proportion to their market values. D.It is the tangency point between the capital market line and the indifference curve. E. All of the options are true.

D.It is the tangency point between the capital market line and the indifference curve The tangency point between the capital market line and the indifference curve is the optimal portfolio for a particular investor.

8. When an investment advisor attempts to determine an investor's risk tolerance, which factor would they be least likely to assess? A. The investor's prior investing experience B. The investor's degree of financial security C. The investor's tendency to make risky or conservative choices D. The level of return the investor prefers E. The investor's feelings about loss

D.The level of return the investor prefers

40. Which statement about portfolio diversification is correct? A. Proper diversification can eliminate systematic risk. B. The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities have been purchased. C. Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return. D. Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate. E. None of the statements are correct

D.Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate. Diversification can eliminate only nonsystematic risk; relatively few securities are required to reduce this risk, thus diminishing returns result quickly.

16. If the index model is valid, _________ would be helpful in determining the covariance between assets GMand GE. A. βGM B. βGE C. σM D. all of the options E. None of the options are correct.

D.all of the options If the index model is valid βGM,βGE, and σMare determinants of the covariance between GEand GM.

17. If the index model is valid, _________ would be helpful in determining the covariance between assets HPQand KMP. A.βHPQ B.βKMP C.σM D. all of the options E. None of the options are correct.

D.all of the options If the index model is valid βHPQ,βKMP,and σMare determinants of the covariance between HPQand KMP.

17. The exact indifference curves of different investors A. cannot be known with perfect certainty. B. can be calculated precisely with the use of advanced calculus. C. are known with perfect certainty and allow the advisor to create more suitable portfolios for the client. D. although not known with perfect certainty, do allow the advisor to create more suitable portfolios for the client.

D.although not known with perfect certainty, do allow the advisor to create more suitable portfolios for the client.

33. An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the capital allocation line must A. lend some of her money at the risk-free rate. B. borrow some money at the risk-free rate and invest in the optimal risky portfolio. C. invest only in risky securities. D. borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky securities E. Such a portfolio cannot be formed.

D.borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky securities

14. In a factor model, the return on a stock in a particular period will be related to A. firm-specific events. B. macroeconomic events. C. the error term. D. both firm-specific events and macroeconomic events. E. neither firm-specific events nor macroeconomic events.

D.both firm-specific events and macroeconomic events. The return on a stock is related to both firm-specific and macroeconomic events

52. To build an indifference curve, we can first find the utility of a portfolio with 100% in the risk-free asset, then A. find the utility of a portfolio with 0% in the risk-free asset. B. change the expected return of the portfolio and equate the utility to the standard deviation. C. find another utility level with 0% risk. D. change the standard deviation of the portfolio and find the expected return the investor would require to maintain the same utility level. E. change the risk-free rate and find the utility level that results in the same standard deviation.

D.change the standard deviation of the portfolio and find the expected return the investor would require to maintain the same utility level.

5. Unique risk is also referred to as A. systematic risk or diversifiable risk. B. systematic risk or market risk. C. diversifiable risk or market risk. D. diversifiable risk or firm-specific risk. E. None of the options are correct.

D.diversifiable risk or firm-specific risk.

6. Firm-specific risk is also referred to as A. systematic risk or diversifiable risk. B. systematic risk or market risk. C. diversifiable risk or market risk. D. diversifiable risk or unique risk.

D.diversifiable risk or unique risk.

7. Nonsystematic risk is also referred to as A. market risk or diversifiable risk. B. firm-specific risk or market risk. C. diversifiable risk or market risk. D. diversifiable risk or unique risk.

D.diversifiable risk or unique risk.

7. Elias is a risk-averse investor. David is a less risk-averse investor than Elias. Therefore, A. for the same risk, David requires a higher rate of return than Elias. B. for the same return, Elias tolerates higher risk than David. C. for the same risk, Elias requires a lower rate of return than David. D. for the same return, David tolerates higher risk than Elias. E. Cannot be determined.

D.for the same return, David tolerates higher risk than Elias

50. The single-index model A. greatly reduces the number of required calculations relative to those required by the Markowitz model. B. enhances the understanding of systematic versus nonsystematic risk. C. greatly increases the number of required calculations relative to those required by the Markowitz model. D. greatly reduces the number of required calculations relative to those required by the Markowitz model and enhances the understanding of systematic versus nonsystematic risk. E. enhances the understanding of systematic versus nonsystematic risk and greatly increases the number of required calculations relative to those required by the Markowitz model.

D.greatly reduces the number of required calculations relative to those required by the Markowitz model and enhances the understanding of systematic versus nonsystematic risk.

44. Based on their relative degrees of risk tolerance, A. investors will hold varying amounts of the risky asset in their portfolios. B. all investors will have the same portfolio asset allocations. C. investors will hold varying amounts of the risk-free asset in their portfolios. D. investors will hold varying amounts of the risky asset and varying amounts of the risk-free asset in their portfolios.

D.investors will hold varying amounts of the risky asset and varying amounts of the risk-free asset in their portfolios.

9. The risk that cannot be diversified away is A. firm-specific risk. B. unique. C. nonsystematic risk. D. market risk.

D.market risk.

27. Given the capital allocation line, an investor's optimal portfolio is the portfolio that A. maximizes her expected profit. B. maximizes her risk. C. minimizes both her risk and return. D. maximizes her expected utility. E. None of the options are correct.

D.maximizes her expected utility.

55. Suppose you are doing a portfolio analysis that includes all of the stocks on the NYSE. Using a single-index model rather than the Markowitz model A. increases the number of inputs needed from about 1,400 to more than 1.4 million. B. increases the number of inputs needed from about 10,000 to more than 125,000. C. reduces the number of inputs needed from more than 125,000 to about 10,000. D. reduces the number of inputs needed from more than 5 million to about 10,000. E. increases the number of inputs needed from about 150 to more than 1,500.

D.reduces the number of inputs needed from more than 5 million to about 10,000.

18. The riskiness of individual assets A. should be considered for the asset in isolation. B. should be considered in the context of the effect on overall portfolio volatility. C. should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio. D. should be considered in the context of the effect on overall portfolio volatility and should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio

D.should be considered in the context of the effect on overall portfolio volatility and should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio

54. The standard deviation of a two-asset portfolio is a linear function of the assets' weights when A. the assets have a correlation coefficient less than zero. B. the assets have a correlation coefficient equal to zero. C. the assets have a correlation coefficient greater than zero. D. the assets have a correlation coefficient equal to one. E. the assets have a correlation coefficient less than one.

D.the assets have a correlation coefficient equal to one.

45. Asset allocation may involve A. the decision as to the allocation between a risk-free asset and a risky asset. B. the decision as to the allocation among different risky assets. C. considerable security analysis. D. the decision as to the allocation between a risk-free asset and a risky asset and the decision as to the allocation among different risky assets. E. the decision as to the allocation between a risk-free asset and a risky asset and considerable security analysis.

D.the decision as to the allocation between a risk-free asset and a risky asset and the decision as to the allocation among different risky assets.

16. The security market line (SML) is A. the line that describes the expected return-beta relationship for well-diversified portfolios only. B. also called the capital allocation line. C. the line that is tangent to the efficient frontier of all risky assets. D.the line that represents the expected return-beta relationship. E. All of the options.

D.the line that represents the expected return-beta relationship.

2. As diversification increases, the standard deviation of a portfolio approaches A. 0. B. 1. C. infinity. D. the standard deviation of the market portfolio. E. None of the options are correct.

D.the standard deviation of the market portfolio.

47. Treasury bills are commonly viewed as risk-free assets because A. their short-term nature makes their values insensitive to interest rate fluctuations. B. the inflation uncertainty over their time to maturity is negligible. C. their term to maturity is identical to most investors' desired holding periods. D. their short-term nature makes their values insensitive to interest rate fluctuations, and the inflation uncertainty over their time to maturity is negligible. E. the inflation uncertainty over their time to maturity is negligible, and their term to maturity is identical to most investors' desired holding periods.

D.their short-term nature makes their values insensitive to interest rate fluctuations, and the inflation uncertainty over their time to maturity is negligible Treasury bills do not exactly match most investors' desired holding periods, but because they mature in only a few weeks or months they are relatively free of interest rate sensitivity and inflation uncertainty.

19. A fair game A. will not be undertaken by a risk-averse investor. B. is a risky investment with a zero risk premium. C. is a riskless investment. D. will not be undertaken by a risk-averse investor and is a risky investment with a zero risk premium. E. will not be undertaken by a risk-averse investor and is a riskless investment.

D.will not be undertaken by a risk-averse investor and is a risky investment with a zero risk premium.

40. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 11%, you should A. buy CAT because it is overpriced. B. sell short CAT because it is overpriced. C. sell short CAT because it is underpriced. D. buy CAT because it is underpriced. E. None of the options, as CAT is fairly priced.

E. None of the options, as CAT is fairly priced. 11% = 4% + 1.0(11% - 4%) = 11.0%; therefore, CAT is fairly priced.

56. The capital asset pricing model assumes A. all investors are price takers. B. all investors have the same holding period. C. investors have homogeneous expectations. D. all investors are price takers and have the same holding period. E. all investors are price takers, have the same holding period, and have homogeneous expectations.

E. all investors are price takers, have the same holding period, and have homogeneous expectations.

76. Security X has expected return of 9% and standard deviation of 18%. Security Y has expected return of 12% and standard deviation of 21%. If the two securities have a correlation coefficient of 0.4, what is their covariance? A. 0.0388 B. 0.0706 C. 0.0184 D. -0.0133 E. -0.0151

E.-0.0151 Cov(r X, r Y) = (-0.4)(0.18)(0.21) = 0.0151

50. Given an optimal risky portfolio with expected return of 20%, standard deviation of 24%, and a risk free rate of 7%, what is the slope of the best feasible CAL? A. 0.64 B. 0.14 C. 0.62 D. 0.33 E. 0.54

E.0.54 Slope = (20 - 7)/24 = .5417

15. Rosenberg and Guy found that __________ helped to predict a firm's beta. A. the firm's financial characteristics B. the firm's industry group C. firm size D. the firm's financial characteristics and the firm's industry group E. All of the options are correct.

E.All of the options are correct. Rosenberg and Guy found that after controlling for the firm's financial characteristics, the firm's industry group was a significant predictor of the firm's beta

53. The capital market line I) is a special case of the capital allocation line. II) represents the opportunity set of a passive investment strategy. III) has the one-month T-Bill rate as its intercept. IV) uses a broad index of common stocks as its risky portfolio. A. I, III, and IV B. II, III, and IV C. III and IV D. I, II, and III E. I, II, III, and IV

E.I, II, III, and IV

59. In their study about predicting beta coefficients, which of the following did Rosenberg and Guy find to be factors that influence beta?I) Industry groupII) Variance of cash flowIII) Dividend yieldIV) Growth in earnings per share A. I and II B. I and III C. I, II, and III D. I, II, and IV E. I, II, III, and IV

E.I, II, III, and IV

11. Which statement is true regarding the market portfolio? I) It includes all publicly traded financial assets. II) It lies on the efficient frontier. III) All securities in the market portfolio are held in proportion to their market values. IV) It is the tangency point between the capital market line and the indifference curve. A. I only B. II only C. III only D. IV only E.I, II, and III

E.I, II, and III

56. When borrowing and lending at a risk-free rate are allowed, which capital allocation line (CAL) should the investor choose to combine with the efficient frontier? I) The one with the highest reward-to-variability ratio. II) The one that will maximize his utility. III) The one with the steepest slope. IV) The one with the lowest slope. A. I and III B. I and IV C. II and IV D. I only E. I, II, and III

E.I, II, and III

20. Which of the following statement(s) is(are) true regarding the selection of a portfolio from those that lie on the capital allocation line? I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. III) Investors choose the portfolio that maximizes their expected utility. A. I only B. II only C. III only D. I and III E. II and III

E.II and III

3. Which of the following statements is(are) false? I) Risk-averse investors reject investments that are fair games. II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A. I only B. II only C. I and II only D. II and III only E. III and IV only

E.III and IV only Risk-averse investors consider a risky investment only if the investment offers a risk premium. Risk-neutral investors look only at expected returns when making an investment decision.

56. One "cost" of the single-index model is that it A. is virtually impossible to apply. B. prohibits specialization of efforts within the security analysis industry. C. requires forecasts of the money supply. D. is legally prohibited by the SEC. E. allows for only two kinds of risk—macro risk and micro risk.

E.allows for only two kinds of risk—macro risk and micro risk.

49. Security returns A. are based on both macro events and firm-specific events. B. are based on firm-specific events only. C. are usually positively correlated with each other. D. are based on firm-specific events only and are usually positively correlated with each other. E. are based on both macro events and firm-specific events and are usually positively correlated with each other.

E.are based on both macro events and firm-specific events and are usually positively correlated with each other.

38. A statistic that measures how the returns of two risky assets move together is: A. variance. B. standard deviation. C. covariance. D. correlation. E. covariance and correlation

E.covariance and correlation

10. According to the index model, covariances among security pairs are A. due to the influence of a single common factor represented by the market index return. B. extremely difficult to calculate. C. related to industry-specific events. D. usually positive. E. due to the influence of a single common factor represented by the market index return and usually positive.

E.due to the influence of a single common factor represented by the market index return and usually positive.

58. The idea that there is a limit to the reduction of portfolio risk due to diversification is A. contradicted by both the CAPM and the single-index model. B. contradicted by the CAPM. C. contradicted by the single-index model. D. supported in theory, but not supported empirically. E. supported both in theory and by empirical evidence.

E.supported both in theory and by empirical evidence.

55. A two-asset portfolio with a standard deviation of zero can be formed when A. the assets have a correlation coefficient less than zero. B. the assets have a correlation coefficient equal to zero. C. the assets have a correlation coefficient greater than zero. D. the assets have a correlation coefficient equal to one. E. the assets have a correlation coefficient equal to negative one.

E.the assets have a correlation coefficient equal to negative one

21. The utility score an investor assigns to a particular portfolio, other things equal, A. will decrease as the rate of return increases. B. will decrease as the standard deviation decreases. C. will decrease as the variance decreases. D. will increase as the variance increases. E. will increase as the rate of return increases.

E.will increase as the rate of return increases.