3315 ch 5

) Investors are rewarded for assuming A) total risk. B) diversifiable risk. C) nondiversifiable risk. D) any type of risk.

c

A stock's beta value is a measure of A) interest rate risk. B) total risk. C) systematic risk. D) diversifiable risk.

c

The beta of the market is A) -1.0. B) 0.0. C) 1.0. D) undefined.

c

The market rate of return increased by 8% while the rate of return on XYZ stock increased by 4%. The beta of XYZ stock is A) -2.0. B) -0.40. C) 0.50. D) 2.0.

c

A portfolio with a beta of 1.26 A) is 126% more risky than the overall market. B) has less risk than the lowest risk security held within that portfolio. C) is 26% more risky than a risk-free asset. D) is considerably more risky than the overall market

d

Beta measures diversifiable risk while standard deviation measures systematic risk.

false

By plotting the efficient frontier, investors can find the unique portfolio that is ideal for all investors.

false

Coefficients of correlation range from a maximum of +10 to a minimum of -10.

false

Diversifiable risk is also called systematic risk.

false

In severe market downturns different asset classes become less correlated.

false

Maximum international diversification can be achieved by investing solely in U.S. multinational corporations.

false

Most assets show a slight degree of negative correlation.

false

Portfolio betas will always be lower than the weighted average betas of the securities in the portfolio.

false

Portfolio objectives should be established independently of tax considerations.

false

Standard deviation is a measure that indicates how the price of an individual security responds to market forces

false

he Dow Jones Industrial Average of thirty stocks is customarily used to represent market returns in the CAPM.

false

The betas of most stocks are constant over time

falsr

) Explain the relationship between correlation, diversification, and risk reduction

Correlation is a statistic that measures the relationship between returns on assets. Positively correlated assets move together; negatively correlated opposites move in opposite directions. Diversification reduces risk most effectively when the assets have low or negative coefficients of correlation.

) Investing globally offers better diversification than investing only domestically

False

Alexis has inherited $120,000 from her grandmother's estate. She has decided to invest $10,000 in each of 12 different industries. Because she has lower than average risk tolerance, she carefully seeks out stocks so that her portfolio will have a weighted average beta of .80. A) Alexis is using traditional portfolio management techniques. B) Alexis is using modern portfolio management techniques. C) Alexis is using a combination of modern and traditional portfolio management techniques. D) Alexis seems to be unaware of modern portfolio management technique

c

American investors have several alternatives available to diversify their portfolios internationally. In terms of transaction costs, which of the alternatives below is least attractive? A) mutual funds with an international focus B) stocks of U.S. based companies with extensive foreign sales and/or operations C) direct investment in foreign stocks D) American Depositary Shares

c

The best stock to own when the stock market is at a peak and is expected to decline in value is one with a beta of A) +1.5. B) +1.0. C) -1.0. D) -0.5.

c

The risk of a portfolio consisting of two uncorrelated assets will be A) equal to zero. B) greater than the risk of the least risky asset but less than the risk level of the more risky asset. C) greater than zero but less than the risk of the more risky asset. D) equal to the average of the risk level of the two assets.

c

When the Capital Asset Pricing Model is depicted graphically, the result is the A) standard deviation line. B) coefficient of variation line. C) security market line. D) alpha-beta line.

c

Which of the following best describes the relationship between a stock's beta and the standard deviation of the stock's returns? A) The higher the standard deviation, the higher the beta. B) The higher the standard deviation, the lower the beta. C) The relationship depends on the correlation between the stock's returns and the market's returns. D) Standard deviation and beta are different ways of measuring the same thing.

c

Which of the following guidelines are appropriate for inclusion in a portfolio management policy? I. Diversify among different types of securities and across industry and geographic lines. II. Determine the risk level and financial situation of the individual investor. III. Utilize beta to help align the portfolio to the risk level of the investor. IV. Minimize the standard deviation of each security in the portfolio. A) I, II and IV only B) II, III and IV only C) I, II and III only D) I, II, III and IV

c

Which of the following measures or concepts are deliberately used by modern portfolio theory? I. beta II. inter industry diversification III. efficient frontier IV. correlation A) II and III only B) I and IV only C) I, III and IV only D) I, II, III and IV

c

Which of the following represent unsystematic risks? I. the president of a company suddenly resigns II. the economy goes into a recessionary period III. a company's product is recalled for defects IV. the Federal Reserve unexpectedly changes interest rates A) I, II and IV only B) II and IV only C) I and III only D) I, II and III only

c

Which of the following statements concerning beta are correct? I. Stock with high standard deviations of returns will always high betas. II. The higher the beta, the higher the expected return. III. A beta can be positive, negative, or equal to zero. IV. A beta of .35 indicates a lower rate of risk than a beta of -0.50. A) II and III only B) I and IV only C) II, III and IV only D) I, II, III and IV

c

Which one of the following conditions can be effectively eliminated through portfolio diversification? A) a general price increase nationwide B) an interest rate reduction by the Federal Reserve C) increased government regulation of auto emissions D) change in the political party that controls Congress

c

Which one of the following conditions can be effectively eliminated through portfolio diversification? A) a general price increase nationwide B) an interest rate reduction by the Federal Reserve C) increased government regulation of auto emissions D) change in the political party that controls Congress

c

A measure of systematic risk is A) standard deviation. B) correlation coefficient. C) beta. D) variance

c beta

The statement "A portfolio is less than the sum of its parts." means A) it is less expensive to buy a group of assets than to buy those assets individually. B) portfolio returns will always be lower than the returns on individual stocks. C) a diversified group of assets will be less volatile than the individual assets within the group. D) for reasons that are not well understood, the value of a portfolio is less than the sum of the values of its components.

c.

) Which of the following statements about the Security Market Line are correct? I. The intercept point is the risk-free rate of return. II. The slope of the line is beta. III. An investor should accept any return located above the SML line. I V. A beta of 1.0 indicates the risk-free rate of return. A) I and II only B) III and IV only C) II, III and IV only D) I,II and III only

d

) Which one of the following will provide the greatest international diversification? A) directly purchasing a foreign stock B) purchasing stock of a U.S. multinational firm C) purchasing an ADS D) purchasing shares of an international mutual fund

d

30) Beta is the slope of the best fit line for the points with coordinates representing the ________ and the ________ for each one of several years. A) rate of return; level of risk for an individual security B) rate of inflation; rate of return for an individual security C) risk level of a stock; market rate of return D) market rate of return; security's rate of return

d

Analysts commonly use the ________ to measure market return. A) the Dow Jones Industrial Average B) the rate of return on 10 year Treasury bonds C) some large, mainstream company such as General Electric D) the Standard & Poor's 500 Index

d

Traditional portfolio managers prefer well-known companies because I. stocks of well-known firms tend to be less risky than stocks of lesser-known firms. II. individuals are more apt to purchase a mutual fund if it contains stocks of well-known firms. III. window dressing encourages the purchase of well-known stocks. IV. institutional investors tend to exhibit "herd-like" behavior. A) I only B) I and II only C) II and III only D) I, II , III and IV

d

When the stock market has bottomed out and is beginning to recover, the best portfolio to own is the one with a beta of A) 0.0. B) +0.5. C) +1.5. D) +2.0.

d

Which of the following factors comprise the CAPM? I. dividend yield II. risk-free rate of return III. the expected rate of return on the market IV. risk premium for the firm A) I and III only B) II and IV only C) III and IV only D) II, III and IV only

d

In designing a portfolio, relevant risk is A) total risk. B) unsystematic risk. C) event risk. D) nondiversifiable risk.

d, non ndiversifiable

) Two assets have a coefficient of correlation of -.4 . A) Combining these assets will increase risk. B) Combining these assets will have no effect on risk. C) Combining these assets may either raise or lower risk. D) Combining these assets will reduce risk.

d.

) If there is no relationship between the rates of return of two assets over time, these assets are A) positively correlated. B) negatively correlated. C) perfectly negatively correlated. D) uncorrelated.

d. uncorrelted

) A stock with a beta of 1.3 is less risky than a stock with a beta of 0.42

false

) By design, half of all stocks betas are positive betas and half are negative

false

) Modern portfolio theory seeks to minimize risk and maximize return by combining highly correlated assets.

false

According to the CAPM, the required rate of a return on a stock can be estimated using only beta and the risk-free rate.

false

Adding stocks with higher standard deviations to a portfolio will necessarily increase the portfolio's risk.

false

An efficient portfolio maximizes the rate of return without consideration of risk

false

Beta is more useful in explaining an individual security's return fluctuations than a large portfolio's return fluctuations.

false

The risk premium to be used in the Capital Asset Pricing Model is calculated as (rrf-rm)

false that is the market premium

Explain what beta measures and how investors can use beta.

nswer: Students should mention some or all of the following. • Beta measures nondiversifiable (market) or systematic risk. • Beta measures how a security will perform in relation to the market. • The higher the beta, the riskier the security. • The beta for the market is 1; stocks may have positive or negative betas. • Stocks with betas greater than 1 are more responsive to changes in the market than is the market. • Beta is derived from the slope of the "characteristic line."

A beta of 0.5 means that a stock is half as risky the overall market.

t

) A portfolio that offers the lowest risk for a given level of return is known as an efficient portoflio

true

) Correlation is a measure of the relationship between two series of numbers

true

) For stocks with positive betas, higher risk stocks will have higher beta values.

true

) Investing in emerging markets is an effective means of diversifying a U.S. portfolio

true

) Portfolios C and X each have expected rates of return of 12%. C's beta is .9; X's beta is 1.1, therefore C dominates X.

true

A negative beta means that on average a stock moves in the opposite direction of the market.

true

A portfolio with a beta of 1.5 will be 50% more volatile than the market portfolio.

true

An investment portfolio should be built around the needs of the individual investor.

true

Betas for actively traded stocks. are readily available from online sources

true

Both modern portfolio theory and traditional portfolio management result in diversified portfolios, but they take different approaches to diversification.

true

Both the efficient frontier and beta are important aspects of MPT.

true

If the actual rate of return on an investment portfolio is constant from year to year, the standard deviation of that portfolio is zero.

true

In the Capital Asset Pricing Model, beta measures a stock's sensitivity to overall market returns

true

Market return is estimated from the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index.

true

Negatively correlated assets reduce risk more than positively correlated assets.

true

Portfolio objectives should be established before beginning to invest.

true

Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible set.

true

Studies have shown that investing in different industries as well as different countries reduces portfolio risk.

true

The CAPM estimates the required rate of return on a stock held as part of a well diversified portfolio

true

The basic theory linking portfolio risk and return is the Capital Asset Pricing Model

true

The index used to represent market returns is always assigned a beta of 1.0.

true

The transaction costs of investing directly in foreign-currency-denominated assets can be reduced by purchasing American Depositary Shares (ADSs).

true

) Systematic risks A) can be eliminated by investing in a variety of economic sectors. B) are forces that affect all investment categories. C) result from random firm-specific events. D) are unique to certain types of investment.

b

) Which of the following represent systematic risks? I. the president of a company suddenly resigns II. the economy goes into a recessionary period III. a company's product is recalled for defects IV. the Federal Reserve unexpectedly changes interest rates A) I, II and IV only B) II and IV only C) I and III only D) I, II and III only

b

Combining uncorrelated assets will A) increase the overall risk level of a portfolio. B) decrease the overall risk level of a portfolio. C) not change the overall risk level of a portfolio. D) cause the other assets in the portfolio to become positively related.

b

Portfolios falling to the left of the efficient frontier A) have too much risk for the expected return. B) would be desirable if only they were possible. C) do not use all of the assets in the portfolio. D) fall within the set of feasible portfolios.

b

Small company stocks are yielding 10.7% while the U.S. Treasury bill has a 1.3% yield and a bank savings account is yielding 0.8%. What is the risk premium on small company stocks? A) 10.7% B) 9.4% C) 12.0% D) 9.9%

b

Stock of Gould and Silber Inc. has a beta of -1. If the market declines by 10%, Gould and Silber would be expected to A) decline by 10%. B) rise by 10%. C) not respond to market fluctuations. D) decline by 1%.

b

The efficient frontier A) is represented by the rightmost boundary of the feasible set of portfolios. B) represents the best attainable tradeoff between risk and return. C) includes all feasible sets of portfolios based on risk and return characteristics. D) provides the highest level of risk for the lowest level of return.

b

The returns on the stock of DEF and GHI companies over a 4 year period are shown below: Year DEF GHI 8% 11% 12% 9% -5% -9% 6% 13% From this limited data you should conclude that returns on A) DEF and GHI are negatively correlated. B) DEF and GHI are somewhat positively correlated. C) DEF and GHI are perfectly positively correlated. D) DEF and GHI are uncorrelated.

b

The stock of ABC, Inc. has a beta of .80. The market rate of return is expected to increase by by 5%. Beta predicts that ABC stock should A) increase in value by 6.25%. B) increase in value by 4.0%. C) decrease in value by 1.0%. D) increase in value by .8%.

b

Traditional portfolio management A) concentrates on only the most recent "hot" sectors of the market. B) typically centers on interindustry diversification. C) uses portfolio betas and standard deviations to minimize risk. D) is based on statistical measures to develop the portfolio plan.

b

Which of the following will always lower a portfolio's beta? I. Diversify among different types of securities and across industry and geographic lines. II. Add investments with low betas to the portfolio. III. Hold more cash or Treasury Bills in the portfolio. IV. Reduce the percentage of the portfolio invested in high beta securities. A) I, II and IV only B) II, III and IV only C) I, II and III only D) I, II, III and IV

b

) Estimates of a stock's beta may vary depending on I. when the estimate was made. II. the risk-free rate of interest used. III. how many months of returns were used to estimate the beta. IV. the index used to represent market returns. A) I, II and IV only B) II and IV only C) I, III and IV only D) I, II and III only

c

) Large, professionally managed portfolios tend to A) lie on or near the efficient frontier . B) exhibit very little overlap in their stock holdings. C) hold many of the same large, well-known companies. D) be constructed to result in array of portfolio betas allowing investors to choose a position on the efficient frontier.

c

) You have gathered the following information concerning a particular investment and conditions in the market. According to the Capital Asset Pricing Model, the required return for this investment is rf = 2,5 mkt = 11 beta = 1.35 A) 8.85%. B) 11.48%. C) 13.98%. D) 14.85%.

c

Explain the differences in how modern and traditional theories of portfolio management approach the issue of diversification

The modern approach to portfolio diversification uses computers to analyze a large number of investment alternatives, mathematically seeking minimum correlation and maximum return. Ideally these methods identify portfolios on the efficient frontier with minimum portfolio betas or standard deviations for the expected level of return. The traditional approach to diversification uses human judgement and experience to choose a diversified combination of stocks and other securities across industry lines and possibly national borders. When done well, this approach also reduces risk without excessively sacrificing return. The traditional approach may lead to overinvestment in the stocks of large, well-known companies because they most readily come to mind for the manager, because the manager fears criticism for omitting them, or wants to avoid blame for less conventional choices (window dressing).

) Beta can be defined as the slope of the line that explains the relationship between A) the return on a security and the return on the market. B) the returns on a security and various points in time. C) the return on stocks and the returns on bonds. D) the risk free rate of return versus the market rate of return.

a

) In the real world, most of the assets available to investors A) tend to be somewhat positively correlated. B) tend to be somewhat negatively correlated. C) tend to be uncorrelated. D) tend to be either perfectly positively or perfectly negatively correlated

a

) Modern portfolio theory does not consider diversifiable risk relevant because A) it is easy to eliminate. B) it is impossible to eliminate. C) its effects are unpredictable. D) its effects are too small to make a difference in portfolio returns

a

) The Capital Asset Pricing Model (CAPM) includes which of the following in its base assumptions? I. Investors should earn a minimum return equal to the risk-free rate. II. Investors in the market should earn a return greater than the return on the overall market. III. Investors should be rewarded for the amount of risk they assume . IV. Investors should earn a return located above the Security Market Line. A) I and III only B) II and IV only C) I, II and III only D) I, III and IV only

a

) The stock of a technology company has an expected return of 15% and a standard deviation of 20% The stock of a pharmaceutical company has an expected return of 13% and a standard deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected return of 14 % and a standard deviation A) less than the average of 20% and 18%. B) the average of 20% and 18%. C) greater than the average of 20% and 18%. D) the answer cannot be determined with the information given

a

American depositary shares (ADS) are A) shares of foreign companies traded on the U.S. markets. B) shares of American companies traded on foreign markets. C) foreign currency deposits in American banks. D) American currency deposits in foreign banks.

a

OKAY stock has a beta of 0.8. The market as a whole is expected to decline by 12% thereby causing OKAY stock to A) decline by 9.6%. B) decline by 12.5%. C) increase by 9.6%. D) increase by 12%.

a

The Capital Asset Pricing Model (CAPM) is a mathematical model that depicts the \ A) positive relationship between risk and return. B) standard deviation between a risk premium and an investment's expected return. C) exact price that an investor should be willing to pay for any given investment. D) difference between a risk-free return and the expected rate of inflation.

a

) Which one of the following types of risk cannot be effectively eliminated through portfolio diversification? A) inflation risk B) labor problems C) materials shortages D) product recalls

a.