FINA 3724
You hold a diversified portfolio consisting of a $5,000 investment in each of 20 different common stocks. The portfolio beta is equal to 1.15. You have decided to sell one of your stocks, a lead mining stock whose b = 1.0, for $5,000 net and to use the proceeds to buy $5,000 of stock in a steel company whose b =2.0. What will be the new beta of the portfolio? 1.12 1.20 1.22 1.10 1.15
1.20
Last year Mike bought 100 shares of Dallas Corporation common stock for $53 per share. During the year he received dividends of $1.45 per share. The stock is currently selling for $60 per share. What rate of return did Mike earn over the years 11.7 percent. 13.2 percent 14.1 percent 15.9 percent.
15.9 percent.
A company has a 40% probability of earning 20%, a 40% probability of earning 10%, and a 20% probability of earning 5%. The standard deviation is 36% 13% 6% 37% None of the above
6%
Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift Down and have steeper slope. Up and have less steep slope. Up and keep same slope. Down and keep same slope. Down and have less steep slope.
Down and have steeper slope.
We will generally find that the beta of a diversified portfolio is more stable over time than the beta of a single security. True False
False
A year ago, you purchased IBM stock for $94 a share. Today, IBM stock is selling for $93 a share. Additionally, you just received a check for $1.20 per share. Your holding period return is 2.34% 1.06% 0.21% 2.13% 2.34%
Initially choose 2.13% **Incorrect** Chose .21%
A security's beta measures its non-diversifiable (systematic or market) risk relative to that of most other securities. True False
True
The tighter the probability distribution of expected future returns the smaller the risk of a given investment as measured by the standard deviation. True False
True
Examples of events that increase risk aversion include a stock market crash assassination of a key political leader . the outbreak of war . all of the above.
all of the above.
To earn a __________ return, you must incur _________ risk higher; lower lower; higher decent; very high higher; higher None of the above
higher; higher
The beta of a portfolio is the sum of the betas of all assets in the portfolio. irrelevant, only the betas of the individual assets are important. does not change over time. is the weighted average of the betas of the individual assets in the portfolio.
is the weighted average of the betas of the individual assets in the portfolio.
Unsystematic risk is not relevant, because it does not change it can be eliminated through diversification. it cannot be estimated it cannot be eliminated through diversification.
it can be eliminated through diversification.
Risk that affects all firms is called total risk. management risk. nondiversifiable risk. diversifiable risk
nondiversifiable risk.
The _____of an event occurring is the percentage chance of a given outcome. dispersion standard deviation probability reliability
probability
Correlation may only be positive is a measure similar to the standard deviation, but more precise. is usually negative for a portfolio with two securities measures the degree to which a change in the riskiness of one security causes the risk of another to change. ranges between −1 and +1
ranges between −1 and +1
An increase in nondiversifiable risk would cause an increase in the beta and would lower the required return. would have no effect on the beta and would, therefore, cause no change in the required return either. would cause an increase in the beta and would increase the required return. would cause a decrease in the beta and would, therefore, lower the required rate
would cause an increase in the beta and would increase the required return.
Asset p has a beta of. 9. The risk-free rate of return is 8 percent, while the return on the market portfolio of assets is 14 percent. The asset's required rate of return is 13.4 percent. 6.0 percent. 5.4 percent. 10 percent
13.4 percent.
Asset p has a beta of. 9. The risk-free rate of return is 8 percent, while the return on the market portfolio of assets is 14 percent. The asset's required rate of return is 13.4 percent. 6.0 percent. 5.4 percent. 10 percent.
13.4 percent.
Asset "KO" (ticker-tape symbol for the stock of Coca-Cola) has a beta of 1.2. The risk-free rate of return is 6 percent, while the return on the market portfolio of assets is 12 percent. In light of the asset's beta, the market risk premium is ... 7.2 percent. 6.0 percent. 13.2 percent. 10 percent.
6.0 percent.
A complete probability distribution is always an objective listing of all possible events. Since it is impossible to list all the possible outcomes from a single event, probability distributions are of limited benefit in assessing risk. True False
False
A peaked probability distribution centered around the expected value will make a stock more desirable thereby incresing its expected return. True False
False
When a firm makes bad managerial judgements or has unforseen negative events happen to it that affect its returns, these random events are unpredictable and therefore cannot be diversified away by the investor. True False
False
Which of the following statements is false? Systematic risk will increase during a recession. Adding more unrelated securities to a portfolio reduces unsystematic risk. Market risk may be reduced through diversification. Changes in Federal Reserve policy have more effect on systematic risk than unsystematic risk. Oil shocks affect market risk.
Market risk may be reduced through diversification.
Which of the following would be the most useful to an investor who is evaluating securities to add to her portfolio? The historical return The simple interest return The Lynch risk-adjusted historical return The expected return The previous opportunity cost of holding the asset
The expected return
Combining stocks together in portfolios reduces risk as long as the correlation between the returns on the securities is not perfect (i.e. r= -1.0 or r=+1.0.) True False
True
If investors become more averse to risk, the slope of the Security Marker Line (SML) will increase. True False
True
The risk of an asset can be measured by its variance, which is found by subtracting worst outcome from the best outcome. True False
True
The risk of an asset may be found by subtracting the worst outcome from the best outcome. True False
True
The ______ is a measure of relative dispersion used in comparing the risk of assets with differing expected returns. coefficient of variation chi square mean standard deviation
coefficient of variation
To earn a __________ return, you must incur _________ risk. higher; lower lower; higher decent; very high higher; higher None of the above.
higher; higher
You are an investor in common stock, and you currently hold a well-diversified porfolio which has an expected return of 12%, a beta of 1.2, and a total value of $9,000. You plan to increase your portfolio by buying 100 shares of AT&E at 10 a share. AT&E has an expected return of 20% with a beta of 2.0. What will be the expected return and the beta of your portfolio after you purchase the new stock? K(p)=20.0%; b(p)=2.00 k(p)=12.8%; b(p)=1.28 k(p)=12.0%; b(p)=1.20 k(p)=13.2%; b(p)=1.40 k(p)=14.0%; b(p)=1.32
k(p)=12.8%; b(p)=1.28
You have developed the following data on three stocks: Stock Standard Deviation Beta A 0.15 0.79 B 0.25 0.61 C 0.20 1.29 If you are a risk minimizer, you should chose Stock "___" if it is to be held in isolation and Stock "_____" if it is to be held as part of a well-delivered portfolio. A; A A; B B; A C; A C; B
A; B
Variance is a measure of the variability of returns and since it involves squaring each deviation of the required return from the expected return, it is always larger than its square root, the standard deviation. True False
False
When a firm makes bad managerial judgements or has unforseen negative events happen to it that affect its returns, these random events are unpredictable and therefore cannot be diversified away by the investor. True False
False
A year ago, you purchased IBM stock for $94 a share. Today, IBM stock is selling for $93 a share. Additionally, you just received a check for $1.20 per share. Your holding period return is 2.34% 1.06% 0.21% 2.13% -2.34%
0.21%
Analysts state that the required return from Plummet Soft Drinks stock is 25%, and the returns from Treasury bills and the market portfolio are 4% and 20% respectively. What is Plummet s beta? 0.05 1.13 0.79 1.31 1.00
1.31
An investment banker has recommended a $100,000 portfolio containing assets B, D, and F. $20,000 will be invested in asset B, with a beta of 1.5; $50,000 will be invested in asset D, with a beta of 2.0; and $30,000 will be invested in asset F, with a beta of .5. The beta of the portfolio is 1.25 1.33 1.45 unable to be determined from the information provided.
1.45
Suppose that you hold a two-asset portfolio consisting of 100 shares of Clooney Brothers at $33 per share and 100 shares of Marx Brothers at $42 per share. Assume that you have computed the expected return on Clooney Brothers and Marx Brothers to be 20% and 12%, respectively. What is the expected return from the portfolio? 15.5% 20.0% 12.0% 16.0% None of the above
15.5%
Oakdale Furniture Inc. has a beta coefficient of 0.7 and an required rate of retun of 15%. The market risk premium is currentlly 5%. If the inflation premium increses by 2 percentage points, and Oakdale acquires new assets which increase its beta by 50%, what will be Oakdale's new required rate of return? 13.5% 22.8% 18.75% 15.25% 17.00%
18.75%
If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected return on Security J is 13 percent, what is the beta of Security J? 1.0 1.5 2.0 2.5 3.0
2.0
Asset "KO" (ticker-tape symbol for the stock of Coca-Cola) has a beta of 1.2. The risk-free rate of return is 6 percent, while the return onthe market portfolio of assets is 12 percent. In light of the asset's beta, the market risk premium is ... 7.2 percent. 6.0 percent. 13.2 percent. 10 percent.
6.0 percent.
Which of the following is not a source of unsystematic risk? The departure of a firm's chief executive officer A crippling labor strike The expiration of a patent A competitor's successful advertising campaign A major economic downturn
A major economic downturn
You have developed the following data on three stocks: Stock Standard Deviation Beta A 0.15 0.79 B 0.25 0.61 C 0.20 1.29 If you are a risk minimizer, you should chose Stock "___" if it is to be held in isolation and Stock "_____" if it is to be held as part of a well-delivered portfolio. A; A A; B B; A C; A C; B
A; B
Assume you currently hold one type of security and decide to construct a portfolio. Which of the following would provide the greatest degree of risk reduction? Adding a security that has perfect negative correlation with the one you are holding Adding a security that has perfect positive correlation with the one you are holding Adding a security that is uncorrelated with your current one. Adding a positively, but not perfectly, correlated security Doubling the quantity of the security you already hold
Adding a security that has perfect negative correlation with the one you are holding
Assume you currently hold one type of security and decide to construct a portfolio. Which of the following would provide the greatest degree of risk reduction? Adding a security that has perfect negative correlation with the one you are holding. Adding a security that has perfect positive correlation with the one you are holding. Adding a security that is uncorrelated with your current one. Adding a positively, but not perfectly correlated security. Doubling the quantity of the security you already hold.
Adding a security that has perfect negative correlation with the one you are holding.
Which of the following statements is false? Investors are usually not fully compensated for bearing the total risk associated with a security. Adding additional securities to a portfolio only reduces market risk The risk-return relationship relates only to market risk The appropriate measure of risk should only consider the incremental risk a security adds to a well-diversified portfolio. Reducing market risk usually implies sacrificing expected return
Adding additional securities to a portfolio only reduces market risk
Which of the following is a false statement? Expected returns are not always predicted accurately. Historical returns can be calculated with more confidence than expected returns. Expected returns may differ from actual returns because of an unforeseen recession. Accurate predictions of expected returns depend on analysts' ability to estimate probabilities. Although expected returns may differ from actual returns, they seldom do.
Although expected returns may differ from actual returns, they seldom do.
A highly risk-averse investor is considering the addition of an asset to a 10-stock portfolio. The two securities under consideration both have an expected return, k, equal to 15 percent. However, the distribution of possible returns associated with Asset A has a standard deviation of 12 percent, while Asset B's standard deviation is 8 percent. Both assets are correlated with the market with r = 0.75. Which asset should the risk-averse investor add to his/her protfolio? Asset A. Asset B. Both A and B. Neither A nor B. Cannot tell without more information.
Asset B.
The systematic (market) risk associated with an individual stock is most closely indentified with the Standard deviation of the returns on the stock. Standard deviation of the returns on the market. Beta of the stock. Coefficient of variation of returns on the stock. Coefficient of variation of returns on the market.
Beta of the stock.
Because any investor can create a portfolio of assets that will eliminate all, or virtually all, non-diversiflable risk, the only relevant risk is diversiflable risk. True False
False
Diversiflable risk is the relevant portion of risk attributable to market factors that affect all firms. True False
False
Even if the correlation between the returns on two different securities is perfectly positive, if the securities are combined in the correct unequal proportions, the resulting portfolio can have less risk than either securities held alone. True False
False
Portflio A has but one security, while Portfolio B has 100 securities. Because of diversification, we know that Portfolio B will have the lower systematic (or market) risk; that is, Portfolio B will have the lower beta. True False
False
The Capital Asset Pricing Model (CAPM) is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk. True False
False
The risk of an asset can be measured by its variance, which is found by subtracting worst outcome from the best outcome. True False
False
When company specific risk has been diversified, the inherent risk that remains is market risk which is constant for all securities in the market. True False
False
Inflation, recession, and high interest rates are economic events which are characterized as Company specific risk that can be diversified away. Market risk. Systematic risk that can be diversified away. Diversifiable risk. Unsystematic risk that can be diversified away.
Market risk.
Which of the following is not a difficulty concerning beta and its estimation? Sometimes a security or project does not have a past history which can be used as a basis for calculating beta. Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different than the "true" or "expected future" beta. The beta of an "average stock", or "the market", can change over time, sometimes drastically. Sometimes the past data used to calculated beta do not reflect the likely risk of the firm for the future because conditions have changed. All of the above are potentialy reious difficulties.
The beta of an "average stock", or "the market", can change over time, sometimes drastically.
Which of the following is not a widely-recognized problem with CAPM? Beta values for any stock often change over time The model is complex and poorly understood by many finance professionals The model is difficult to test The model does not accurately explain stock returns over time Other factors besides market risk may influence security returns
The model is complex and poorly understood by many finance professionals
A given change in inflationary expectations will be fully reflected in a corresponding change in the returns of all assets and will be reflected graphically in a parallel Shift of the SML. True False
True
A portfolio that combine two assets having perfectly positively correlated returns can not reduce the portfolio's overall risk below the risk of the least risky asset. True False
True
A stock's beta is more relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only one stock. True False
True
According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the isolated risk of individual stocks. Thus, the relevant risk is an individual stock's contribution to the overall riskiness of the portfolio. True False
True
Any investor (or firm) must be concerned solely with nondiversiflable risk because it can create a portfolio of assets that will eliminate all, or virtually all diversiflable risk. True False
True
Assume Stock A has a standard deviation of 0.21 while Stick B has a standard deviation of 0.10. If both Stock A and Stock B muse be held in isolation, and if investors are risk averse, we can conclude that Stock A will have a greater required return. However, if the assets could be held in portfolios, it is conceivable that the required return could be higher on the low standard deviation stock. True False
True
Changes in risk aversion, and therefore shifts in the SML, result from changing tastes and preferences of investors, which generally result from various economic, political, and social events. True False
True
Combining uncorrelated assets can reduce risk not as effectively as combining negatively correlated assets, but more effectively than combining positively correlate assets. True False
True
If an investor buys enough stocks, he or she can, through diversification, eliminate all of the nonmarket (or company-specific) risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all market risks. True False
True
If we develop a weighted average of the possible return outcomes, multiplying each outcome or "state" by its respective probability of occurence for a partibular stock, we can construct a payoff matrix of expected returns. True False
True
If you plotted the returns of a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future. True False
True
New investments must be considered in light of their impact on the risk and return the portfolio of assets because the risk of any single proposed asset investment is not independent of other assets. True False
True
One key result of applying the Capital Asset Pricing Model is that the risk and return of an individual security should be analyzed by how that security affects the risk and return of the portfolio in which it is held. True False
True
Over long periods, returns from internationally diversified portfolios tend to be superior to those yielded by purely domestic ones. Over any single short or intermediate period, however, international diversification can yield subpar returns particularly during periods when the dollar is appreciating in value relative to other currencies. True False
True
Risk aversion is a general dislike for risk and a preference for certainty. That is, investors would be willing to give up a risk premium of return in order to obtain a lower return with certainty. True False
True
Since the market return represents the return on an average stock, that return carries risk with it. As a result, there exists a market risk premium which is the amount over and above the risk-free rate that is required to compensate an investor for assuming an average amount of risk. True False
True
Suppose that two firms, A and B, have identical expected returns but Firm A has the possibility of a much higher return than Firm B. We can conclude from this that Firm A will have a higher coefficient of variation than Firm B. True False
True
The CAPM is based on an assumed efficient market in which there are many small lnvestors, each having the same information and expectations with respect to securities; there are no restrictions on investment, no taxes, and no transactions costs; and all investors are rational, view securities similarly, and are risk-averse, preferring higher returns and lower risk. True False
True
The Capital Asset Pricing Model (CAPM) is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk. True False
True
The SML relates required returns to a firm's systematic (or market) risk. The slope and intercept of this line cannot be controlled by the financial manager. True False
True
The coefficient of variation, calculated as the standard deviation devided by the expected return, is a standardized, measure of the risk per unit of expected return. True False
True
The creation of a portfolio by combining two assets having perfectly positively correlated returns cannot reduce the portfolio's overall risk below the risk of the less risky asset, whereas a portfolio combining two assets with less than perfectly positive correlation can reduce total risk to a level below that of either of the components. True False
True
The difference between the return to the market portfolio of assets and the risk-free rate of return represents the premium the investor must receive for taking the average amount of risk associated with holding the market portfolio of assets. True False
True
The higher the probability that the return on an investment will not pay off its average promised value, the higher the expected return must be to induce an investor to invest in it. True False
True
The larger the difference between an asset's worst outcome from its best outcome, the higher the risk of the asset. True False
True
The more certain the return from an asset, the less variability and therefore the less risk. True False
True
The required return on an asset is an increasing function of its nondiversifiable risk. True False
True
The slope of the SML reflects the degree of risk aversion; the steeper its slope, the Greater the degree of risk aversion. True False
True
The value of zero for beta coefficient of the risk-free asset reflects not only its absence of risk but also the fact that the asset's return is unaffected by movements in the market return True False
True
While the portfolio return is a weighted average of realized security returns, portfolio risk is not necessarily a weighted average of the standard deviations of the securites in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and actually reduce the riskiness of a portfolio. True False
True
Tom wishes to calculate the riskiness of his portfolio, which is comprised of equal amounts of two stocks. Which of the following measures would you recommend? Weighted average standard deviations. A weighted average of the correlation between the two securities Weighted average betas of the two securities The slope of the security market line A weighted average of the coefficients of variation
Weighted average betas of the two securities
Tom wishes to calculate the riskiness of his portfolio, which is comprised of equal amounts of two stocks. Which of the following measures would you recommend? Weighted average standard deviations. A weighted average of the correlation between the two securities. Weighted average betas of the two securities. The slope of the security market line. A weighted average of the coefficients of variation.
Weighted average betas of the two securities.
The expected return on an asset is 13% and the required return is 12%. You should probably buy the asset now. sell the asset now. hold the asset. wait and see what happens to actual returns before making a decision. None of the above.
buy the asset now.
The _________________ standardizes the standard deviation to make assets with different returns comparable. standard deviation variance coefficient of determination coefficient of variation None of the above.
coefficient of variation
Risk aversion is the behavior exhibited by managers who require a greater than proportional increase in return, for a given decrease in risk increase in return, for a given increase in risk. decrease in return, for a given increase in risk. decrease in return, for a given decrease in risk
increase in return, for a given increase in risk.
As risk aversion increases a firm's beta will increase. investors' required rate of return will increase. a firm' s beta will decrease. investors' required rate of return will decrease.
investors' required rate of return will decrease.
Risk that affects all firms is called total risk. management risk. nondiversifiable risk. diversifiable risk.
nondiversifiable risk.
Calculate the required rate of return for Mercury Inc., assuming that investors expect a 5% rate of inflation in the future. The real risk-free rate is equal to 3% and the market risk premium is 5%. Mercury has a beta of 2.0, and its realized rate of return has averaged 15% per year over the last 5 years. 15% 16% 17% 19% none of the above (this question belongs in another chapter anyway)
none of the above (this question belongs in another chapter anyway); The correct answer is 18%
In the Capital Asset Pricing Model (CAPM), beta measures the firm-specific risk of an asset. the degree of correlation between two securities. the standard deviation of a single asset. the historical relationship between the returns from an asset and the returns from the efficient portfolio. the price volatility of a single security not held in a portfolio.
the historical relationship between the returns from an asset and the returns from the efficient portfolio.
The higher an asset's beta, the more responsive it is to changing market returns. the less responsive it is to changing market returns. the higher the expected return will be in a down market. the lower the expected return will be in an up market.
the more responsive it is to changing market returns.
An expected return from a portfolio will exceed the highest expected return from any of the securities in the portfolio will be lower than the expected return from the security in the portfolio with the lowest yield because portfolios have less risk than individual securities can be calculated more accurately than the expected return from any of the securities in the portfolio will lie somewhere between the highest and lowest expected returns from securities in the portfolio cannot be computed if there are fewer than three securities in the portfolio.
will lie somewhere between the highest and lowest expected returns from securities in the portfolio
If General Motors expects profits of $50 million in a booming economy, what is the expected profit during a recession if this is the only other possibility and the overall expected profit is $35 million? The probability of a recession is 70%. $28.57 million $25.00 million $35.00 million $39.50 million $23.45 million
$28.57 million
A firm cannot change its beta through any managerial decision because betas are completely market determined. True False
False
The security market line shifts in response to changing inflationary expectations is negatively sloped. always has a slope of one does not respond to investor expectations about political stability does not respond to changes in investors' willingness to bear risk
shifts in response to changing inflationary expectations