Chapter 11
Which one of these represents systematic risk? Major layoff by a regional manufacturer of power boats Increase in consumption created by a reduction in personal tax rates Surprise firing of a firm's chief financial officer Closure of a major retail chain of stores Product recall by one manufacturer
Increase in consumption created by a reduction in personal tax rates
Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies to the 28 percent? Portfolio variance Portfolio standard deviation Portfolio weight Portfolio expected return Portfolio beta
Portfolio weight
Which one of the following represents the amount of compensation an investor should expect to receive for accepting the unsystematic risk associated with an individual security? Security beta multiplied by the market rate of return Market risk premium Security beta multiplied by the market risk premium Risk-free rate of return Zero
Zero
Which one of the following is the computation of the risk premium for an individual security? E(R) is the expected return on the security, Rf is the risk-free rate, β is the security's beta, and E(RM) is the expected rate of return on the market. E(RM) -Rf E(R) - E(RM) E(R) - [E(RM) + Rf] β[E(RM) -Rf] β[E(R) -Rf]
β[E(RM) -Rf]
PL Lumber stock is expected to return 22 percent in a booming economy, 15 percent in a normal economy, and lose 2 percent in a recession. The probabilities of an economic boom, normal state, or recession are 5 percent, 92 percent, and 3 percent, respectively. What is the expected rate of return on this stock? 14.84 percent 14.23 percent 14.51 percent 15.47 percent 15.26 percent
14.84 percent
A stock is expected to return 13 percent in an economic boom, 10 percent in a normal economy, and 3 percent in a recessionary economy. Which one of the following will lower the overall expected rate of return on this stock? An increase in the rate of return in a recessionary economy An increase in the probability of an economic boom A decrease in the probability of a recession occurring A decrease in the probability of an economic boom An increase in the rate of return for a normal economy
A decrease in the probability of an economic boom
Which statement is correct? An underpriced security will plot below the security market line. A security with a beta of 1.54 will plot on the security market line if it is correctly priced. A portfolio with a beta of .93 will plot to the right of the overall market. A security with a beta of .99 will plot above the security market line if it is correctly priced. A risk-free security will plot at the origin.
A security with a beta of 1.54 will plot on the security market line if it is correctly priced.
Which one of the following is the best example of unsystematic risk? Inflation exceeding market expectations A warehouse fire Decrease in corporate tax rates Decrease in the value of the dollar Increase in consumer spending
A warehouse fire
Which statement is correct? A portfolio that contains at least 30 diverse individual securities will have a beta of 1.0. Any portfolio that is correctly valued will have a beta of 1.0. A portfolio that has a beta of 1.12 will lie to the left of the market portfolio on a security market line graph. A risk-free security plots at the origin on a security market line graph. An underpriced security will plot above the security market line.
An underpriced security will plot above the security market line.
Which one of the following is the minimum required rate of return on a new investment that makes that investment attractive? Risk-free rate Market risk premium Expected return minus the risk-free rate Market rate of return Cost of capital
Cost of capital
Which one of these is the best example of systematic risk? Discovery of a major gas field Decrease in textile imports Increase in agricultural exports Decrease in gross domestic product Decrease in management bonuses for banking executives
Decrease in gross domestic product
Which term best refers to the practice of investing in a variety of diverse assets as a means of reducing risk? Systematic Unsystematic Diversification Security market line Capital asset pricing model
Diversification
Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock. Which one of the following best describes the 16.5 percent rate? Expected return Real return Market rate Systematic return Risk premium
Expected Return
Which one of the following statements is correct? The risk premium on a risk-free security is generally considered to be one percent. The expected rate of return on any security, given multiple states of the economy, must be positive. There is an inverse relationship between the level of risk and the risk premium given a risky security. If a risky security is correctly priced, its expected risk premium will be positive. If a risky security is priced correctly, it will have an expected return equal to the risk-free rate.
If a risky security is correctly priced, its expected risk premium will be positive.
World United stock currently plots on the security market line and has a beta of 1.04. Which one of the following will increase that stock's rate of return without affecting the risk level of the stock, all else constant? An increase in the risk-free rate Decrease in the security's beta Overpricing of the stock in the marketplace Increase in the market risk-to-reward ratio Decrease in the market rate of return
Increase in the market risk-to-reward ratio
Julie wants to create a $5,000 portfolio. She also wants to invest as much as possible in a high risk stock with the hope of earning a high rate of return. However, she wants her portfolio to have no more risk than the overall market. Which one of the following portfolios is most apt to meet all of her objectives? Invest the entire $5,000 in a stock with a beta of 1.0 Invest $2,500 in a stock with a beta of 1.98 and $2,500 in a stock with a beta of 1.0 Invest $2,500 in a risk-free asset and $2,500 in a stock with a beta of 2.0 Invest $2,500 in a stock with a beta of 1.0, $1,250 in a risk-free asset, and $1,250 in a stock with a beta of 2.0 Invest $2,000 in a stock with a beta of 3, $2,000 in a risk-free asset, and $1,000 in a stock with a beta of 1.0
Invest $2,500 in a risk-free asset and $2,500 in a stock with a beta of 2.0
Diversifying a portfolio across various sectors and industries might do more than one of the following. However, this diversification must do which one of the following? Increase the expected risk premium Reduce the beta of the portfolio to one Increase the security's risk premium Reduce the portfolio's systematic risk level Reduce the portfolio's unique risks
Reduce the portfolio's unique risks
Which one of the following is the vertical intercept of the security market line? Market rate of return Individual security rate of return Market risk premium Individual security beta multiplied by the market risk premium Risk-free rate
Risk-free rate
Which one of the following is the best example of an announcement that is most apt to result in an unexpected return? A news bulletin that the anticipated layoffs by a firm will occur as expected on December 1 Announcement that the CFO of the firm is retiring June 1 as previously announced Announcement that a firm will continue its practice of paying a $3 a share annual dividend Statement by a firm that it has just discovered a manufacturing defect and is recalling its product The verification by senior management that the firm is being acquired as had been rumored
Statement by a firm that it has just discovered a manufacturing defect and is recalling its product
The risk premium for an individual security is based on which one of the following types of risk? Total Surprise Diversifiable Systematic Unsystematic
Systematic
Which statement is true? The expected rate of return on any portfolio must be positive. The arithmetic average of the betas for each security held in a portfolio must equal 1.0. The beta of any portfolio must be 1.0. The weights of the securities held in any portfolio must equal 1.0. The standard deviation of any portfolio must equal 1.0.
The weights of the securities held in any portfolio must equal 1.0.
Which one of the following best exemplifies unsystematic risk? Unexpected economic collapse Unexpected increase in interest rates Unexpected increase in the variable costs for a firm Sudden decrease in inflation Expected increase in tax rates
Unexpected increase in the variable costs for a firm
Systematic risk is defined as: any risk that affects a large number of assets. the total risk of an individual security. diversifiable risk. asset-specific risk. the risk unique to a firm's management.
any risk that affects a large number of assets.
The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is measured by the: squared deviation. beta coefficient. standard deviation. mean. variance.
beta coefficient
The capital asset pricing model: assumes the market has a beta of zero and the risk-free rate is positive. rewards investors based on total risk assumed. considers the relationship between the fluctuations in a security's returns versus the market's returns. applies to portfolios but not to individual securities. assumes the market risk premium is constant over time.
considers the relationship between the fluctuations in a security's returns versus the market's returns.
The security market line is defined as a positively sloped straight line that displays the relationship between the: beta and standard deviation of a portfolio. systematic and unsystematic risks of a security. nominal and real rates of return. expected return and beta of either a security or a portfolio. risk premium and beta of a portfolio.
expected return and beta of either a security or a portfolio.
The security market line is a linear function that is graphed by plotting data points based on the relationship between the: risk-free rate and beta. market rate of return and beta. market rate of return and the risk-free rate. risk-free rate and the market rate of return. expected return and beta.
expected return and beta.
The systematic risk principle states that the expected return on a risky asset depends only on the asset's ___ risk. unique diversifiable asset-specific market unsystematic
market
Unsystematic risk can be defined by all of the following except: unrewarded risk. diversifiable risk. market risk. unique risk. asset-specific risk.
market risk
The slope of the security market line represents the: risk-free rate. market risk premium. beta coefficient. risk premium on an individual asset. market rate of return.
market risk premium.
The addition of a risky security to a fully diversified portfolio: must decrease the portfolio's expected return. must increase the portfolio beta. may or may not affect the portfolio beta. will increase the unsystematic risk of the portfolio. will have no effect on the portfolio beta or its expected return.
may or may not affect the portfolio beta.
If a security plots to the right and below the security market line, then the security has ____ systematic risk than the market and is ____. more; overpriced more; underpriced less; overpriced less; underpriced less; correctly priced
more; overpriced
Assume you own a portfolio of diverse securities which are each correctly priced. Given this, the reward-to-risk ratio: for the portfolio must equal 1.0. for the portfolio must be less than the market risk premium. for each security must equal zero. of each security is equal to the risk-free rate. of each security must equal the slope of the security market line.
of each security must equal the slope of the security market line.
According to the capital asset pricing model, the expected return on a security will be affected by all of the following except the: market risk premium. risk-free rate. market rate of return. security's standard deviation. security's beta.
security's standard deviation.
The expected return on a security is not affected by the: security's unique risks. risk-free rate. security's risk premium. security's beta. market rate of return.
security's unique risks
For a risky security to have a positive expected return but less risk than the overall market, the security must have a beta: of zero. that is > 0 but < 1. of one. that is > 1. that is infinite.
that is > 0 but < 1.
The beta of a risky portfolio cannot be less than _____ nor greater than ____. 0; 1 1; the market beta the lowest individual beta in the portfolio; market beta the market beta; the highest individual beta in the portfolio the lowest individual beta in the portfolio; the highest individual beta in the portfolio
the lowest individual beta in the portfolio; the highest individual beta in the portfolio
Standard deviation measures _____ risk while beta measures _____ risk. systematic; unsystematic unsystematic; systematic total; unsystematic total; systematic asset-specific; market
total; systematic
Portfolio diversification eliminates: all investment risk. the portfolio risk premium. market risk. unsystematic risk. the reward for bearing risk.
unsystematic risk
A portfolio is comprised of 35 securities with varying betas. The lowest beta for an individual security is .74 and the highest of the security betas of 1.51. Given this information, you know that the portfolio beta: must be 1.0 because of the large number of securities in the portfolio. is the geometric average of the individual security betas. must be less than the market beta. will be between 0 and 1.0. will be greater than or equal to .74 but less than or equal to 1.51.
will be greater than or equal to .74 but less than or equal to 1.51.