Finance Quiz Chapter 13

The security market line is a positively sloped straight line that displays the relationship between expected return and ____________. WACC Risk Portfolio Market Risk Premium Beta

Beta

Risk-free assets have a beta of 0 and the market portfolio has a beta of 1.

True

A stock has an expected return of 6.5 percent, the risk-free rate is 1.1 percent, and the market risk premium is 5 percent. What is the stock's beta? .98 1.12 .96 1.08

1.08 E(Ri) = .065 = .011 + βi(.05) βi = 1.08

Portfolio Beta is the ______________ average of the Betas of the investments included in the portfolio. Weighted Arithmetic Geometric Riskless Expected

Weighted

Most financial securities have some level of ________ risk. unsystematic diversifiable systematic asset-specific industry

systematic

You recently purchased a stock that is expected to earn 12 percent in a booming economy, 6.5 percent in a normal economy, and lose 1.5 percent in a recessionary economy. The probability of a booming economy is 14 percent while the probability of a normal economy is 65 percent. What is your expected rate of return on this stock? 6.22% 5.59% −2.24% 0.35% 5.67%

Boom: .12*.14 Normal: .065*.65 Lose: -0.015*.21 Total: 5.59%

The slope of the security market line is the: expected return of the market. market standard deviation. beta coefficient. risk-free interest rate. market risk premium.

market risk premium.

If risk-free investments are currently 6% and our expected return from Stock V was 14%. What is the risk premium on this investment? 2% 4% 6% 8% 10%

14% - 6% = 8%

You own a portfolio that has $1,720 invested in Stock A and $3,470 invested in Stock B. The expected returns on these stocks are 13.7 percent and 8.0 percent, respectively. What is the expected return on the portfolio? 9.20% 10.23% 12.18% 7.13% 9.89%

1720+3740 = 5190 1720/5190 = .33 3740/5190 = .66 .33*.137 + .66*.08 = .0989 9.89%

The expected return on Cerrato, Incorporated, stock is 16.28 percent while the expected return on the market is 11.97 percent. The stock's beta is 1.63. What is the risk-free rate of return? 2.22% 4.31% 2.42% 4.50% 5.13%

5.13% E(r) = .1628 = rf + 1.63(.1197 − rf) rf = .0513, or 5.13%

Of the options listed below, which is the best example of unsystematic risk? An across-the-board increase in income taxes An adoption of a national sales tax A decrease in the national level of inflation An increased feeling of global prosperity A national decrease in consumer spending on entertainment

A national decrease in consumer spending on entertainment

The stock of Rullo Rigs has a beta of 1.34. The risk-free rate of return is 1.9 percent, the inflation rate is 2.2 percent, and the market risk premium is 6.9 percent. What is the expected rate of return on this stock? 2.8% 8.8% 11.1% 9.4% 8.6%

E(r) = .019 + 1.34(.069) E(r) = .111, or 11.1%

What is the standard deviation of the returns on a portfolio that is invested 37 percent in Stock Q and 63 percent in Stock R?

E(r)Boom = .37(.16) + .63(.15) = .1537 E(r)Normal = .37(.09) + .63(.13) = .1152 E(r)Portfolio = .15(.1537) + .85(.1152)E(r)Portfolio = .1210 σPortfolio = [.15(.1537 − .1210)^2 + .85(.1152 − .1210)^2] sqrt σPortfolio = .0137, or 1.37%

An investor wants to reduce the unsystematic risk in her portfolio. Which of the following actions is least likely to do so? Reducing the number of stocks held in her stock portfolio Adding bonds to her stock portfolio Adding international securities into her portfolio of U.S. stocks Adding U.S. Treasury bills to her risky portfolio Adding technology stocks to her portfolio of industrial stocks

Reducing the number of stocks held in her stock portfolio

________ measures total risk, and ________ measures systematic risk. Beta; alpha Beta; standard deviation Alpha; beta Standard deviation; beta Standard deviation; variance

Standard deviation; beta

The Capital Asset Pricing Model (CAPM) shows that the expected return for a particular asset depends on all of the following, except: The return on a risk-less asset The pure time value of money The reward for bearing systematic risk The amount of systematic risk

The return on a risk-less asset

A ________ is the market's measure of systematic risk. beta of 1 beta of 0 standard deviation of 1 standard deviation of 0 variance of 1

beta of 1

The ________ explains the relationship between the expected return on a security and the level of that security's systematic risk. capital asset pricing model time value of money equation unsystematic risk equation market performance equation expected risk formula

capital asset pricing model

While evaluating a stock, you estimate that it will earn a return of 11 percent if economic conditions are favorable, and 3 percent if economic conditions are unfavorable. Given the probabilities of favorable versus unfavorable economic conditions, you conclude that the stock will earn 7.2 percent next year. The 7.2 percent figure is called the: arithmetic return. historical return. expected return. geometric return.

expected return.

Assume the market rate of return is 10.1 percent and the risk-free rate of return is 3.2 percent. Lexant stock has 2 percent less systematic risk than the market and has an actual return of 10.2 percent. This stock: is underpriced. is correctly priced. will plot below the security market line. will plot on the security market line. will plot to the right of the overall market on a security market line graph.

is underpriced.

Rafia owns stocks of 15 different companies. Together, the stocks have a value of $78,640. Twelve percent of that total value is from one company, Gambrell & Valdez. The twelve percent figure is called a(n): portfolio return. portfolio weight. degree of risk. price-earnings ratio. index value.

portfolio weight.

To calculate the expected risk premium on a stock, one must subtract the ________ from the stock's expected return. expected market rate of return risk-free rate inflation rate standard deviation variance

risk-free rate

Expected return is the return on a _______ asset expected in the future. average risky no-risk risk-free portfolio

risky

The ________ is a positively sloped linear function that plots securities' expected returns against their betas. reward-to-risk matrix portfolio weight graph normal distribution security market line market real returns

security market line

If the economy is normal, Taeana Wear stock is expected to return 9.3 percent. If the economy falls into a recession, the stock's return is projected at a negative 6.3 percent. The probability of a normal economy is 74 percent. What is the variance of the returns on this stock? .001802 .007432 .004682 .006084 .031962

(.093*.74) + (-.063*.26) = .05244 .74(.093-.05244)^2 + .26(-.063-.052)^2 .004682

If the economy is normal, the stock of Flores Corporation is expected to return 12 percent. If the economy falls into a recession, the stock's return is projected at a negative 3.5 percent. The probability of a normal economy is 76 percent. What is the standard deviation of the returns on this stock? 43.82% 12.35% 8.28% 2.88% 6.62%

(.12*.76) + (-.035*.24) = .0828 .76(.12-.0828^2 + .24(-.035-.0828)^2 =.00438 st dev = sqrt of .004 .0662 6.62%

The economy has been very volatile lately. There is a 40% chance of recession and a 60% chance of a boom. Stock A would have a return of −15% if there was a recession but, a 40% return in a boom economy. What is the expected return for Stock A? −18% −15% 18% 15% 40%

(.4*-.15) + (.6*.4) = 18%

Suppose you put half of your money in Monster Beverage and half in IBM. What would the beta of this combination be if Monster Beverage has a beta of 1.52 and Pepsi has a beta of .55? .35 .55 .75 1.00 1.04

(.5*1.52) + (.5*.55) = 1.04

You decide to invest $20,500 in Bank of America and $14,500 in Twitter. What is the portfolio's beta? Bank of America beta: 1.27 Twitter beta: 1.96 1.015 1.553 1.954 2.00 2.05

20,500 + 14,500 = 35,000 20500/35000 = .5857 14500/35000 - .414 .5857 * 1.27 = .747 .414 * 1.96 = .812 .747 + .812 = 1.553

You decide to invest $20,500 in Bank of America and $14,500 in Twitter. What is the portfolio's beta? Bank of America beta: 1.27 Twitter beta: 1.96

35,000 total 20,500/35,000 = .5857 14,500/35,000 = .414 .5857 * 1.27 = .414 * 1.96 1.553

What is the expected return and standard deviation for the following stock? 9.936%; 4.47% 9.936%; 3.76% 9.616%; 4.47% 7.202%; 3.76% 9.616%; 3.76%

9.616%; 3.76% E(R) = .08(−.02) + .73(.098) + .19(.138) E(R)= .09616, or 9.616% σ = [.08(−.02 − .09616)^2 + .73(.098 − .09616)^2 + .19(.138 − .09616)^2]. take sqrt 0376, or 3.76%

Of the options listed below, which is the best measure of systematic risk? The weighted average standard deviation Beta The geometric average The standard deviation The arithmetic average

Beta

What is the expected return of an equally weighted portfolio comprised of the following three stocks? 9.82% 10.96% 9.67% 10.48% 11.33%

E(RP)Boom = (.19 + .13 + .07)/3 = .13, E(RP)Normal = (.15 + .05 + .13)/3 = .11 E(RP)Bust = (−.29 − .14 + .22)/3 = −.07, Boom = .25(.13) + .72(.11) + .03(−.07) E(RP)Boom = .1096, or 10.96%

A portfolio is invested 45 percent each in Stock A and Stock B, and 10 percent in Stock C. The expected T-bill rate is 3.2 percent. What is the expected risk premium on the portfolio? 5.55% 12.38% 1.67% 4.29% 8.75%

E(RP)Boom = .45(.27) + .45(.15) + .10(.11) = .2000 E(RP)Normal = .45(.14) + .45(.11) + .10(.09) = .1215 E(RP)Bust = .45(-.19) + .45(-.06) + .10(.05) = −.1075 E(RP) = .15(.2000) + .65(.1215) + .20(−.1075)E(RP) = .0875, or 8.75% RPP = .0875 − .032RPP = .0555, or 5.55% 5.55%

In a booming economy, the stock of Pattee Productions is expected to return 17 percent. It is expected to return 9 percent in a normal economy and will decline 18 percent in a recessionary economy. The probability of a recession is 18 percent while the probability of a boom is 22 percent. What is the standard deviation of the returns on this stock? 13.71% 15.83% 11.65% 12.08% 14.77%

E(r) = .22(.17) + .60(.09) + .18(−.18) E(r) = .059, or 5.9% .22(.17 − .059)^2 + .60(.09 − .059)^2 + .18(−.18 − .059)^2 = .013569 sqrt of .0136 = .1165, or 11.65%

Which of the following items are included when calculating the expected return on a portfolio? I. Percentage of the portfolio invested in each individual security II. Projected states of the economy III. The performance of each security given various economic states IV. Probability of occurrence for each state of the economy

I, II, III, and IV

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

I, III, and IV only

Of the options listed below, which is the best example of systematic risk? Investors panic causing security prices around the globe to fall precipitously. A flood washes away a firm's warehouse. A city imposes an additional one percent sales tax on all products. A toymaker has to recall its top-selling toy. Corn prices increase due to increased demand for alternative fuels.

Investors panic causing security prices around the globe to fall precipitously.

Which of the following statements regarding unsystematic risk is accurate? It can be effectively eliminated by portfolio diversification. It is compensated for by the risk premium. It is measured by beta. It is measured by standard deviation. It is related to the overall economy.

It can be effectively eliminated by portfolio diversification.

Which of the following statements is true of a portfolio's standard deviation? It is a weighted average of the standard deviations of the individual securities held in the portfolio. It can never be less than the standard deviation of the most risky security in the portfolio. It is equal to or greater than the lowest standard deviation of any single security held in the portfolio. It is an arithmetic average of the standard deviations of the individual securities which comprise the portfolio. It can be less than the standard deviation of the least risky security in the portfolio.

It can be less than the standard deviation of the least risky security in the portfolio.

Which of the following statements best describes the principle of diversification? Concentrating an investment in two or three stocks will eliminate all of the unsystematic risk. Concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. Spreading an investment across multiple diverse companies will not lower the total risk. Spreading an investment across many diverse assets will eliminate all of the systematic risk. Spreading an investment across many diverse assets will eliminate some of the total risk.

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

The common stock of Alpha Manufacturers has a beta of 1.24 and an actual expected return of 13.25 percent. The risk-free rate of return is 3.7 percent and the market rate of return is 11.78 percent. Which one of the following statements is true given this information? The actual expected stock return will graph above the security market line. The stock is currently underpriced. To be correctly priced according to CAPM, the stock should have an expected return of 13.56 percent. The stock has less systematic risk than the overall market. The actual expected stock return indicates the stock is currently overpriced.

The actual expected stock return indicates the stock is currently overpriced. E(r) = .037 + 1.24(.1178 − .037)E(r) = .1372, or 13.72%

The expected return of a stock, based on the likelihood of various economic outcomes, equals the: highest expected return given any economic state. arithmetic average of the returns for each economic state. summation of the individual expected rates of return. weighted average of the returns for each economic state. return for the economic state with the highest probability of occurrence.

weighted average of the returns for each economic state.

The market risk premium equals the: risk-free rate of return plus the inflation rate. risk-free rate of return plus the market rate of return. inflation rate minus the risk-free rate of return. market rate of return minus the risk-free rate of return. risk-free rate of return multiplied by the market beta.

market rate of return minus the risk-free rate of return.

Buchi owns several financial instruments: stocks issued by seven different companies, plus bonds issued by four different companies. Her investments are best described as a(n): index. portfolio. collection. grouping. risk-free position.

portfolio