Investments Final Chapter 12

22. A portfolio beta is computed as which one of the following? A. weighted average B. arithmetic average C. geometric average D. correlated value E. covariance value See Section 12.4

A. weighted average

17. Which one of the following betas represents the greatest level of systematic risk? A. .05 B. .68 C. 1.00 D. 1.19 E. 1.27 See Section 12.4

E. 1.27

35. Stocks D, E, and F have actual reward-to-risk ratios of 7.1, 6.8, and 7.4, respectively. Given this, you know for certain that: A. stock E is preferable to stock F. B. stock D has a higher beta than stock F. C. the market risk premium is greater than 6.8 and less than 7.4. D. stock F is riskier than stock D. E. at least two of the securities are mispriced. See Section 12.5

E. at least two of the securities are mispriced.

45. Phil realized a total return of 13.2 percent which is less than his expected return of 14.4 percent. What is the amount of his unexpected return? A. -1.2 percent B. -0.6 percent C. 0.6 percent D. 1.2 percent E. 1.3 percent U = 13.2 percent - 14.4 percent = -1.2 percent

A. -1.2 percent

14. Which one of the following statements applies to unsystematic risk? A. It can be eliminated through portfolio diversification. B. It is also called market risk. C. It is a type of risk that applies to most, if not all, securities. D. Investors receive a risk premium as compensation for accepting this risk. E. This risk is related to expected returns. See Section 12.2

A. It can be eliminated through portfolio diversification.

47. Reed Plastics just announced the earnings per share for the quarter just ended were $.45 a share. Analysts were expecting $.51. What is the amount of the surprise portion of the announcement? A. -$.12 B. -$.06 C. $.06 D. $.00 E. $.03 Surprise = $.45 - $.51 = -$.06

B. -$.06

7. Which one of the following is the theory which states that the value of a security is dependent upon the pure time value of money, the reward for bearing systematic risk, and the amount of systematic risk? A. reward-to-risk theory B. capital asset pricing model C. risk premium proposal D. market slope hypothesis E. security market line proposition See Section 12.5

B. capital asset pricing model

________ has the greatest level of total risk and _________ has the highest risk premium

Combination of high beta and high standard deviation; highest beta

9. Retail Specialties just announced that its Chief Operating Officer is retiring at the end of this month. This announcement will cause the firm's stock price to: A. increase. B. either increase or remain constant. C. remain constant. D. decrease. E. either increase, decrease, or remain constant. See Section 12.1

E. either increase, decrease, or remain constant.

19. What is the beta of a risk-free security? A. .00 B. .50 C. 1.00 D. 1.50 E. 2.00 See Section 12.4

A. .00

6. Which one of the following is expressed as "E(RM) - Rf"? A. market risk premium B. individual security risk premium C. real rate of return D. total expected rate of return E. market rate of return See Section 12.5

A. market risk premium

1. Which one of the following is the type of risk that affects a large number of assets? A. unique B. systematic C. asset-specific D. unsystematic E. firm-specific See Section 12.2

B. systematic

37. Which two of the following determine how sensitive a security is relative to movements in the overall market? I. the standard deviation of the security II. correlation between the security's return and the market return III. the volatility of the security relative to the market IV. the amount of unsystematic risk inherent in the security A. I and III only B. I and IV only C. II and III only D. II and IV only E. III and IV only See Section 12.6

C. II and III only

12. Which one of the following terms is another name for systematic risk? A. unique risk B. firm risk C. market risk D. asset-specific risk E. diversifiable risk See Section 12.2

C. market risk

24. A portfolio of securities has a beta of 1.14. Given this, you know that: A. adding another security to the portfolio must lower the portfolio beta. B. the portfolio has more risk than a risk-free asset but less risk than the market. C. each of the securities in the portfolio has more risk than an average security. D. the portfolio has 14 percent more risk than a risk-free security. E. the expected return on the portfolio is greater than the expected market return. See Section 12.4

E. the expected return on the portfolio is greater than the expected market return.

16. Which one of the following qualifies as diversifiable risk? A. market risk B. systematic risk associated with an individual security C. market crash D. the systematic portion of an expected return E. the unsystematic portion of an unexpected return See Section 12.3

E. the unsystematic portion of an unexpected return

32. According to the capital asset pricing model, which of the following will increase the expected rate of return on a security that has a beta that is less than that of the market? Assume the market rate of return is greater than the risk-free rate and both rates are positive. I. increase in the risk-free rate II. decrease in the risk-free rate III. increase in the market risk premium IV. decrease in the market rate of return A. I and III only B. II and III only C. I and IV only D. II and IV only E. II, III, and IV only See Section 12.5

A. I and III only

31. Where will a security plot in relation to the security market line (SML) if it is considered to be a good purchase because it is underpriced? A. above the SML B. either on or above the SML C. on the SML D. on or below the SML E. below the SML See Section 12.5

A. above the SML

4. Which one of the following measures systematic risk? A. beta B. alpha C. variance D. standard deviation E. correlation coefficient See Section 12.4

A. beta

15. Which one of the following is the best example of unsystematic risk? A. decrease in company sales B. increase in market interest rates C. change in corporate tax rates D. increase in inflation E. This risk is related to expected portfolio returns See Section 12.2

A. decrease in company sales

29. The slope of the security market line is equal to the: A. market risk premium. B. risk-free rate of return. C. market rate of return. D. market rate of return multiplied by any security's beta, given an inefficient market. E. market rate of return multiplied by the risk-free rate. See Section 12.5

A. market risk premium.

30. Where will a security plot in relation to the security market line (SML) if it has a beta of 1.1 and is overvalued? A. to the right of the overall market and above the SML B. to the right of the overall market and below the SML C. to the left of the overall market and above the SML D. to the left of the overall market and below the SML E. on the SML See Section 12.5

B. to the right of the overall market and below the SML

36. Which one of the following will increase the slope of the security market line? Assume all else constant. A. increasing the beta of an efficiently-priced portfolio B. increasing the risk-free rate C. increasing the market risk premium D. decreasing the market rate of return E. replacing a low-beta stock with a high-beta stock within a portfolio See Section 12.5

C. increasing the market risk premium

33. Which one of the following has the highest expected risk premium? A. stock portfolio with a beta of 1.06 B. U.S. Treasury bill C. individual stock with a beta of 1.46 D. a stock mutual fund with a beta of .89 E. individual stock with a beta of .94 See Section 12.5

C. individual stock with a beta of 1.46

44. Which one of the following combinations will tend to produce the highest rate of return according to the Fama-French three-factor model? Assume beta is constant in all cases. A. large market capitalization and high book-to-market ratio B. large market capitalization and low book-to-market ratio C. small market capitalization and high book-to-market ratio D. small market capitalization and a book-to-market ratio of 1.0 E. small market capitalization and a low book-to-market ratio See Section 12.7

C. small market capitalization and high book-to-market ratio

40. Which of the following will affect the beta value of an individual security? I. interval of time frequency used for the data sample II. length of the time period used for the data sample III. particular time period selected for the sampling IV. choice of index used as the measure of the market A. I and II only B. I and III only C. II and IV only D. II, III, and IV only E. I, II, III, and IV See Section 12.6

E. I, II, III, and IV

42. Which one of the following statements is true? A. Risk and return are inversely related. B. Investors are compensated only for diversifiable risk. C. The beta of a portfolio may be lower than the lowest beta of any individual security held within the portfolio. D. How a security affects the risk of a portfolio is less important than the actual risk of the security itself. E. Investing has two dimensions: risk and return. See Section 12.7

E. Investing has two dimensions: risk and return.

43. Which of the following correctly identifies the factors included in the Fama-French three-factor model? A. standard deviation, beta, and company size B. the risk-free rate, beta, and the market risk premium C. company size, company industry, and beta D. price-earnings ratios, beta, and book-to-market ratios E. beta, company size, and book-to-market ratios See Section 12.7

E. beta, company size, and book-to-market ratios

41. Which one of the following is most commonly used as the measure of the overall market rate of return? A. DJIA B. S&P 500 C. NASDAQ 100 D. Wilshire 5000 E. Wilshire 3000 See Section 12.6

B. S&P 500

10. Which one of the following is the best example of a risk associated with stock ownership? A. The stock paid a regular quarterly dividend. B. The firm's net income decreased by 4 percent for the quarter, as had been expected. C. One of the firm's patent applications was unexpectedly rejected. D. The firm's cost of debt increased as the result of an expected tax cut. E. The firm's production costs increased in line with previous years. See Section 12.1

C. One of the firm's patent applications was unexpectedly rejected.

25. You own three stocks which have betas of 1.16, 1.34, and 1.02. You would like to add a fourth security such that your portfolio beta will match that of the market. Given this situation, the new security: A. must have a beta of 1.0. B. must have a beta of zero. C. could be a U.S. Treasury bill. D. could have any beta greater than 1.0. E. must have a portfolio weight of 50 percent or more. See Section 12.4

C. could be a U.S. Treasury bill.

2. Which one of the following is the type of risk that only affects either a single firm or just a small number of firms? A. unexpected B. market C. systematic D. unsystematic E. expected See Section 12.2

D. unsystematic

34. Which one of the following must be equal for two individual securities with differing betas if those securities are correctly priced according to the capital asset pricing model? A. standard deviation B. rate of return C. beta D. risk premium E. reward-to-risk ratio See Section 12.5

E. reward-to-risk ratio

Which has the highest expected risk premium?

Highest Beta

46. Brooke invested $4,500 in the stock market with the expectation of earning 6.25 percent. She actually earned 7.15 percent for the year. What is the amount of her unexpected return? A. -1.2 percent B. -0.6 percent C. 0.9 percent D. 1.9 percent E. 2.4 percent U = 7.15 percent - 6.25 percent = 0.9 percent

C. 0.9 percent

13. Which one of the following is the best example of systematic risk? A. there is a shortage of nurses B. a fire destroys a warehouse C. gas prices rise sharply D. the cost of sugar increases E. two firms merge their operations See Section 12.2

C. gas prices rise sharply

27. What is the beta of an average asset? A. 0 B. > 0 but < 1 C. < 1 D. 1 E. > 1 See Section 12.4

D. 1

38. Which of the following are needed to compute the beta of an individual security? I. average return on the market for the period II. standard deviation of the security and the market III. returns on the security and the market for multiple time periods IV. correlation of the security to the market A. I and III only B. I and IV only C. II and III only D. II and IV only E. I, II, and III only See Section 12.6

D. II and IV only

3. According to the systematic risk principle, the reward for bearing risk is based on which one of the following types of risk? A. unsystematic B. firm specific C. expected D. systematic E. diversifiable See Section 12.4

D. systematic

26. The amount of risk premium allocated to Security A is dependent upon which one of the following? A. unsystematic risk associated only with Security A B. total risk associated with Security A's classification C. total surprise associated with Security A D. the difference between the expected return and the actual return on Security A E. systematic risk associated with Security A See Section 12-04

E. systematic risk associated with Security A

5. The security market line depicts the graphical relationship between which two of the following? I. expected return II. surprise return III. systematic risk IV. unsystematic risk A. I and III B. I and IV C. II and III D. II and IV E. none of these See Section 12.5

A. I and III

23. You own a portfolio which is invested equally in two stocks and a risk-free security. The stock betas are .89 for Stock A and 1.26 for Stock B. Which one of the following will increase the portfolio beta, all else constant? A. increasing the amount invested in the risk-free security B. decreasing the weight of Stock B and increasing the weight of Stock A C. replacing Stock A with a security that has a beta of .77 D. increasing the weight of Stock A and decreasing the weight of the risk-free security E. replacing Stock B with Stock C, which has a beta equal to that of the market See Section 12.4

D. increasing the weight of Stock A and decreasing the weight of the risk-free security

8. Which one of the following terms is the measure of the tendency of two things to move or vary together? A. variance B. squared deviation C. standard deviation D. alpha E. covariance See Section 12.6

E. covariance

11. Which one of the following announcements is most apt to cause the price of a firm's stock to increase? A. The firm met its quarterly earnings forecast. B. An unpopular CEO unexpectedly announced he is resigning effective immediately. C. A firm officially confirmed the rumors that it is merging with a competitor. D. The firm just lowered its projected earnings per share for next year. E. Analysts are expected to lower the firm's credit rating on its debt. See Section 12.1

B. An unpopular CEO unexpectedly announced he is resigning effective immediately.

18. A stock with which one of the following betas has an expected return that most resembles the overall market expected rate of return? A. .33 B. .74 C. .99 D. 1.06 E. 1.22 See Section 12.4

C. .99

28. All else held constant, which of the following will increase the expected return on a security based on CAPM? Assume the market return exceeds the risk-free rate and both values are positive. Also assume the beta exceeds 1.0. I. decrease in the security beta II. increase in the market risk premium III. decrease in the risk-free rate IV. increase in the market rate of return A. I and III only B. II and IV only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV See Section 12.5

D. II, III, and IV only

39. A security has a zero covariance with the market. This means that: A. the return on the security is always equal to that of the market. B. the return on the security moves in the same direction as the market return. C. the security is a risk-free security. D. there is no identifiable relationship between the return on the security and that of the market. E. the return on the security must vary more than that of the market. See Section 12.6

D. there is no identifiable relationship between the return on the security and that of the market.