FIN 351 Chapter 13

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset? Beta Reward-to-risk ratio Risk ratio Standard deviation Price-earnings ratio

Beta

Your portfolio is comprised of 40 percent of stock X, 15 percent of stock Y, and 45 percent of stock Z. Stock X has a beta of 1.16, stock Y has a beta of 1.47, and stock Z has a beta of 0.42. What is the beta of your portfolio? 0.87 1.09 1.13 1.18 1.21

BetaPortfolio = (0.40 × 1.16) + (0.15 × 1.47) + (0.45 × 0.42) = 0.87

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk? Capital asset pricing model Time value of money equation Unsystematic risk equation Market performance equation Expected risk formula

Capital asset pricing model

Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the: Average arithmetic return. Expected return. Market rate of return. Internal rate of return. Cost of capital.

Cost of capital.

You recently purchased a stock that is expected to earn 30 percent in a booming economy, 9 percent in a normal economy, and lose 33 percent in a recessionary economy. There is a 5 percent probability of a boom and a 75 percent chance of a normal economy. What is your expected rate of return on this stock? -3.40 percent -2.25 percent 1.65 percent 2.60 percent 3.50 percent

E(r) = (0.05 x 0.30) + (0.75 x 0.09) + (0.20 x -0.33) = 1.65 percent

The common stock of Manchester & Moore is expected to earn 13 percent in a recession, 6 percent in a normal economy, and lose 4 percent in a booming economy. The probability of a boom is 5 percent while the probability of a recession is 45 percent. What is the expected rate of return on this stock? 8.52 percent 8.74 percent 8.65 percent 9.05 percent 9.28 percent

E(r) = (0.45 ×0.13) + (0.50 ×0.06) + (0.05 ×- 0.04) = 8.65 percent

The risk-free rate of return is 3.9 percent and the market risk premium is 6.2 percent. What is the expected rate of return on a stock with a beta of 1.21? 10.92 percent 11.40 percent 12.22 percent 12.47 percent 12.79 percent

E(r) = 0.039 + (1.21 x 0.062) = 11.40 percent

Thayer Farms stock has a beta of 1.12. The risk-free rate of return is 4.34 percent and the market risk premium is 7.92 percent. What is the expected rate of return on this stock? 8.35 percent 9.01 percent 10.23 percent 13.21 percent 13.73 percent

E(r) = 0.0434 + (1.12 x 0.0792) = 13.21 percent

Which one of the following is an example of systematic risk? Investors panic causing security prices around the globe to fall precipitously. A flood washes away a firm's warehouse. A city imposes an additional one percent sales tax on all products. A toymaker has to recall its top-selling toy. Corn prices increase due to increased demand for alternative fuels.

Investors panic causing security prices around the globe to fall precipitously.

Which one of the following should earn the most risk premium based on CAPM? Diversified portfolio with returns similar to the overall market. Stock with a beta of 1.38. Stock with a beta of 0.74. U.S. Treasury bill. Portfolio with a beta of 1.01.

Stock with a beta of 1.38.

Which one of the following is a risk that applies to most securities? Unsystematic Diversifiable Systematic Asset-specific Total

Systematic

Standard deviation measures which type of risk? Total Non diversifiable Unsystematic Systematic Economic

Total

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by 20 percent. What type of risk does this news flash best represent? Portfolio Non diversifiable Market Unsystematic Total

Unsystematic

Which one of the following is an example of unsystematic risk? a. income taxes are increased across the board b. a national sales tax is adopted c. inflation decreases at the national level d. an increased feeling of prosperity is felt around the globe e. consumer spending on entertainment decreased nationally

e. consumer spending on entertainment decreased nationally

Unsystematic risk: Can be effectively eliminated by portfolio diversification. Is compensated for by the risk premium. Is measured by beta. Is measured by standard deviation. Is related to the overall economy.

Can be effectively eliminated by portfolio diversification.

The common stock of Jensen Shipping has an expected return of 14.7 percent. The return on the market is 10.8 percent and the risk-free rate of return is 3.8 percent. What is the beta of this stock? .92 1.23 1.33 1.41 1.56

E(r) = 0.147 = 0.038 + ? (0.108 - 0.038); ? = 1.56

What is the expected return on a portfolio that is invested 25 percent in stock A, 55 percent in stock B, and the remainder in stock C? State of Economy Prob. of State of Economy Boom 5% Normal 45% Recession 50% Rate of Return if State Occurs A B C Boom 19% 9% 6% Normal 11% 8% 13% Recession -23% 5% 25% -1.06 percent 2.38 percent 2.99 percent 5.93 percent 6.10 percent

E(r)Boom = (0.25 × 0.19) + (0.55 × 0.09) + (0.20 × 0.06) = 0.109 E(r)Normal = (0.25 × 0.11) + (0.55 × 0.08) + (0.20 × 0.13) = 0.0975 E(r)Bust = (0.25 × -0.23) + (0.55 × 0.05) + (0.20 × 0.25) = 0.02 E(r)Portfolio = (0.05 × 0.109) + (0.45 × 0.0975) + (0.50 × 0.02) = 5.93 percent

The expected risk premium on a stock is equal to the expected return on the stock minus the: Expected market rate of return. Risk-free rate. Inflation rate. Standard deviation. Variance

Risk-free rate.

The principle of diversification tells us that: Concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. Concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. Spreading an investment across five diverse companies will not lower the total risk. Spreading an investment across many diverse assets will eliminate all of the systematic risk. Spreading an investment across many diverse assets will eliminate some of the total risk.

Spreading an investment across many diverse assets will eliminate some of the total risk.

What is the beta of the following portfolio? Stick Amount Invested Security Beta A $6,700 1.41 B 3,000 1.23 C 8,500 0.79 .95 1.01 1.05 1.09 1.23

ValuePortfolio = $6,700 + 3,000 + 8,500 = $18,200 BetaPortfolio = ($6,700/$18,200)(1.41) + ($4,900/$18,200)(1.23) + ($8,500/$18,200)(0.79) = 1.09

The expected return on a stock given various states of the economy is equal to the: Highest expected return given any economic state. Arithmetic average of the returns for each economic state. Summation of the individual expected rates of return. Weighted average of the returns for each economic state. Return for the economic state with the highest probability of occurrence.

Weighted average of the returns for each economic state.