Finn-3120 Exam 2 ch. 6

12) Assume that an investment is forecasted to produce the following returns: a 10% probability of a $1,400 return; a 50% probability of a $6,600 return; and a 40% probability of a $1,500 return. What is the expected amount of return this investment will produce? A) $4,040 B) $7,640 C) $12140 D) $1,540

A) $4,040

48) Assume that you have $165,000 invested in a stock whose beta is 1.25, $85,000 invested in a stock whose beta is 2.35, and $235,000 invested in a stock whose beta is 1.11. What is the beta of your portfolio? A) 1.37 B) 2.01 C) 1.85 D) 1.57

A) 1.37

28) Decker Corp. common stock has a required return of 17.5% and a beta of 1.75. If the expected risk free return is 3%, what is the expected return for the market based on the CAPM? A) 11.29% B) 14.29% C) 13.35% D) 15.27%

A) 11.29%

46) You purchased 500 shares of A.M.J. Inc. common stock one year ago for $50 per share. You received a dividend of $2 per share today and decide to take your profits by selling at $54.50 per share. What is your holding period return? A) 13.0% B) 9.0% C) 6.5% D) 4.0%

A) 13.0%

19) Wendy purchased 800 shares of Robotics stock at $3 per share on 1/1/09. Wendy sold the shares on 12/31/09 for $3.45. Robotics stock has a beta of 1.3, the risk-free rate of return is 3%, and the market risk premium is 8%. The required return on Robotics stock is A) 13.4%. B) 16.5%. C) 17.6%. D) 21.1%.

A) 13.4%.

27) Anchor Incorporated has a beta of 1.0. If the expected return on the market is 15%, what is the expected return on Anchor Incorporated's stock? A) 15% B) 14% C) 18% D) cannot be determined without the risk-free rate

A) 15%

28) Wendy purchased 800 shares of Genetics Stock at $3 per share on 1/1/12. Wendy sold the shares on 12/31/12 for $3.45. Genetics stock has a beta of 1.9, the risk-free rate of return is 4%, and the market risk premium is 9%. Wendy's holding period return is A) 15.0%. B) 16.5%. C) 17.6%. D) 21.1%.

A) 15.0%.

30) You are considering buying some stock in Continental Grain. Which of the following are examples of non-diversifiable risks? I. Risk resulting from a general decline in the stock market. II. Risk resulting from a possible increase in income taxes. III. Risk resulting from an explosion in a grain elevator owned by Continental. IV. Risk resulting from a pending lawsuit against Continental. A) I and II B) III and IV C) I only D) II, III, and IV

A) I and II

37) Which of the following is/are true? A) Most of the unsystematic risk is removed by the time a portfolio contains 30 stocks. B) Two points on the Characteristic Line are the T-bill and the market portfolio. C) The greater the total risk of an asset, the greater the expected return. D) All securities have a beta between 0 and 1.

A) Most of the unsystematic risk is removed by the time a portfolio contains 30 stocks.

25) Which of the following statements is MOST correct concerning diversification and risk? A) Risk-averse investors often choose companies from different industries for their portfolios because the correlation of returns is less than if all the companies came from the same industry. B) Risk-averse investors often select portfolios that include only companies from the same industry group because the familiarity reduces the risk. C) Only wealthy investors can diversify their portfolios because a portfolio must contain at least 50 stocks to gain the benefits of diversification. D) Proper diversification generally results in the elimination of risk.

A) Risk-averse investors often choose companies from different industries for their portfolios because the correlation of returns is less than if all the companies came from the same industry.

10) You are considering a sales job that pays you on a commission basis or a salaried position that pays you $50,000 per year. Historical data suggests the following probability distribution for your commission income. Which job has the higher expected income? Commission Probability of Occurrence $15,000 .15 $35,000 .20 $48,000 .35 $67,000 .22 $80,000 .18 A) The salary of $50,000 is greater than the expected commission of $49,630. B) The salary of $50,000 is greater than the expected commission of $48,400. C) The salary of $50,000 is less than the expected commission of $50,050. D) The salary of $50,000 is less than the expected commission of $52,720.

A) The salary of $50,000 is greater than the expected commission of $49,630.

13) A typical measure for the risk-free rate of return is the A) U.S. Treasury bill rate. B) prime lending rate. C) money-market rate. D) short-term AAA-rated bond rate.

A) U.S. Treasury bill rate.

30) You determine that LMN common stock has an expected return of 24%. LMN has a Beta of 1.5. The risk-free rate is 5%, and the market expected return is 15%. Which of the following is most likely to happen? A) You and other investors will buy up LMN stock and its price will rise. B) You and other investors will sell LMN stock and its return will fall. C) You and other investors will buy up LMN stock and its return will rise. D) You and other investors will sell LMN stock and its price will fall.

A) You and other investors will buy up LMN stock and its price will rise.

16) Stock A has a beta of 1.2 and a standard deviation of returns of 18%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the market risk premium increases, then A) the required return on stock B will increase more than the required return on stock A. B) the required returns on stocks A and B will both increase by the same amount. C) the required returns on stocks A and B will remain the same. D) the required return on stock A will increase more than the required return on stock B.

A) the required return on stock B will increase more than the required return on stock A.

45) Which of the following types of risk is diversifiable? A) unsystematic, or company-unique risk B) betagenic, or ecocentric risk C) systematic risk D) market risk

A) unsystematic, or company-unique risk

9) Stock A has the following returns for various states of the economy: State of the Economy Probability Stock A's Return Recession 9% -72% Below Average 16% -15% Average 51% 16% Above Average 14% 35% Boom 10% 85% Stock A's expected return is A) 9.9%. B) 12.7%. C) 13.8%. D) 16.5%.

B) 12.7%.

9) Assume that you have $330,000 invested in a stock that is returning 11.50%, $170,000 invested in a stock that is returning 22.75%, and $470,000 invested in a stock that is returning 10.25%. What is the expected return of your portfolio? A) 15.6% B) 12.9% C) 18.3% D) 14.8%

B) 12.9%

33) Marble Corp. has a beta of 2.5 and a standard deviation of returns of 20%. The return on the market portfolio is 15% and the risk-free rate is 4%. According to CAPM, what is the required rate of return on Collectible's stock? A) 37.5% B) 31.5% C) 26.5% D) 23.5%

B) 31.5%

33) A well-diversified portfolio includes investments in 50 securities. The portfolio's systematic risk is likely to be about A) 50% of the total risk. B) 40% of the total risk. C) 25% of the total risk. D) zero because risk is eliminated with a portfolio of 50 securities or more.

B) 40% of the total risk.

22) White Company stock has a beta of 2 and a required return of 23%, while Black Company stock has a beta of 1.0 and a required return of 14%. The standard deviation of returns for White Company is 10% more than the standard deviation for Black Company. The risk-free rate of return according to the CAPM is A) 4%. B) 5%. C) 6%. D) impossible to determine with the information given.

B) 5%

26) Which of the following statements is MOST correct concerning diversification and risk? A) Diversification is mainly achieved by the selection of individual securities for each type of asset held in a portfolio. B) Diversification is mainly achieved by the asset allocation decision, not the selection of individual securities within each asset category. C) Large company stocks and small company stocks together in a portfolio lead to dramatic reductions in risk because their returns are negatively correlated. D) Asset allocation is important for pension funds but not for individual investors.

B) Diversification is mainly achieved by the asset allocation decision, not the selection of individual securities within each asset category.

8) Which of the following investments is clearly preferred to the others for an investor who is not holding a well-diversified portfolio? Investment σ A 18% 20% B 20% 20% C 20% 22% A) Investment A B) Investment B C) Investment C D) Cannot be determined without information regarding the risk-free rate of return.

B) Investment B

8) If you were to use the standard deviation as a measure of investment risk, which of the following has historically been the least risky investment? A) common stock of large firms B) U.S. Treasury bills C) common stock of small firms D) long-term government bonds

B) U.S. Treasury bills

54) Changes in the general economy, like changes in interest rates or tax laws, represent what type of risk? A) company-unique risk B) market risk C) unsystematic risk D) diversifiable risk

B) market risk

12) The capital asset pricing model A) provides a risk-return trade-off in which risk is measured in terms of the market volatility. B) provides a risk-return trade-off in which risk is measured in terms of beta. C) measures risk as the coefficient of variation between security and market rates of return. D) depicts the total risk of a security.

B) provides a risk-return trade-off in which risk is measured in terms of beta.

7) The category of securities with the highest historical risk premium is A) large company stocks. B) small company stocks. C) government bonds. D) small company corporate bonds.

B) small company stocks.

14) If the beta for stock A equals zero, then A) stock A's required return is equal to the required return on the market portfolio. B) stock A's required return is equal to the risk-free rate of return. C) stock A has a guaranteed return. D) stock A's required return is greater than the required return on the market portfolio.

B) stock A's required return is equal to the risk-free rate of return.

35) A stock's beta is a measure of its A) unsystematic risk. B) systematic risk. C) company-unique risk. D) diversifiable risk.

B) systematic risk.

39) What is the name given to the equation that financial managers use to measure an investor's required rate of return? A) the standard deviation B) the capital asset pricing model C) the coefficient of variation D) the MIRR

B) the capital asset pricing mode

17) Stock A has a beta of 1.2 and a standard deviation of returns of 14%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the risk-free rate of return increases and the market risk premium remains constant, then A) the required return on stock B will increase more than the required return on stock A. B) the required returns on stocks A and B will both increase by the same amount. C) the required returns on stocks A and B will not change. D) the required return on stock A will increase more than the required return on stock B.

B) the required returns on stocks A and B will both increase by the same amount.

32) Most stocks have betas between A) -1.00 and 1.00. B) 0.00 and 1.00. C) 0.60 and 1.60. D) 1.00 and 2.00.

C) 0.60 and 1.60.

49) Assume that you have $100,000 invested in a stock whose beta is .85, $200,000 invested in a stock whose beta is 1.05, and $300,000 invested in a stock whose beta is 1.25. What is the beta of your portfolio? A) 0.97 B) 1.02 C) 1.12 D) 1.21

C) 1.12

17) Assume that you expect to hold a $20,000 investment for one year. It is forecasted to have a year end value of $21,000 with a 30% probability; a year end value of $24,000 with a 45% probability; and a year end value of $30,000 with a 25% probability. What is the standard deviation of the holding period return for this investment? A) 12.06% B) 14.36% C) 16.36% D) 33.45%

C) 16.36%

5) Stock W has the following returns for various states of the economy: State of the Economy Probability Stock W's Return Recession 10% -30% Below Average 20% -2% Average 40% 10% Above Average 20% 18% Boom 10% 40% Stock W's standard deviation of returns is A) 10%. B) 14%. C) 17%. D) 20%

C) 17%.

13) Assume that an investment is forecasted to produce the following returns: a 20% probability of a 12% return; a 50% probability of a 16% return; and a 30% probability of a 19% return. What is the standard deviation of return for this investment? A) 5.89% B) 16.1% C) 2.43% D) 15.7%

C) 2.43%

42) Assume that you expect to hold a $40,000 investment for one year. It is forecasted to have a year end value of $42,000 with a 30% probability; a year end value of $48,000 with a 45% probability; and a year end value of $60,000 with a 25% probability. What is the expected holding period return for this investment? A) 50% B) 25% C) 23% D) 18%

C) 23%

6) Stock W has the following returns for various states of the economy: State of the Economy Probability Stock W's Return Recession 9% -72% Below Average 16% -15% Average 51% 16% Above Average 14% 35% Boom 10% 85% Stock W's standard deviation of returns is A) 12%. B) 29%. C) 37%. D) 43%.

C) 37%.

8) Stock A has the following returns for various states of the economy: State of the Economy Probability Stock A's Return Recession 10% -30% Below Average 20% -2% Average 40% 10% Above Average 20% 18% Boom 10% 40% Stock A's expected return is A) 5.4%. B) 7.2%. C) 8.2%. D) 9.6%

C) 8.2%.

5) Investment A has an expected return of 15% per year, while Investment B has an expected return of 12% per year. A rational investor will choose A) Investment A because of the higher expected return. B) Investment B because a lower return means lower risk. C) Investment A if A and B are of equal risk. D) Investment A only if the standard deviation of returns for A is higher than the standard deviation of returns for B.

C) Investment A if A and B are of equal risk.

11) Rogue Recreation, Inc. has normally distributed returns with an expected return of 15% and a standard deviation of 5%, while Lake Tours, Inc. has normally distributed returns with an expected return of 15% and a standard deviation of 15%. Which of the following is true? A) Lake Tours' investors are not being adequately compensated for relevant risk. B) Rogue Rec is likely to experience returns larger than those of Lake Tours. C) Lake Tours is more likely to have negative returns than Rogue Rec. D) Rational investors will prefer Lake Tours, Inc. over Rogue Recreation, Inc.

C) Lake Tours is more likely to have negative returns than Rogue Rec.

44) How can investors reduce the risk associated with an investment portfolio without having to accept a lower expected return? A) Wait until the stock market rises. B) Increase the amount of money invested in the portfolio. C) Purchase a variety of securities; i.e., diversify. D) Purchase stocks that have exceptionally high standard deviations.

C) Purchase a variety of securities; i.e., diversify.

51) What is diversifying among different kinds of assets known as? A) portfolio funding B) capital asset classification C) asset allocation D) multi-diversification

C) asset allocation

38) If we are able to fully diversify, what is the appropriate measure of risk to use? A) expected return B) standard deviation C) beta D) risk-free rate of return

C) beta

43) Portfolio risk is typically measured by ________ while the risk of a single investment is measured by ________. A) standard deviation; beta B) security market line; standard deviation C) beta; standard deviation D) beta; slope of the characteristic line

C) beta; standard deviation

11) The relevant variable a financial manager uses to measure returns is A) net income determined using generally accepted accounting principles. B) earnings per share minus dividends per share. C) cash flows. D) dividends.

C) cash flows.

9) If you were to use the standard deviation as a measure of investment risk, which of the following has historically been the highest risk investment? A) common stock of large firms B) U.S. Treasury bills C) common stock of small firms D) long-term government bonds

C) common stock of small firms

20) Based on the security market line, Robo-Tech stock has a required return of 14% and Friendly Insurance Company has a required return of 10%. Robo-Tech has a standard deviation of returns of 18%. Therefore, A) Friendly must have a standard deviation of returns of less than 18% because Friendly is less risky than Robo-Tech. B) all rational investors will prefer Friendly over Robo-Tech. C) for a well-diversified investor, Friendly is less risky than Robo-Tech. D) the beta for Friendly must be greater than the beta for Robo-Tech because Friendly is the better buy for a risk-averse investor.

C) for a well-diversified investor, Friendly is less risky than Robo-Tech.

41) The minimum rate of return necessary to attract an investor to purchase or hold a security is referred to as the A) stock's beta. B) investor's risk premium. C) investor's required rate of return.

C) investor's required rate of return.

23) Surf and Spray Inc. has a beta equal to 1.8 and a required return of 15% based on the CAPM. If the market risk premium is 7.5%, the risk-free rate of return is A) 4.1%. B) 3.4%. C) 2.0%. D) 1.5%.

D) 1.5%.

24) Surf and Spray Inc. has a beta equal to 1.8 and a required return of 15% based on the CAPM. If the risk-free rate of return is 4.2%, the expected return on the market portfolio is A) 21%. B) 19.2%. C) 13.4%. D) 10.2%.

D) 10.2%.

32) Marble Corp. has a beta of 2.5 and a standard deviation of returns of 20%. The return on the market portfolio is 15% and the risk-free rate is 4%. What is the risk premium on the market? A) 5% B) 6% C) 9.00% D) 11%

D) 11%

36) The rate on T-bills is currently 2%. Environment Help Company stock has a beta of 1.5 and a required rate of return of 17%. According to CAPM, determine the return on the market portfolio. A) 27.5% B) 19.0% C) 14.0% D) 12.0%

D) 12.0%

21) Green Company stock has a beta of 2 and a required return of 23%, while Gold Company stock has a beta of 1.0 and a required return of 14%. The standard deviation of returns for Green Company is 10% more than the standard deviation for Gold Company. The expected return on the market portfolio according to the CAPM is A) 9%. B) 10%. C) 12%. D) 14%.

D) 14%.

29) Wildings, Inc. common stock has a beta of 1.2. If the expected risk free return is 4% and the expected market risk premium is 9%, what is the expected return on Wildings' stock? A) 10.0% B) 12.0% C) 13.8% D) 14.8%

D) 14.8%

13) Assume that an investment is forecasted to produce the following returns: a 30% probability of a 12% return; a 50% probability of a 16% return; and a 20% probability of a 19% return. What is the expected percentage return this investment will produce? A) 33.3% B) 16.1% C) 9.5% D) 15.4%

D) 15.4%

10) Assume that you have $100,000 invested in a stock that is returning 14%, $150,000 invested in a stock that is returning 18%, and $200,000 invested in a stock that is returning 15%. What is the expected return of your portfolio? A) 13.25% B) 14.97% C) 15.67% D) 15.78%

D) 15.78%

40) You are considering an investment in Citizens Bank Corp. The firm has a beta of 1.6. Currently, U.S. Treasury bills are yielding 2.75% and the expected return for the S & P 500 is 14%. What rate of return should you expect for your investment in Citizens Bank? A) 11.15% B) 15.39% C) 16.75% D) 20.75%

D) 20.75%

15) The risk-free rate of interest is 4% and the market risk premium is 9%. Howard Corporation has a beta of 2.0, and last year generated a return of 16% with a standard deviation of returns of 27%. The required return on Howard Corporation stock is A) 36%. B) 34%. C) 26%. D) 22%.

D) 22%.

37) The return on the market portfolio is currently 12%. Mobile Phone Corporation stockholders require a rate of return of 30% and the stock has a beta of 3.2. According to CAPM, determine the risk-free rate. A) 9.80% B) 6.50% C) 4.64% D) 3.82%

D) 3.82%

50) Which of the following statements is MOST correct regarding beta? A) Beta must be calculated using at least 5 years of monthly returns data to be accurate. B) Beta can only be measured properly using daily returns. C) Beta for a particular company remains constant over time. D) Even professionals may not agree on the measurement of beta.

D) Even professionals may not agree on the measurement of beta

29) You are considering investing in Ford Motor Company. Which of the following are examples of diversifiable risk? I. Risk resulting from possibility of a stock market crash. II. Risk resulting from uncertainty regarding a possible strike against Ford. III. Risk resulting from an expensive recall of a Ford product. IV. Risk resulting from interest rates decreasing. A) I only B) I and IV C) I, II, III, IV D) II, III

D) II, III

31) Of the following, which differs in meaning from the other three? A) systematic risk B) market risk C) undiversifiable risk D) asset-unique risk

D) asset-unique risk

47) Which of the following measures the average relationship between a stock's returns and the market's returns? A) coefficient of validation B) standard deviation C) geometric regression D) beta coefficient

D) beta coefficient

26) The appropriate measure for risk according to the capital asset pricing model is A) the standard deviation of a firm's cash flows. B) alpha. C) the standard deviation of a firm's stock returns. D) beta

D) beta.

7) Stock W has an expected return of 12% with a standard deviation of 8%. If returns are normally distributed, then approximately two-thirds of the time the return on stock W will be A) between 12% and 20%. B) between 8% and 12%. C) between -4% and 28%. D) between 4% and 20%.

D) between 4% and 20%.

6) Of the following different types of securities, which is typically considered most risky? A) long-term corporate bonds B) long-term government bonds C) common stocks of large companies D) common stocks of small companies

D) common stocks of small companies

52) Investment A has an expected return of 14% with a standard deviation of 4%, while investment B has an expected return of 20% with a standard deviation of 9%. Therefore, A) a risk averse investor will definitely select investment A because the standard deviation is lower. B) a rational investor will pick investment B because the return adjusted for risk (20% - 9%) is higher than the return adjusted for risk for investment A ($14% - 4%). C) it is irrational for a risk-averse investor to select investment B because its standard deviation is more than twice as big as investment A's, but the return is not twice as big. D) rational investors could pick either A or B, depending on their level of risk aversion.

D) rational investors could pick either A or B, depending on their level of risk aversion.

35) The beta of ABC Co. stock is the slope of A) the security market line. B) the characteristic line for a plot of returns on the S&P 500 versus returns on short-term Treasury bills. C) the arbitrage pricing line. D) the characteristic line for a plot of ABC Co. returns against the returns of the market portfolio for the same period.

D) the characteristic line for a plot of ABC Co. returns against the returns of the market portfolio for the same period

38) Which of the following is the slope of the security market line? A) beta B) one C) It varies, and it is steeper for riskier securities. D) the market risk premium

D) the market risk premium

34) Beta is a statistical measure of A) unsystematic risk. B) total risk. C) the standard deviation. D) the relationship between an investment's returns and the market return.

D) the relationship between an investment's returns and the market return.

41) Beginning with an investment in one company's securities, as we add securities of other companies to our portfolio, which type of risk declines? A) systematic risk B) market risk C) non-diversifiable risk D) unsystematic risk

D) unsystematic risk