FINA 6140 Final

87. Which of the following statements about the correlation coefficient is FALSE? a. The values range between -1 to +1. b. A value of +1 implies that the returns for the two stocks move together in a completely linear manner. c. A value of -1 implies that the returns move in a completely opposite direction. d. A value of zero means that the returns are independent. e. A value of zero means that the returns had no linear relationship.

A value of zero means that the returns are independent.

1. A good portfolio is a collection of individually good assets. T/F

False

13. In a three-asset portfolio, the standard deviation of the portfolio is one-third of the square root of the sum of the individual standard deviations. T/F

False

15. Assuming that everyone agrees on the efficient frontier (given a set of costs), there would be consensus that the optimal portfolio on the frontier would be where the ratio of return per unit of risk was greatest. T/F

False

19. The set of portfolios with the maximum rate of return for every given risk level is known as the optimal frontier. T/F

False

3. Beta is a measure of unsystematic risk. T/F

False

37. The January Effect is an anomaly in that returns in January are significantly smaller than in any other month. T/F

False

6. CML and SML measure total risk by the standard deviation of the investment. T/F

False

9. The expected return and standard deviation of a portfolio of risky assets is equal to the weighted average of the individual asset's expected returns and standard deviation. T/F

False

32. The Markowitz model is based on several assumptions regarding investor behavior. Which of the following is NOT such any assumption? a. Investors consider each investment alternative as being represented by a probability distribution of expected returns over some holding period. b. Investors maximize one-period expected utility. c. Investors estimate the risk of the portfolio on the basis of the variability of expected returns. d. Investors base decisions solely on expected return and risk. e. None of these are correct (that is, all are assumptions of the Markowitz model).

None of these are correct (that is, all are assumptions of the Markowitz model).

1. The capital asset pricing model (CAPM) extends capital market theory in a way that allows investors to evaluate the risk-return trade-off for both diversified portfolios and individual securities. T/F

True

14. As the number of risky assets in a portfolio increases, the total risk of the portfolio decreases. T/F

True

17. A portfolio is efficient if no other asset or portfolios offer higher expected return with the same (or lower) risk or lower risk with the same (or higher) expected return. T/F

True

2. Beta can be thought of as indexing the asset's systematic risk to that of the market portfolio. T/F

True

2. Risk is defined as the uncertainty of future outcomes. T/F

True

20. Investors choose a portfolio on the efficient frontier based on their utility functions that reflect their attitudes towards risk. T/F

True

21. One of the assumptions of capital market theory is that investors can borrow or lend at the risk-free rate. T/F

True

22. The usefulness of CAPM theory is limited in practice due to benchmark error. T/F

True

26. The capital market line is the tangent line between the risk-free rate of return and the efficient frontier. T/F

True

27. The portfolios on the capital market line are combinations of the risk-free asset and the market portfolio. T/F

True

30. Quality financial statements are a good reflection of reality; accounting tricks and one-time changes are not used to make the firm appear stronger than it really is. T/F

True

32. The APT assumes that capital markets are perfectly competitive. T/F

True

4. A basic assumption of the Markowitz model is that investors base decisions solely on expected return and risk. T/F

True

5. Markowitz assumed that, given an expected return, investors prefer to minimize risk. T/F

True

5. The CAPM can also be illustrated as the security market line (SML). T/F

True

6. The correlation coefficient and the covariance are measures of the extent to which two random variables move together. T/F

True

8. If the covariance of two stocks is positive, these stocks tend to move together over time. T/F

True

Implied market risk premium is equal to:

[E(Rm)-RFR]

106. The correlation coefficient between the market return and a risk-free asset would a. be +¥. b. be -¥. c. be +1. d. be -1. e. be zero.

be zero.

98. The most important criteria when adding new investments to a portfolio is the a. expected return of the new investment. b. standard deviation of the new investment. c. correlation of the new investment with the portfolio. d. selection of the risk-free asset. e. variance of the risk-free asset.

correlation of the new investment with the portfolio.

79. In a two-stock portfolio, if the correlation coefficient between two stocks were to decrease over time, everything else remaining constant, the portfolio's risk would a. decrease. b. remain constant. c. increase. d. fluctuate positively and negatively. e. be a negative value.

decrease.

47. Beta is a measure of a. company specific risk. b. industry risk. c. diversifiable risk. d. systematic risk. e. unique risk.

diversifiable risk.

46. Using the constant growth model, a reduction in the required rate of return from 19 to 17 percent combined with a reduction in the growth rate from 11 to 9 percent would cause the price to a. fall more than 2 percent. b. fall less than 2 percent. c. remain constant. d. rise more than 2 percent. e. rise less than 3 percent.

fall less than 2 percent.

108. Which of the following is NOTa relaxation of the assumptions for the CAPM? a. differential lending and borrowing rates b. a zero-beta model c. transaction costs d. taxes e. fixed planning periods

fixed planning periods

40. All of the following are assumptions of the Capital Asset Pricing Model (CAPM) EXCEPT a. investors can borrow and lend any amount at the risk-free rate. b. investors all have homogeneous expectations regarding expected returns. c. investors can have different time horizons, daily, weekly, annual, or some other period. d. all investments are infinitely divisible. e. capital markets are in equilibrium.

investors can have different time horizons, daily, weekly, annual, or some other period.

91. A portfolio is considered to be efficient if a. no other portfolio offers higher expected returns with the same risk. b. no other portfolio offers lower risk with the same expected return. c. there is no portfolio with a higher return. d. it is the risk-minimizing portfolio. e. it is the risk-maximizing portfolio.

it is the risk-minimizing portfolio.

46. The ____ the number of stocks in a portfolio and the ____ the time period, the ____ the portfolio beta. a. larger, longer, less stable b. larger, longer, more stable c. larger, shorter, less stable d. larger, shorter, more stable e. smaller, longer, more stable

larger, longer, more stable

40. The growth rate of equity earnings without external financing is equal to a. retention rate plus return on equity. b. retention rate minus return on equity. c. retention rate divided by return on equity. d. retention rate times return on equity. e. return on equity divided by retention rate.

retention rate times return on equity.

31. The probability of an adverse outcome is a definition of a. statistics. b. variance. c. random. d. risk. e. semi-variance above the mean.

risk.

48. If an individual owns only one security the most appropriate measure of risk is a. standard deviation. b. correlation. c. beta. d. covariance. e. the risk-free rate.

standard deviation.

34. Markowitz believes that any asset or portfolio of assets can be described by ____ parameter(s). a. one b. two c. three d. four e. five

two

Standard deviation of a risk-free rate

zero

38. According to the dividend growth model, if a company were to declare that it would never pay dividends, its value would be a. based on earnings. b. based on expectations regarding. c. higher than similar firms because it could reinvest a greater amount in new projects. d. zero. e. based on the capital asset pricing model.

zero.