Chapter 12
The variance of a portfolio can be calculated by finding the variances of the individual components of the portfolio and finding the weighted average of those variances.
F
The variance or standard deviation measures the risk per unit of return.
F
Unsystematic risk is the risk that cannot be eliminated through diversification.
F
When we speak of ex-ante returns, we are referring to historical information or data.
F
If a financial asset has a historical variance of 25, then its standard deviation must be 12.5%.
F σ=√25=5
The greatest level of risk reduction through diversification can be achieved when combining two securities whose returns are perfectly negatively correlated.
T
The market portfolio is a portfolio that contains all risky assets.
T
The only relevant risk for investors that hold well diversified portfolios of securities is nondiversifiable risk.
T
The return on a portfolio is simply equal to the weighted average return of the securities that comprise it.
T
The term "ex-ante" refers to expected or forecasted information.
T
If a financial asset has a historical variance of 16, then its standard deviation must be 4.
T σ=√16=4
If Stock A is considered to be of lower risk than Stock B, then Stock A should have returns that are a. lower than Stock B b. higher than Stock B c. they would have equal returns d. cannot determine from the information given
A
If the variance for Stock A is greater than the variance for Stock B, then the standard deviation for Stock A: a. is greater than the standard deviation for Stock B b. is less than the standard deviation for Stock B c. is the same as the standard deviation for stock b d. cannot be determined by this information
A
Maximum diversification benefit can be achieved if one were to form a portfolio of two stocks whose returns had a correlation coefficient of: a. -1.0 b. +1.0 c. 0.0 d. none of the above
A
Systematic risk is rewarded with higher returns in the market because: a. it is associated with market movements which cannot be eliminated through diversification b. it is a microeconomic risk c. that risk is unique to a firm or an industry d. none of the above
A
The Capital Asset Pricing Model (CAPM) states that the expected return on an asset depends upon its level of: a. systematic risk b. unsystematic risk c. all of the above d. none of the above
A
The Security Market Line describes the relationship between the: a. expected return on securities and their systematic risk b. expected return on securities and their unsystematic risk c. expected return on a security and the expected return on the market portfolio d. risk-free rate and the expected return on the market portfolio
A
The ____________ the coefficient of variation, the ____________ the risk. a. lower, lower b. higher, lower c. lower, higher d. more stable, higher e. none of the above
A
The benefits of diversification are greatest when asset returns have: a. negative correlations b. positive correlations c. zero correlations d. low positive covariances
A
The portfolio that contains all risky assets is known as the: a. market portfolio b. efficient portfolio c. efficient frontier d. value-weighted portfolio
A
The risk caused by variations in interest expense unrelated to sales or operating income arising from changes in the level of interest rates in the economy is called: a. interest rate risk b. business risk c. tax risk d. financial risk e. none of the above
A
Variations in operating income over time because of variations in unit sales, price, cost margins, and/or fixed expenses are called: a. business risk b. exchange rate risk c. purchasing power risk d. financial risk e. none of the above
A
Which of the following statements is most correct? a. The U.S. stock market appears to be a fairly good example of a semi-strong form efficient market. b. A market in which prices reflect all past and current publicly known information is a strong form efficient market. c. A weak-form efficient market implies that technical analysis can be used to predict future price movements. d. All of the above statements are correct.
A
Which of the following statements is most correct? a. The security market line graphically shows the expected return and systematic risk relationship. b. Unsystematic risk is the major determinant of returns for individual assets. c. Assets that have greater systematic risk than the market have betas greater than 0.0. d. All of the above statements are correct.
A
If the variance in returns for Stock A is 400% and the expected return is 5%, then the coefficient of variation is: a. 4 b. 80 c. .25 d. cannot be determined by this information
A σA=√400=20% → CV=20% / 5%=4
The expected rate of return on a portfolio is the weighted average of the expected returns of the individual assets in the portfolio.
T
After controlling for risk, if someone were able to earn greater than the average returns for the market on a consistent basis using publicly available information, which form of market efficiency is violated? a. none of forms would be violated b. semi-strong c. strong d. all of the forms of market efficiency would be violated
B
As defined in accordance with efficient markets notions, a weak-form efficient market would be a market in which asset prices reflect all: a. current information b. past information c. inside information d. public information
B
If a person requires greater return when risk increases, that person is said to be: a. risk seeking b. risk averse c. risk aware d. risk indifferent e. none of the above
B
If the risk-free rate, the expected return on the market portfolio, and the _____________ of a stock is known, an investor can use the security market line to determine the expected return on that stock. a. standard deviation b. beta c. coefficient of variation d. unsystematic risk
B
The correlation between the return on the risk-free asset with a constant return over time and the return on a risky asset is always: a. -1 b. 0 c. 1 d. 0.5
B
The effect on revenues and expenses from variations in the value of the U.S. dollar in terms of other currencies is called: a. interest rate risk b. exchange rate risk c. purchasing power risk d. financial risk e. none of the above
B
The market portfolio would have a beta of: a. 0 b. 1 c. -1 d. 0.8
B
The slope of the linear relation between the returns on a stock and the returns on the market portfolio is called the: a. alpha b. beta c. covariance d. coefficient of variance
B
The total risk of a well-diversified international portfolio of stocks appears to be about what proportion of the risk of an average one-stock portfolio? a. one-quarter b. one-third c. one-half d. two-thirds e. three-fourths
B
The total risk of a well-diversified portfolio of U.S. stocks appears to be about what proportion of the risk of an average one-stock portfolio? a. one-third b. one-half c. two-thirds d. three-fourths
B
Which of the following is not required to compute the expected return of a three-asset portfolio? a. the amount invested in each stock b. the correlation between the returns on each stock c. the expected return on each stock d. all of the above are required
B
Which of the following statements is most correct? a. Combining positively correlated assets having the same expected return results in a portfolio with the same level of expected return and a lower level of risk. b. Combining negatively correlated assets having the same expected return results in a portfolio with the same level of expected return and a lower level of risk. c. Combining positively correlated assets having the same expected return results in a portfolio with a lower level of expected return and a lower level of risk. d. Combining negatively correlated assets having the same expected return results in a portfolio with a lower level of expected return and a lower level of risk. e. all of the above
B
According to the definitions given in the text, if Stock A has a standard deviation of 4% and expected returns of 9%, and Stock B has a standard deviation of 3% and expected returns of 1%, which stock is riskier? a. Stock A b. Stock B c. they are equally risky d. cannot determine from the information given
B CVa=4% / 9%=0.44 compared to CVb=3% / 1%=3
Rico bought 100 shares of Banana Republic stock for $24.00 per share on January 1, 2010. He received a dividend of $2.00 per share at the end of 2010 and $3.00 per share at the end of 2011. At the end of 2012, Rico collected a dividend of $4.00 per share and sold his stock for $18.00 per share. What was Rico's realized holding period return? a. -12.5% b. 12.5% c. -16.7% d. 16.7% e. none of the above
B Dollar Return = ($18 - $24) + $2 + $3 + $4 = $3 Holding Period Return= $3 / $24=12.5%
Assume the probability of a pessimistic, most likely and optimistic state of nature is .25, .45 and .30, and the returns associated with those states of nature are 10%, 12%, and 16% for asset X. Based on this information, the expected return and standard deviation of return are: (Pick the closest answer.) a. 12.0% and 4.0% b. 12.7% and 2.3% c. 12.7% and 4.0% d. 12.0% and 2.3% e. 12.9% and 5.30%
B E(R) = (0.25)(10%) + (0.45)(12%) + (0.30)( 16%) =12.70% σ^2 = (.25)(10%-12.7%)^2+(.45)(12%-12.7%)^2+(.30)(16%-12.7%)^2 =5.2945 σ=√5.2945 = 2.3%
A fruit company has 20% returns in periods of normal rainfall and -3% returns in droughts. The probability of normal rainfall is 60% and droughts 40%. What would the fruit company's expected returns be? a. 24% b. 10.8% c. 0 d. cannot determine from the information given
B E(R) = (60%)(20%) +(40%)(-3%) = 12% - 1.2% = 10.8%
If IBM has a beta of 1.2 when the risk-free rate is 6% and the expected return on the market portfolio is 18%, the expected return on IBM is: a. 17.2% b. 20.4% c. 22.1% d. 23.6%
B E(R) = 6% + (18% - 6%)1.2 = 6% + 12%(1.2) = 20.4%
If the expected return on the market portfolio is 12%, and the beta on Consolidated Edison is .8, then using the Security Market Line, the expected return on Con Ed is: a. greater than 12% b. less than 12% c. greater or less than 12%, depending on the risk-free rate of return d. dependent on some other factors
B RFR < 12% → E(RCon Ed) = RFR + (12% - RFR)(0.8) < 12%
If Stock A had a price of $120 at the beginning of the year, $150 at the end of the year and paid a $6 dividend during the year, what would be the annualized holding period return? a. 36% b. 30% c. 24% d. none of the above
B dollar return = $150 - $120 + $6 = $36 → % return=$36 / $120=30%
In an efficient market: a. it is fairly easy to find stocks whose prices do not fairly reflect the present value of future expected cash flows b. expected news will cause a rapid change in prices c. information flows are random, both in timing and in content d. all the above
C
If prices in a particular market fully reflect all public and private knowledge, the market is efficient in the: a. weak form b. semi-strong form c. strong form d. both a and b
C
If the expected returns for Stock A are 3% and this year's returns are 3%, next year's returns would be a. 3% b. 6% c. cannot say for certain d. 4.5%
C
Portfolio risk is comprised of: a. systematic and market risk b. unsystematic and microeconomic risk c. systematic and unsystematic risk d. systematic and macroeconomic risk
C
The risk caused by changes in inflation that affect revenues, expenses and profitability is called: a. interest rate risk b. business risk c. purchasing power risk d. financial risk e. none of the above
C
The risk caused by variations in income before taxes over time because fixed interest expenses do not change when operating income rises or falls is called: a. interest rate risk b. business risk c. financial risk d. purchasing power risk e. none of the above
C
Unsystematic risk is also known as: a. market risk b. nondiversifiable risk c. firm-specific risk d. macroeconomic risk
C
Which of the following statements is most correct? a. Perfectly negatively correlated series move exactly together and have a correlation coefficient of -1.0 while perfectly positively correlated series move exactly in opposite directions and have a correlation coefficient of +1.0. b. Perfectly negatively correlated series move exactly together and have a correlation coefficient of +1.0 while perfectly positively correlated series move exactly in opposite directions and have a correlation coefficient of -1.0. c. Perfectly positively correlated series move exactly together and have a correlation coefficient of +1.0 while perfectly negatively correlated series move exactly in opposite directions and have a correlation coefficient of -1.0. d. Perfectly positively correlated series move exactly together and have a correlation coefficient of -1.0 while perfectly positively correlated series move exactly in opposite directions and have a correlation coefficient of +1.0. e. none of the above
C
Which of the following statements is most correct? a. The variance of a portfolio is a weighted average of asset variances. b. The benefits of diversification are greatest when asset returns have zero correlations. c. The market portfolio truly eliminates all unsystematic risk. d. Beta is the measure of an asset's unsystematic risk.
C
If the expected return on Stock 1 is 6%, and the expected return on Stock 2 is 20%, the expected return on a two-asset portfolio that holds 10% of its funds in Stock 1 and 90% in Stock 2 is: a. 11.52% b. 13% c. 18.6% d. 19.14%
C (10%) (6%) + (90%)(20%) = 0.6% + 18% = 18.6%
If you invest 40% of your investment in GE with an expected rate of return of 10% and the remainder in IBM with an expected rate of return of 16%, the expected return on your portfolio is: a. 12.4% b. 13% c. 13.6% d. 14.5%
C E(Rp) = (40%)(10%) + (60%)(16%) = 4% + 9.6% = 13.6%
A stock that went from $40 per share at the beginning of the year to $45 at the end of the year and paid a $2 dividend provided an investor with a ____ return. a. 8.75% b. 14% c. 17.5% d. 7% e. none of the above
C dollar return = $45 - $40 + $2 = $7 →% return=$7 / $40=17.5%
If we assume that asset X has an expected return of 10 and a variance of 10, then its coefficient of variation is: (Pick the closest answer.) a. 3.162 b. 1.000 c. 0.316 d. 0.032
C σ=√10=3.16 → CV=3.16 / 10=0.316
A statistical concept that relates movements in one set of returns to movements in another set over time is called: a. variance b. standard deviation c. coefficient of variation d. correlation
D
An aggressive (that is, higher risk) portfolio would have a beta of: a. 1 b. 0 c. less than 1 but greater than 0 d. more than 1
D
As defined in accordance with efficient markets notions, a strong-form efficient market would be a market in which asset prices reflect all: a. past information b. current information c. public information d. public and private information
D
If the variance for Stock A is greater than the variance for Stock B, then the coefficient of variation for Stock A: a. is greater than the coefficient of variation for Stock B b. is less than the coefficient of variation for Stock B c. is the same as the coefficient of variation for stock b d. cannot be determined by this information
D
In an efficient market which of the following would not be expected to cause a quick price change in the stock of a company? a. an unexpected announcement by a major competitor b. higher than predicted earnings announcement c. unexpected death of CEO d. all the above would be expected to cause a quick price change
D
The security market line can be used to determine the expected return on a security if we know the: a. risk-free rate b. systematic risk of that security c. market risk premium d. all of the above
D
The square root of the standard deviation is called the: a. variance b. coefficient of variation c. beta d. none of the above
D
The strong-form efficient market implies that: a. no investor can consistently beat the market after adjusting for risk differences b. stock prices reflect all public and private knowledge c. even corporate officers and insiders cannot earn above-average, risk-adjusted profits d. all of the above
D
Which of the following is not a component of the security market line equation? a. risk-free rate b. expected return on the market c. an asset's systematic risk d. an asset's unsystematic risk
D
Which of the following statements is false? a. Diversification cannot eliminate risk that is inherent in the macroeconomy or market risk. b. The expected rate of return on a portfolio does not depend on the correlation between the return on each stock. c. Although gold is a risky investment by itself, including gold in a stock portfolio may reduce total risk of the portfolio. d. All of the above statements are correct.
D
Which one of the following is not considered to be a generally recognized type of market efficiency? a. strong-form b. semi-strong form c. weak-form d. insider-information form
D
Assume the probability of a pessimistic, most likely and optimistic state of nature is .25, .55 and .20, and the returns associated with those states of nature are 5%, 10%, and 13% for asset Y. Based on this information, the expected return, standard deviation, and coefficient of variation for asset Y are: (Pick the closest answer.) a. 10.50%, 2.96% and 0.395 respectively b. 10.35%, 2.86% and 0.345 respectively c. 9.35%, 7.63% and 0.816 respectively d. 9.35%, 2.76% and 0.295 respectively e. none of the above
D E(R) = (0.25)(5%) + (0.55)(10%) + (0.20)( 13%) =9.35% σ^2 = (.25)(5%-9.35%)^2+(.55)(10%-9.35%)^2+(.20)(13%-9.35%)^2 =7.6275 σ=√7.6275 = 2.7618% CV=2.7618% / 9.35%=0.2954
According to the definitions given in the text, if Stock A has a standard deviation of 4% and Stock B has a standard deviation of 3% which stock is riskier? a. Stock A b. Stock B c. they are equally risky d. cannot determine from the information given
D use CV to compare the risk of the two stocks
The effect on revenues and expenses from variations in the value of the U.S. dollar in terms of other currencies is called: a. interest rate risk b. business risk c. purchasing power risk d. financial risk e. none of the above
E
The risk caused by changes in inflation that affect revenues, expenses and profitability is called: a. interest rate risk b. business risk c. tax risk d. financial risk e. none of the above
E
The risk caused by variations in income before taxes over time because fixed interest expenses do not change when operating income rises or falls is called: a. interest rate risk b. business risk c. tax risk d. purchasing power risk e. none of the above
E
The risk caused by variations in interest expense unrelated to sales or operating income arising from changes in the level of interest rates in the economy is called: a. financial risk b. business risk c. tax risk d. purchasing power risk e. none of the above
E
Variations in a firm's tax rate and tax-related charges over time due to changing tax laws and regulations is called: a. interest rate risk b. business risk c. exchange rate risk d. purchasing power risk e. none of the above
E
Variations in operating income over time because of variations in unit sales, price, cost margins, and/or fixed expenses are called: a. interest rate risk b. exchange rate risk c. purchasing power risk d. financial risk e. none of the above
E
A market system that allows for quick execution of customers' trades is said to be informationally efficient.
F
A stock that went from $40 per share at the beginning of the year to $45 at the end of the year and paid a $2 dividend provided an investor with a 14% return.
F
A strong-form efficient market is one in which prices reflect all public knowledge, including past and current information.
F
A weak-form efficient market is one in which prices reflect all public and private knowledge, including past and current information.
F
A weak-form efficient market is one in which prices reflect all public knowledge, including past and current information.
F
Any predictable trend in the same direction as the price change would be evidence of an efficient market.
F
If Stock A has a higher standard deviation than Stock B, it will also have a greater coefficient of variation.
F
If the expected return is 10%, the standard deviation is 3%, about 68% of the time returns will be expected to fall between 10% and 13%.
F
In an efficient market, both expected and unexpected news should cause stock prices to move up or down.
F
Most market risk can be eliminated through diversification.
F
Most nondiversifiable risk can be eliminated by creating a portfolio of around 30 stocks.
F
Research suggests that a portfolio of 20 or 30 different stocks can eliminate most of a portfolio's systematic risk.
F
The Capital Asset Pricing Model states that the expected return on an asset depends on its level of unsystematic risk.
F
The benefits of diversification are greatest when asset returns have positive correlations.
F
The coefficient of variation is a measure of total return on a stock.
F
The historical percentage return for a single financial asset is equal to any dividends received minus the difference between the selling price and the purchase price, all divided by the purchase price.
F
The risk of a portfolio is simply equal to the weighted average variance of the securities that comprise it.
F
The term "ex-ante" refers to the past or historical information.
F
The variance is the square root of the standard deviation.
F
A higher coefficient of variation indicates more risk per unit of return.
T
A portfolio is any combination of financial assets or investments.
T
A weak-form efficient market is a market in which prices reflect all past information.
T
Although gold is a risky investment by itself, including gold in a stock portfolio can make the portfolio less risky.
T
Beta measures the variability of an asset's returns relative to the market portfolio.
T
Diversification occurs when we invest in several different assets rather than just a single one.
T
Future returns and risk cannot be predicted precisely from past measures.
T
If a market is semi-strong form efficient, it also is by definition weak-form efficient.
T
If standard deviation is used to measure the risk of stocks, one problem that arises is the inability to tell which stock is riskier by looking at the standard deviation alone.
T
In an efficient market, investors cannot consistently earn above average profits after taking risk differences into account.
T
In general, large company stocks are more risky than Treasury bonds.
T
In general, securities with higher historical standard deviations have provided higher returns.
T
In general, securities with lower returns have lower historical standard deviations.
T
Standard deviation is stated in the same units of measurement (e.g., dollars, percent) as those of the data from which they were generated.
T
Standard deviation is the square root of the variance.
T
The coefficient of variation measures the risk per unit of return.
T
The existence of chartists or technicians suggests that some investors believe that markets are not weak form efficient.
T