Ch. 12

Which of the following statements is FALSE?

Efficient portfolios can be easily ranked, because investors will choose from among them those with the highest expected returns.

If two stocks are perfectly negatively correlated, a portfolio with equal weighting in each stock will always have a volatility (standard deviation) of 0.

False

If you build a large enough portfolio, you can diversify away all the risks of a portfolio.

False

When we form an equally weighted portfolio of stocks and keep increasing the number of stocks in the portfolio, the volatility of the portfolio also increases.

False

You observe the following scatterplot of Ford's weekly returns against the S&P 500. Which of the following statements is true about Ford's beta against the S&P 500?

Ford's beta appears to be positive.

You expect General Motors (GM) to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM) to be 0.9 over the next year. Also, you expect the volatility of General Motors to be 40% and that of Exxon Mobil to be 30% over the next year. Which stock has more systematic risk? Which stock has more total risk?

GM, GM

Which of the following statements is FALSE?

Graphically, the line through the risk-free investment and the market portfolio is called the capital market line (CML).

Which of the following statements is FALSE?

Graphically, when the tangent line goes through the market portfolio, it is called the security market line (SML).

Which of the following combinations of two stocks would give you the biggest reduction in risk?

Microsoft and Duke Energy

A linear regression was done to estimate the relation between Sprint's stock returns and the market's return. The intercept of the line was found to be 0.23 and the slope was 1.47. Which of the following statements is true regarding Sprint's stock?

Sprint's beta is 1.47.

A stock market comprises 2100 shares of stock A and 2100 shares of stock B. The share prices for stocks A and B are $25 and $15, respectively. What proportion of the market portfolio is comprised of each stock?

Stock A is 62.5% and Stock B is 37.5%.

Which of the following statements is FALSE?

The covariance allows us to gauge the strength of the relationship between stocks.

Which of the following statements is FALSE?

The risk premium of a security is equal to the market risk premium divided by the amount of market risk present in the security's returns measured by its beta with the market.

Which of the following statements is FALSE?

The variance of a portfolio depends only on the variance of the individual stocks.

A portfolio comprises two stocks, A and B, with equal amounts of money invested in each. If stock A's stock price increases and that of stock B decreases, the weight of stock A in the portfolio will increase.

True

Correlation is the degree to which the returns of two stocks share common risks.

True

The Capital Asset Pricing Model (CAPM) says that the risk premium on a stock is equal to its beta times the market risk premium.

True

The market or equity risk premium can be estimated by computing the historical average excess return on the market portfolio.

True

The security market line is a graph of the expected return of a stock as a function of its beta with the market.

True

The volatility of an individual stock is more than the volatility of a well-diversified portfolio of stocks.

True

When we combine stocks in a portfolio, the amount of risk that is eliminated depends on the degree to which the stocks face common risks and move together.

True

Which of the following statements is FALSE?

We say a portfolio is an efficient portfolio whenever it is possible to find another portfolio that is better in terms of both expected return and volatility.

Which of the following statements is FALSE?

While the sign of a correlation is easy to interpret, its magnitude is not.

Which of the following statements is FALSE?

Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return.

You expect General Motors (GM) to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM) to be 1.9 over the next year. Also, you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year. Which stock has more systematic risk? Which stock has more total risk?

XOM, GM

You expect General Motors (GM) to have a beta of 1 over the next year and the beta of Exxon Mobil (XOM) to be 1.2 over the next year. Also, you expect the volatility of General Motors to be 30% and that of Exxon Mobil to be 40% over the next year. Which stock has more systematic risk? Which stock has more total risk?

XOM, XOM

Stocks tend to move together if they are affected by ________.

common economic events

The amount of a stock's risk that is diversified away ________.

depends on the portfolio that you add it to

Stocks have both diversifiable risk and undiversifiable risk, but only diversifiable risk is rewarded with higher expected returns.

false

The expected return is usually ________ the baseline risk-free rate of return that we demand to compensate for inflation and the time value of money.

higher than

The market portfolio is the portfolio of all risky investments held ________.

in proportion to their value

The Capital Asset Pricing Model asserts that the expected return ________.

is equal to the risk-free rate plus a risk premium for systematic risk

We can reduce volatility by investing in less than perfectly correlated assets through diversification because the expected return of a portfolio is the weighted average of the expected returns of its stocks, but the volatility of a portfolio ________.

is less than the weighted average volatility

The volatility of Home Depot Share prices is 50% and that of General Motors shares is 50%. When I hold both stocks in my portfolio and the stocks returns have zero correlation, the overall volatility of returns of the portfolio is ________.

less than 50%

Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away. These stocks tend to have ________ betas.

low

The volatility of Home Depot share prices is 20% and that of General Motors shares is 20%. When I both stocks in my portfolio, the overall volatility of the portfolio is ________.

not possible to calculate as information as inadequate

As we add more uncorrelated stocks to a portfolio where the stocks are held in equal weights, the benefit of diversification is most dramatic ________.

at the outset

Diversification reduces the risk of a portfolio because ________, and some of the risks are averaged out of the portfolio.

stocks do not move identically

The systematic risk (beta) of a portfolio is ________ by holding more stocks, even if they each had the same systematic risk.

unchanged

The volatility of Home Depot share prices is 30% and that of General Motors shares is 15%. When I hold both stocks in my portfolio and the stocks returns have a correlation of 1, the overall volatility of returns of the portfolio is ________.

unchanged at 30%

If you build a large enough portfolio, you can diversify away all ________ risk, but you will be left with ________ risk.

unsystematic, systematic

The S&P 500 index traditionally is a(n) ________ portfolio of the 500 largest U.S. stocks.

value weighted

Which of the following equations is INCORRECT?

xi = total value of portfolio/value of investment

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%. When I hold both stocks in my portfolio with an equal amount in each, and the stocks returns have a correlation of minus 1, the overall volatility of returns of the portfolio is ________.

zero

A linear regression to estimate the relation between General Motors' stock returns and the market's return gives the best fitting line that represents the relation between the stock and the market. The slope of this line is our estimate of ________.

beta

For each 1% change in the market portfolio's excess return, the investment's excess return is expected to change by ________ due to risks that it has in common with the market.

beta

Historically, the average excess return of the S&P 500 over the return of U.S. Treasury bonds has been ________ and is proxy for the market risk premium.

between 5% and 7%

A stock market comprises 1500 shares of stock A and 3000 shares of stock B. The share prices for stocks A and B are $24 and $34, respectively. What is the capitalization of the market portfolio?

$138,000

A stock market comprises 4600 shares of stock A and 2000 shares of stock B. Assume the share prices for stocks A and B are $25 and $35, respectively. What is the capitalization of the market portfolio?

$185,000

Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share. Suppose over the next year Ball has a return of 12.3%, Lowes has a return of 23%, and Abbott Labs has a return of -10%. The value of your portfolio over the year is ________.

$20,872

A stock market comprises 2400 shares of stock A and 2400 shares of stock B. The share prices for stocks A and B are $15 and $5, respectively. What is the capitalization of the market portfolio?

$48,000

A stock market comprises 4600 shares of stock A and 1600 shares of stock B. Assume the share prices for stocks A and B are $15 and $30, respectively. If you have $15,000 to invest and you want to hold the market portfolio, how much of your money will you invest in Stock A?

$8846.15

Suppose you invest in 100 shares of Harley-Davidson (HOG) at $40 per share and 230 shares of Yahoo (YHOO) at $25 per share. If the price of Harley-Davidson increases to $50 and the price of Yahoo decreases to $20 per share, what is the return on your portfolio?

-1.54%

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a(n) 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange-traded fund (ETF) with a 10% expected return and a 20% volatility. Assume that the ETF you invested in returns -10%. Then the realized return on your investment is closest to ________.

-26%

The covariance between Lowes' and Home Depot's returns is closest to ________.

0.10

A portfolio comprises Coke (beta of 1.6) and Wal-Mart (beta of 0.6). The amount invested in Coke is $10,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

0.93

The beta of the market portfolio is ________.

1

A portfolio comprises Coke (beta of 1.3) and Wal-Mart (beta of 0.7). The amount invested in Coke is $20,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

1.00

A portfolio comprises Coke (beta of 1.4) and Wal-Mart (beta of 0.8). The amount invested in Coke is $20,000 and in Wal-Mart is $30,000. What is the beta of the portfolio?

1.04

Your retirement portfolio comprises 300 shares of the S&P 500 fund (SPY) and 100 shares of iShares Barclays Aggregate Bond Fund (AGG). The price of SPY is $136 and that of AGG is $97. If you expect the return on SPY to be 11% in the next year and the return on AGG to be 10%, what is the expected return for your retirement portfolio?

10.81%

UPS, a delivery services company, has a beta of 1.4, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 4% and the market risk premium is 6%. What is the expected return on a portfolio with 50% of its money in UPS and the balance in Wal-Mart?

10.9%

Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

13.6%

The price of Microsoft is $37 per share and that of Apple is $43 per share. The price of Microsoft increases to $42 per share after one year and to $47 after two years. Also, shares of Apple increase to $49 after one year and to $59 after two years. If your portfolio comprises 100 shares of each security, what is your portfolio return in year 1 and year 2? Assume no dividends are paid.

13.75%, 16.48%

Your estimate of the market risk premium is 7%. The risk-free rate of return is 4%, and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

13.8%

A portfolio has three stocks — 110 shares of Yahoo (YHOO), 210 Shares of General Motors (GM), and 70 shares of Standard and Poor's Index Fund (SPY). If the price of YHOO is $20, the price of GM is $20, and the price of SPY is $130, calculate the portfolio weight of YHOO and GM.

14.2%, 27.1%

Your estimate of the market risk premium is 9%. The risk-free rate of return is 3.8% and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

16.4%

UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal-Mart?

16.62%

The price of Microsoft is $30 per share and that of Apple is $58 per share. The price of Microsoft increases to $39 per share after one year and to $42 after two years. Also, shares of Apple increase to $66 after one year and to $71 after two years. If your portfolio comprises 100 shares of each security, what is your portfolio return over year 1 and year 2? Assume no dividends are paid.

19.32%, 7.62%

Suppose you invest in 110 shares of Merck (MRK) at $40 per share and 120 shares of Yahoo (YHOO)at $25 per share. If the price of Merck increases to $45 and the price of Yahoo decreases to $22 per share, what is the return on your portfolio?

2.57%

Suppose you invest $15,000 by purchasing 200 shares of Abbott Labs (ABT) at $40 per share, 200 shares of Lowes (LOW) at $20 per share, and 100 shares of Ball Corporation (BLL) at $30 per share. The weight of Ball Corporation in your portfolio is ________.

20.00%

A portfolio has 40% of its value in IBM shares and the rest in Microsoft (MSFT). The volatility of IBM and MSFT are 40% and 30%, respectively, and the correlation between IBM and MSFT is -0.3. What is the standard deviation of the portfolio?

20.8

A portfolio has three stocks — 300 shares of Yahoo (YHOO), 300Shares of General Motors (GM), and 80 shares of Standard and Poor's Index Fund (SPY). If the price of YHOO is $20, the price of GM is $30, and the price of SPY is $150, calculate the portfolio weight of YHOO and GM.

22.2%, 33.3%

The price of Microsoft is $25 per share and that of Apple is $50 per share. The price of Microsoft increases to $36 per share after one year and to $41 after two years. Also, shares of Apple increase to $56 after one year and to $66 after two years. If your portfolio comprises 100 shares of each security, what is your portfolio return over year 1 and year 2? Assume no dividends are paid.

22.67%, 16.30%

A portfolio has 45% of its value in IBM shares and the rest in Microsoft (MSFT). The volatility of IBM and MSFT are 33% and 35%, respectively, and the correlation between IBM and MSFT is 0. What is the standard deviation of the portfolio?

24.31%

A portfolio has 30% of its value in IBM shares and the rest in Microsoft (MSFT). The volatility of IBM and MSFT are 35% and 30%, respectively, and the correlation between IBM and MSFT is 0.5. What is the standard deviation of the portfolio?

27.78%

Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share. Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 21%, and Abbott Labs has a return of -10%. The return on your portfolio over the year is ________.

3.8%

The expected return of a portfolio that is equally invested in Duke Energy and Microsoft is closest to ________.

30%

Suppose you invest $22,500 by purchasing 200 shares of Abbott Labs (ABT) at $55 per share, 200 shares of Lowes (LOW) at $35 per share, and 100 shares of Ball Corporation (BLL) at $45 per share. The weight of Lowes in your portfolio is ________.

31.11%

The volatility on Lowes' returns is closest to ________.

35%

The volatility on Home Depot's returns is closest to ________.

42%

A portfolio has three stocks — 240 shares of Yahoo (YHOO), 150 Shares of General Motors (GM), and 40 shares of Standard and Poor's Index Fund (SPY). If the price of YHOO is $30, the price of GM is $30, and the price of SPY is $130, calculate the portfolio weight of YHOO and GM.

42.6%, 26.6%

Suppose you invest $22,500 by purchasing 200 shares of Abbott Labs (ABT) at $55 per share, 200 shares of Lowes (LOW) at $35 per share, and 100 shares of Ball Corporation (BLL) at $45 per share. The weight of Abbott Labs in your portfolio is ________.

48.89%

The volatility of a portfolio that is equally invested in Wal-Mart and Duke Energy is closest to ________.

6.7%

A stock market comprises 4700 shares of stock A and 2300 shares of stock B. Assume the share prices for stocks A and B are $25 and $30, respectively. What proportion of the market portfolio is comprised of stock A?

63.0%

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a(n) 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange-traded fund (ETF) with a 11% expected return and a 20% volatility. The expected return on your of your investment is closest to ________.

7%

Suppose you invest in 220 shares of Johnson and Johnson (JNJ) at $70 per share and 240 shares of Yahoo (YHOO) at $20 per share. If the price of Johnson and Johnson increases to $80 and the price of Yahoo decreases to $18 per share, what is the return on your portfolio?

8.51%

Your retirement portfolio comprises 100 shares of the Standard & Poor's 500 fund (SPY) and 100 shares of iShares Barclays Aggregate Bond Fund (AGG). The price of SPY is $118 and that of AGG is $97. If you expect the return on SPY to be 11% in the next year and the return on AGG to be 6%, what is the expected return for your retirement portfolio?

8.74%

The volatility of a portfolio that is equally invested in Duke Energy and Microsoft is closest to ________.

9.0%

Your retirement portfolio comprises 200 shares of the S&P 500 fund (SPY) and 100 shares of iShares Barclays Aggregate Bond Fund (AGG). The price of SPY is $134 and that of AGG is $110. If you expect the return on SPY to be 10% in the next year and the return on AGG to be 8%, what is the expected return for your retirement portfolio?

9.42%

UPS, a delivery services company, has a beta of 1.1, and Wal-Mart has a beta of 0.7. The risk-free rate of interest is 4% and the market risk premium is 7%. What is the expected return on a portfolio with 30% of its money in UPS and the balance in Wal-Mart?

9.74%

If this pattern of stock returns is typical of AT&T stock, and you calculated a beta against the S&P 500, which of the following is true?

AT&T's beta is positive.

Which of the following statements is FALSE?

Almost all of the correlations between stocks are negative, illustrating the general tendency of stocks to move together.

Which of the following equations is INCORRECT?

Corr(Ri,Rj)= Corr(Ri,Rj)/Var(Ri)Var(Rj)

Which of the following statements is FALSE?

Correlation is the expected product of the deviations of two returns.