Finance Quiz 3

The beta of the market portfolio is:

1

Which of the following statements is CORRECT?

A security's beta measures its non-diversifiable, or systematic, risk.

Which of the following statements is CORRECT?

An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

As a risk minimizer, you would choose Stock _______ if it is to be held in isolation and Stock ______ if it is to be held as part of a well-diversified portfolio.

C;A

Jane has a portfolio of 20 stocks, each stock has a Beta of 1.2; and Dick has a portfolio of 2 stocks, each has a Beta of 1.2. Assuming the market is in equilibrium, which of the following statements is CORRECT?

Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios.

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would shift in this manner:

Down and have a steeper slope.

Is volatility a reasonable measure of risk when evaluating the investment in a single stock?

FALSE

Portfolio A has one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B is by definition riskless.

False

Which of the following statements is FALSE?

Fluctuations of a stock's returns that are due to firm-specific news are common risks.

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

If investors becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

If the market risk premium increases by 1%, then the required return of a stock will increase by its Beta.

Which of the following is NOT a diversifiable risk?

Inflation

Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away. These stocks tend to have ________ betas.

Low

Based on historical data, which of the following statements is FALSE?

On average, larger stocks have higher volatility than smaller stocks.

For someone who holds the market portfolio, which security is more risky, A or B? Why?

Since security A has a higher beta, it is more risky.

For markets to be in equilibrium/efficient (that is, for all current information be incorporated into stock prices),

The expected rate of return must be equal to the required rate of return

Which of the following statements is CORRECT?

The market portfolio will have a higher beta than a single stock that has a beta of 0.5.

Which of the following statements is FALSE?

The risk premium of a security is equal to the market risk premium (the amount by which the market's expected return exceeds the risk-free rate) divided by beta of the asset.

Which of the following statements is CORRECT?

The security market line is a graph of the expected return of a stock as a function of systematic risk (beta).

A security with a beta of 1 has an expected return of 14% when the market has an expected return of 7%.

This statement is inconsistent with CAPM.

A security with only diversifiable risk has an expected return that exceeds the risk-free rate.

This statement is inconsistent with CAPM.

Small stocks with a beta of 0.5 have higher average returns than large stocks with a beta of 0.5.

This statement is inconsistent with CAPM.

The excess return is the difference between the average return on a security and the average return for

Treasury bills

"Risk aversion" implies that investors require higher expected returns on risky securities if they are to be induced to purchase them.

True

A portfolio of stocks where each stock has a large component of idiosyncratic risk benefits when such stocks are held in a portfolio, because the idiosyncratic risks are averaged out. This is also referred to as diversification of risks.

True

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific" events, and their effects on investment risk can in theory be diversified away.

True

If beta of Selleck & Company is negative, the CAPM would indicate that the required rate of return on Sellecks stock should be less than the risk-free rate for a well-diversified investor.

True

If investors are risk averse and hold only one stock, we can conclude that the return they would require on a stock whose standard deviation is 0.21 will be greater than the return required on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the low standard deviation stock.

True

Is volatility a reasonable measure of risk when evaluating large portfolios?

True

It is possible for a stock to have high total risk but low systematic risk.

True

The S&P 500 index traditionally is a ________ portfolio of the 500 largest U.S. stocks.

Value weighted

You expect General Motors (GM) to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM) to be 1.9 over the next year. Also, you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year. Which stock has more systematic risk? Which stock has more total risk?

XOM, GM

You expect General Motors (GM) to have a beta of 1 over the next year and the beta of Exxon Mobil (XOM) to be 1.2 over the next year. Also, you expect the volatility of General Motors to be 30% and that of Exxon Mobil to be 40% over the next year. Which stock has more systematic risk? Which stock has more total risk?

XOM, XOM

Inflation, recession and high interest rates are economic events that are best characterized as being

among the factors that are responsible for market risk.

As we add assets to a portfolio where the assets are held in equal weights, the benefit of diversification is most dramatic

at the outset.

For each 1% change in the market risk premium, the investment's excess return is expected to change by ________ percent due to risks that it has in common with the market (systematic risk).

beta

As we increase the number of stocks in a portfolio, the standard deviation of returns of the portfolio?

decreases.

Because investors can eliminate unsystematic risk "for free" by diversifying their portfolios, they ________ a risk premium for bearing it.

do not require

The market portfolio is the portfolio of all risky investments held

in proportion to their value.

The risk premium of a security is determined by its ________ risk and does not depend on its ________ risk.

systematic, unsystematic

Which of the following is NOT a systematic risk?

the risk that your new product will not receive regulatory approval

Many former employees at Enron, an energy trading and supply company, had a large part of their portfolio invested in Enron stock. These employees were bearing a high degree of ________ risk.

unsystematic

In the market portfolio, you can diversify away all _______ risk, but you will be left with ________ risk.

unsystematic, systematic

While ________ seems to be a reasonable measure of risk when evaluating a large portfolio, the ________ of an individual security does not explain the size of its average return.

volatility, volatility