Finance Ch 12

The beta of the market portfolio is

1

If this pattern of stock returns is typical of AT&T stock, and you calculated a beta against the S&P500, which of the following is true?

AT&T's beta is positive

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

At the outset

A linear regression to estimate the relation between General Motor's 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 the line is our estimate of _________

Beta

Which of the following statements is false? A. Correlation has no effect on the expected return on a portfolio. B. The volatility of the portfolio will differ, depending on the correlation between the securities in the portfolio. C. 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 D. We can rule out inefficient portfolios because they represent inferior investment choices.

C

Which of the followings statements are false? A. A stockʹs return is perfectly positively correlated with itself. B. The closer the correlation is to -1, the more the returns tend to move in opposite directions. C. The variance of a portfolio depends only on the variance of the individual stocks D. When the covariance equals 0, the stocks have no tendency to move either together or in opposition of one another.

C

Stocks tend to move together is they are affected by

Common economic events

Which of the following equations is incorrect?

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

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

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 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

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 Motor 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 US stocks

Value weighted

You expect General Motors (GM) to have a beta of 1.5 over the next year.....Which stock has more total risk?

XOM, GM

You expect General Motors (GM) to have a beta of 1 over the next year......Which stock has more total risk?

XOM, XOM

Which of the following equations is incorrect?

Xi= Total value of portfolio/value of investment

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

Which of the following statements is false? A. Independent risks are uncorrelated. B. While the sign of correlation is easy to interpret, its magnitude is not C. To find the risk of a portfolio, we need to know more than the risk and return of the component stocks; we need to know the degree to which the stocksʹ returns move together. D. When the covariance equals 0, the returns are uncorrelated.

B

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&P500 over the return of US Treasury bonds has been ________ and is proxy for the market risk premium.

Between 5% and 7%

Which of the following statements is false? A. A portfolioʹs risk premium and volatility are determined by the fraction that is invested in the market. B. Because all investors should hold risky securities in the same proportions as the efficient portfolio, their combined portfolio will also reflect the same proportions as the efficient portfolio. C. The Capital Asset Pricing Model (CAPM) assumptions hold that the return on any portfolio is the combination of the risk-free rate of return plus a risk premium proportional to the amount of systematic risk in the investment. D. Graphically, when the tangent line goes through the market portfolio, it is called the security market line (SML)

D

Which of the following statements is false? A. The correlation between two stocks has the same sign as their covariance, so it has a similar interpretation. B. If two stocks move in opposite directions, the covariance will be negative. C. The covariance of a stock with itself is simply its variance. D. The covariance allows us to gauge the strength of the relationship between stocks

D

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

Depends on the portfolio that you add it to

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 expect General Motors (GM) to have a beta of 1.2 over the next year.....Which stock has more total risk?

GM, GM

The volatility of Home Depot share prices is 50% and that of General Motor 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%

Diversification reduces the risk of a portfolio because_______, and some of the risks are average out of the portfolio

Stocks do not move identically

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

True

Which of the following statements is false? A. Almost all of the correlations between stocks are negative, illustrating the general tendency of stocks to move together B. Stock returns will tend to move together if they are affected similarly by economic events. C. With a positive amount invested in each stock, the more the stocks move together and the higher their covariance or correlation, the more volatile the portfolio will be. D. Stocks in the same industry tend to have more highly correlated returns than stocks in different industries.

A

Which of the following statements is false? A. Efficient portfolios can be easily ranked, because investors will choose from among them those with the highest expected return B. When stocks are perfectly positively correlated, the set of portfolios is identified graphically by a straight line between them. C. An investor seeking high returns and low volatility should only invest in an efficient portfolio. D. When the correlation between securities is less than 1, the volatility of the portfolio is reduced due to diversification.

A

Which of the following statements is false? A. The expected return of a portfolio is simply the weighted average of the expected returns of the investments within the portfolio. B. Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return C. Portfolio weights add up to 1 so that they represent the way we have divided our money between the different individual investments in the portfolio. D. A portfolio weight is the fraction of the total investment in the portfolio held in an individual investment in the portfolio.

B

Which of the following statements is false? A. The expected return of a portfolio should correspond to the portfolioʹs beta. B. Graphically, the line through the risk-free investment and the market portfolio is called the capital market line (CML) C. By holding a negative-beta security, an investor can reduce the overall market risk of her portfolio. D. The beta of a portfolio is the weighted average beta of the securities in the portfolio.

B

Which of the following statements are false? A. The covariance and correlation allow us to measure the co-movement of returns B. The amount of risk that is eliminated in a portfolio depends on the degree to which the stocks face common risks and their prices move together. C. Correlation is the expected product of the deviations of two returns D. Because the stocksʹ prices do not move identically, some of the risk is averaged out in a portfolio.

C

Which of the following statements is false? A. The beta of a portfolio is the weighted average beta of the securities in the portfolio. B. A security with a negative beta has a negative correlation with the market, which means that this security tends to perform well when the rest of the market is doing poorly. C. 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 D. There is a linear relationship between a stockʹs beta and its expected return.

C

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 20% and that of General Motor shares is 20%. When I hold both stocks in my portfolio, the overall volatility of the portfolio is

Not possible to calculate as information is inadequate

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 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

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

zero