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1 Portfolio Returns and Portfolio Risk: D) Cannot Be Determined
1 Portfolio Returns and Portfolio Risk: D) Cannot Be Determined
A) Investment A
B) Investment B
C) Investment C
D) Cannot be determined
2) You are considering investing in U.S. Steel. Which of the following is an example of
nondiversifiable risk?
A) Risk resulting from foreign expropriation of U.S. Steel property
B) Risk resulting from oil exploration by Marathon Oil (a U.S. Steel subsidy)
C) Risk resulting from a strike against U.S. Steel
D) None of the above
3) You are considering buying some stock in Continental Grain. Which of the following
is an example of nondiversifiable risk?
A) Risk resulting from a general decline in the stock market
B) Risk resulting from a news release that several of Continental's grain silos were
tainted
C) Risk resulting from an explosion in a grain elevator owned by Continental
D) Risk resulting from an impending lawsuit against Continental
4) If there is a 20% chance we will get a 16% return, a 30% chance of getting a 14%
return, a 40% chance of getting a 12% return, and a 10% chance of getting an 8%
return, what is the expected rate of return?
A) 12%
B) 13%
C) 14%
D) 15%
5) If there is a 20% chance we will get a 16% return, a 30% chance of getting a 14%
return, a 40% chance of getting a 12% return, and a 10% chance of getting an 8%
return, what would be the standard deviation?
A) 2.24
B) 2.56
C) 2.83
D) 2.98
6) You are considering investing in a portfolio consisting of 40% Electric General and
60% Buckstar. If the expected rate of return on Electric General is 16% and the
expected return on Buckstar is 9%, what is the expected return on the portfolio?
A) 12.50%
B) 13.20%
C) 11.80%
D) 10.00%
7) The expected return on MSFT next year is 12% with a standard deviation of 20%.
The expected return on AAPL next year is 24% with a standard deviation of 30%. If
James makes equal investments in MSFT and AAPL, what is the expected return on his
portfolio.
A) 20%
B) 16%
C) 18%
D) 25%
8) The expected return on MSFT next year is 12% with a standard deviation of 20%.
The expected return on AAPL next year is 24% with a standard deviation of 30%. The
correlation between the two stocks is .6. If James makes equal investments in MSFT
and AAPL, what is the expected return on his portfolio.
A) 21.45%
B) 25.00%
C) 4.60%
D) 15.00%
Use the following information, which describes the possible outcomes from investing in a
particular asset, to answer the following question(s).
12) What is the expected rate of return on a portfolio Which consists of $9,000 invested
in an S&P 500 Index fund, $32,500 in a technology fund, and $8,500 in Treasury Bills.
The expected rate of return is 11% on the S&P Index fund, 14% on the technology fund
and 2% on the Treasury Bills.
A) $154.00
B) $142.80
C) $65.00
D) $15.12
Use the following information, which describes the expected return and standard deviation for
three different assets, to answer the following question(s).
13) If an investor must choose between investing in either portfolio X or portfolio Y, then
A) she will always choose Asset X over Asset Y.
B) she will always choose Asset Y over Asset X.
C) she will be indifferent between investing in Asset X and Asset Y.
D) none of the above.
14) An investor will get maximum risk reduction by combining assets that are
A) negatively correlated.
B) positively correlated.
C) uncorrelated.
D) perfectly, positively correlated.
17) When assets are positively correlated, they tend to rise or fall together.
Answer: TRUE
18) The standard deviation of a portfolio is always just the weighted average of the
standard deviations of assets in the portfolio.
Answer: FALSE
19) A correlation coefficient of +1 indicates that returns on one asset can be exactly
predicted from the returns on another asset.
Answer: TRUE
21) A portfolio will always have less risk than the riskiest asset in it if the correlation of
assets is less than perfectly positive.
Answer: TRUE
22) The standard deviation of returns on Warchester stock is 20% and on Shoesbury
stock it is 16%. The coefficient of correlation between the stocks is .75. The standard
deviation of any portfolio combining the two stocks will be less than 20%.
Answer: TRUE
24) Portfolio returns can be calculated as the geometric mean of the returns on the
individual assets in the portfolio.
Answer: FALSE
25) When constructing a portfolio, it is a good idea to put all your eggs in one basket,
then watch the basket closely.
Answer: FALSE
26) A portfolio containing a mix of stocks, bonds, and real estate is likely to be more
diversified than a portfolio made up of only one asset class.
Answer: TRUE
27) An asset with a large standard deviation of returns can lower portfolio risk if its
returns are uncorrelated with the returns on the other assets in the portfolio.
Answer: TRUE
28) The greater the dispersion of possible returns, the riskier is the investment.
Answer: TRUE
29) For the most part, there has been a positive relation between risk and return
historically.
Answer: TRUE
30) The benefit from diversification is far greater when the diversification occurs across
asset types.
Answer: TRUE
32) You are considering a portfolio consisting of equal investments in the stocks
Northbank Inc. and Tropical Escapes Inc. Returns on the 2 stocks under various
conditions are shown below.
2) The appropriate measure for risk according to the capital asset pricing model is
A) the standard deviation of a firm's cash flows.
B) alpha.
C) beta.
D) probability of correlation.
3) You are considering investing in Ford Motor Company. Which of the following is an
example of diversifiable risk?
A) Risk resulting from the possibility of a stock market crash
B) Risk resulting from uncertainty regarding a possible strike against Ford
C) Risk resulting from an expected recession
D) Risk resulting from interest rates decreasing
4) On average, when the overall market changes by 10%, the stock of Veracity
Communications changes 12%. What is Veracity's beta?
A) 1.2
B) 8.33%
C) 12%
D) Insufficient information is provided
10) A stock with a beta greater than 1.0 has returns that are ________ volatile than the
market, and a stock with a beta of less than 1.0 exhibits returns which are ________
volatile than those of the market portfolio.
A) more, more
B) more, less
C) less, more
D) less, less
Percent
Security of Portfolio Beta Return
X Corporation 20% 1.35 14%
Y Corporation 35% .95 10%
Z Corporation 45% .75 8%
13) You are thinking of adding one of two investments to an already well diversified
portfolio.
14) The market (systematic) risk associated with an individual stock is most closely
identified with the
A) variance of the returns of the stock.
B) variance of the returns of the market.
C) beta of the stock.
D) standard deviation of the stock.
18) Currently, the expected return on the market is 12.5% and the required rate of
return for Alpha, Inc. is 12.5%. Therefore, Alpha's beta must be
A) less than 1.0.
B) greater than 1.0.
C) equal to 1.0.
D) unknown based on the information provided.
22) Which of the following is generally used to measure the market when calculating
betas?
A) The Dow Jones Industrial Average
B) The Standard & Poors 500 Index
C) The Value Line Quantam Index
D) The Case Schiller Housing Index
23) Your broker mailed you your year-end statement. You have $25,000 invested in
Dow Chemical, $18,000 tied up in GM, $36,000 in Microsoft stock, and $11,000 in Nike.
The betas for each of your stocks are 1.55 for Dow, 1.12 for GM, 2.39 for Microsoft, and
.76 for Nike. What is the beta of your portfolio?
A) 1.46
B) 1.70
C) 2.60
D) 0.41
24) You are considering a portfolio of three stocks with 30% of your money invested in
company X, 45% of your money invested in company Y, and 25% of your money
invested in company Z. If the betas for each stock are 1.22 for company X, 1.46 for
company Y, and 1.03 for company Z, what is the portfolio beta?
A) 1.24
B) 1.00
C) 1.28
D) 1.33
25) Beta is a measurement of the relationship between a security's returns and the
general market's returns.
Answer: TRUE
26) Total risk equals unique security risk times systematic risk.
Answer: FALSE
27) The CAPM designates the risk-return tradeoff existing in the market, where risk is
defined in terms of beta.
Answer: TRUE
29) Stocks with higher betas are usually more stable than stocks with lower betas.
Answer: FALSE
30) A stock with a beta of 1.0 would on average earn the risk-free rate.
Answer: FALSE
32) Increasing a portfolio from 2 stocks to 4 stocks will reduce risk more than increasing
a portfolio from 10 stocks to 12 stocks.
Answer: FALSE
33) The market rewards assuming additional unsystematic risk with additional returns.
Answer: FALSE
34) On average, the market rewards assuming additional systematic risk with additional
returns.
Answer: TRUE
36) A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with
a beta of 1.0.
Answer: FALSE
37) Briefly discuss why there is no reason to believe that the market will reward
investors with additional returns for assuming unsystematic risk.
Answer: Through diversification, risk can be lowered without sacrificing returns. The
market rewards investors for the systematic risk that cannot be eliminated through
proper asset allocation in a diversified portfolio.
38) Provide an intuitive discussion of beta and its importance for measuring risk.
Answer: Beta is an important measure that indicates the systematic risk of a given
investment. Since systematic risk cannot be diversified away, investors are
compensated for taking this risk. Beta compares the market risk of a particular
investment with the market risk of the market, and the risk premium necessary for a
stock is directly proportional to the risk premium for the market as a whole. When the
risk premium is added to the risk free rate, this results in the required return for the
stock.
2) Siebling Manufacturing Company's common stock has a beta of .8. If the expected
risk-free return is 2% and the market offers a premium of 8% over the risk-free rate,
what is the expected return on Siebling's common stock?
A) 7.8%
B) 13.4%
C) 14.4%
D) 8.4%
3) Huit Industries' common stock has an expected return of 11.4% and a beta of 1.2. If
the expected risk-free return is 3%, what is the expected return for the market (round
your answer to the nearest .1%)?
A) 7.7%
B) 9.6%
C) 10.0%
D) 11.4%
4) Tanzlin Manufacturing's common stock has a beta of 1.5. If the expected risk-free
return is 2% and the expected return on the market is 14%, what is the expected return
on the stock?
A) 13.5%
B) 21.0%
C) 16.8%
D) 20.0%
5) Given the capital asset pricing model, a security with a beta of 1.5 should return
________, if the risk-free rate is 3% and the market return is 11%.
A) 16.5%
B) 14.0%
C) 14.5%
D) 15.0%
6) The security market line (SML) relates risk to return, for a given set of market
conditions. If expected inflation increases, which of the following would most likely
occur?
A) The market risk premium would increase.
B) Beta would increase.
C) The slope of the SML would increase.
D) The SML line would shift up.
7) The security market line (SML) relates risk to return, for a given set of market
conditions. If risk aversion increases, which of the following would most likely occur?
A) The market risk premium would increase.
B) Beta would increase.
C) The slope of the SML would increase.
D) The SML line would shift up.
8) The Elvis Alive Corporation, makers of Elvis memorabilia, has a beta of 2.35. The
return on the market portfolio is 12%, and the risk-free rate is 2.5%. According to
CAPM, what is the risk premium on a stock with a beta of 1.0?
A) 12.00%
B) 22.33%
C) 9.5%
D) 14.5%
9) Bell Weather, Inc. has a beta of 1.25. The return on the market portfolio is 12.5%,
and the risk-free rate is 5%. According to CAPM, what is the required return on this
stock?
A) 20.62%
B) 9.37%
C) 14.37%
D) 15.62%
10) The rate on six-month T-bills is currently 5%. Andvark Company stock has a beta of
1.69 and a required rate of return of 15.4%. According to CAPM, determine the return
on the market portfolio.
A) 11.15%
B) 6.15%
C) 17.07%
D) 14.11%
11) You are going to invest all of your funds in one of three projects with the following
distribution of possible returns:
12) The expected return on the market portfolio is currently 11%. Battmobile
Corporation stockholders require a rate of return of 23.0%, and the stock has a beta of
2.5. According to CAPM, determine the risk-free rate.
A) 17.5%
B) 2.75%
C) 3.0%
D) 9.2%
13) Hefty stock has a beta of 1.2. If the risk-free rate is 7% and the market risk premium
is 6.5%, what is the required rate of return on Hefty?
A) 14.8%
B) 14.4%
C) 12.4%
D) 13.5%
15) Marjen stock has a required return of 20%. The expected market return is 15%, and
the beta of Marjen's stock is 1.5. Calculate the risk-free rate.
A) 4%
B) 5%
C) 6%
D) 7%
16) You are thinking about purchasing 1,000 shares of stock in the following firms:
Number of Shares Firm's Beta
Firm A 100 0.75
Firm B 200 1.47
Firm C 200 0.82
Firm D 600 1.60
If you purchase the number of shares specified, then the beta of your portfolio will be:
A) 1.16.
B) 1.35.
C) 1.00.
D) Cannot be determined without knowing the stock prices.
Beta
Market 1
Firm A 1.25
Firm B 0.6
22) Long-term bonds issued by large, established corporations are commonly used to
estimate the risk-free rate.
Answer: FALSE
24) The S&P 500 Index is commonly used to estimate the market rate of return.
Answer: TRUE
25) The security market line (SML) intercepts the Y axis at the risk-free rate.
Answer: FALSE
26) The security market line can drawn by connecting the risk-free rate and the
expected return on the market portfolio.
Answer: TRUE
27) If investors expected inflation to increase in the future, the SML would shift up, but
the slope would remain the same.
Answer: TRUE
28) If investors became more risk averse The SML would shift downward and the slope
of the SML would fall.
Answer: FALSE
29) A security with a beta of zero has a required rate of return equal to the overall
market rate of return.
Answer: FALSE
30) The return for the market during the next period is expected to be 11.5%; the risk-
free rate is 2.5%. Calculate the required rate of return for a stock with a beta of 1.5.
Answer:
K = 2.5% + 1.5(11.5% - 2.5%) = 16%
31) Asset A has a required return of 18% and a beta of 1.4. The expected market return
is 14%. What is the risk-free rate? Plot the security market line.
Answer:
K = Krf + (Km - Krf)b
18% = X + (14% - X)1.4
18% - X =19.6% - 1.4X
.4X = 1.6%
X = 4% = Risk - free Rate = Krf
32) Security A has an expected rate of return of 22% and a beta of 2.5. Security B has a
beta of 1.20. If the Treasury bill rate is 2.0%, what is the expected rate of return for
security B?
Answer:
RA = RF + BA(Rm - Rf)
.22 = .02 + 2.5 (Rm - .02)
.20 = 2.5 (Rm - .02) = 2.5 Rm - .05
.25 = 2.5 Rm
.10 = Rm
RB = Rf + BB(Rm - Rf)
RB = .02 + 1.20(.10 - .02)
RB = .116 or 11.6%
33) AA & Co. has a beta of .656. If the expected market return is 13.2% and the risk-
free rate is 5.7%, what is the appropriate required return of AA & Co. using the CAPM
model?
Answer: Required Rate of Return = Risk-Free Rate + (Market Return - Risk-Free Rate)
× Beta = 5.7% + (13.2% - 5.7%) × 0.656 = 10.62%