Deck 10: Risk and Return: the Capital Asset Pricing Model

Question 1

The amount of systematic risk present in a particular risky asset, relative to the systematic risk present in an average risky asset, is called the particular asset's:

A)beta coefficient.
B)reward-to-risk ratio.
C)total risk.
D)diversifiable risk.
E)Treynor index.

Answer 1

beta coefficient.

Question 2

Which one of the following is an example of a nondiversifiable risk?

A)a well respected chief executive of a firm suddenly resigns
B)a well respected chairman of the European Central Bank suddenly resigns
C)a key employee suddenly resigns and accepts employment with a key competitor
D)a well managed firm reduces its work force and automates several jobs
E)a poorly managed firm suddenly goes out of business due to lack of sales

Answer 2

a well respected chairman of the European Central Bank suddenly resigns

Question 3

When computing the expected return on a portfolio of shares the portfolio weights are based on the:

A)number of shares owned in each equity.
B)share price.
C)market value of the total shares held in each equity.
D)original amount invested in each equity.
E)cost per share of each equity held.

Answer 3

market value of the total shares held in each equity.

Question 4

The percentage of a portfolio's total value invested in a particular asset is called that asset's:

A)portfolio return.
B)portfolio weight.
C)portfolio risk.
D)rate of return.
E)investment value.

Question 5

The principle of diversification tells us that:

A)concentrating an investment in two or three large shares will eliminate all of your risk.
B)concentrating an investment in three companies all within the same industry will greatly
Reduce your overall risk.
C)spreading an investment across five diverse companies will not lower your overall risk at
All)
D)spreading an investment across many diverse assets will eliminate all of the risk.
E)spreading an investment across many diverse assets will eliminate some of the risk.

Question 6

The characteristic line is graphically depicted as:

A)the plot of the relationship between beta and expected return.
B)the plot of the returns of the security against the beta.
C)the plot of the security returns against the market index returns.
D)the plot of the beta against the market index returns.
E)None of the above.

Question 7

Risk that affects at most a small number of assets is called _____ risk.

A)portfolio
B)undiversifiable
C)market
D)unsystematic
E)total

Question 8

Risk that affects a large number of assets, each to a greater or lesser degree, is called _____ risk.

A)idiosyncratic
B)diversifiable
C)systematic
D)asset-specific
E)total

Question 9

You are considering purchasing share S.This share has an expected return of 8% if the economy booms and 3% if the economy goes into a recessionary period.The overall expected rate of return
On this share will:

A)be equal to one-half of 8% if there is a 50% chance of an economic boom.
B)vary inversely with the growth of the economy.
C)increase as the probability of a recession increases.
D)be equal to 75% of 8% if there is a 75% chance of a boom economy.
E)increase as the probability of a boom economy increases.

Question 10

The linear relation between an asset's expected return and its beta coefficient is the:

A)reward-to-risk ratio.
B)portfolio weight.
C)portfolio risk.
D)security market line.
E)market risk premium.

Question 11

The slope of an asset's security market line is the:

A)reward-to-risk ratio.
B)portfolio weight.
C)beta coefficient.
D)risk-free interest rate.
E)market risk premium.

Question 12

Standard deviation measures _____ risk.

A)total
B)nondiversifiable
C)unsystematic
D)systematic
E)economic

Question 13

If investors possess homogeneous expectations over all assets in the market portfolio, when riskless lending and borrowing is allowed, the market portfolio is defined to:

A)be the same portfolio of risky assets chosen by all investors.
B)have the securities weighted by their market value proportions.
C)be a diversified portfolio.
D)All of the above.
E)None of the above.

Question 14

The risk premium for an individual security is computed by:

A)multiplying the security's beta by the market risk premium.
B)multiplying the security's beta by the risk-free rate of return.
C)adding the risk-free rate to the security's expected return.
D)dividing the market risk premium by the quantity (1 - beta).
E)dividing the market risk premium by the beta of the security.

Question 15

The portfolio expected return considers which of the following factors? I.the amount of money currently invested in each individual security.
II)various levels of economic activity.
III)the performance of each share given various economic scenarios.
IV)the probability of various states of the economy.

A)I and III only.
B)II and IV only.
C)I, III, and IV only.
D)II, III, and IV only.
E)I, II, III, and IV.

Question 16

A portfolio is:

A)a group of assets, such as shares and bonds, held as a collective unit by an investor.
B)the expected return on a risky asset.
C)the expected return on a collection of risky assets.
D)the variance of returns for a risky asset.
E)the standard deviation of returns for a collection of risky assets.

Question 17

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.

A)Efficient Markets Hypothesis (EMH)
B)Systematic Risk Principle
C)Open Markets Theorem
D)Law of One Price
E)Principle of Diversification

Question 18

The expected return on a share that is computed using economic probabilities is:

A)guaranteed to equal the actual average return on the share for the next five years.
B)guaranteed to be the minimal rate of return on the share over the next two years.
C)guaranteed to equal the actual return for the immediate twelve month period.
D)a mathematical expectation based on a weighted average and not an actual anticipated
Outcome.
E)the actual return you will receive.

Question 19

The beta of a security is calculated by:

A)dividing the covariance of the security with the market by the variance of the market.
B)dividing the correlation of the security with the market by the variance of the market.
C)dividing the variance of the market by the covariance of the security with the market.
D)dividing the variance of the market by the correlation of the security with the market.
E)None of the above.

Question 20

Which one of the following statements is correct concerning the expected rate of return on an individual share given various states of the economy?

A)The expected return is a geometric average where the probabilities of the economic
States are used as the exponential powers.
B)The expected return is an arithmetic average of the individual returns for each state of the
Economy.
C)The expected return is a weighted average where the probabilities of the economic states
Are used as the weights.
D)The expected return is equal to the summation of the values computed by dividing the
Expected return for each economic state by the probability of the state.
E)As long as the total probabilities of the economic states equal 100%, then the expected
Return on the share is a geometric average of the expected returns for each economic
State.

Question 21

In practice, most of the idiosyncratic risk from the assets in a diversified portfolio can be eliminated when the portfolio has approximately _____ diverse securities.

A)3
B)6
C)30
D)50
E)75

Question 22

The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is referred to as the:

A)market rate of return.
B)market risk premium.
C)systematic return.
D)total return.
E)real rate of return.

Question 23

Which one of the following is an example of systematic risk?

A)The price of lumber declines sharply.
B)Airline pilots go on strike.
C)The European Central Bank increases interest rates.
D)A hurricane hits a tourist destination.
E)People become diet conscious and avoid fast food restaurants.

Question 24

Which one of the following measures is relevant to the systematic risk principle?

A)variance
B)alpha
C)standard deviation
D)theta
E)beta

Question 25

The efficient set of portfolios

A)contains the portfolio combinations with the highest return for a given level of risk.
B)contains the portfolio combinations with the lowest risk for a given level of return.
C)is the lowest overall risk portfolio.
D)Both A and B
E)Both A and C.

Question 26

Systematic risk is measured by:

A)the mean.
B)beta.
C)the geometric average.
D)the standard deviation.
E)the arithmetic average.

Question 27

The market risk premium is computed by:

A)adding the risk-free rate of return to the inflation rate.
B)adding the risk-free rate of return to the market rate of return.
C)subtracting the risk-free rate of return from the inflation rate.
D)subtracting the risk-free rate of return from the market rate of return.
E)multiplying the risk-free rate of return by a beta of 1.0.

Question 28

The intercept point of the security market line is the rate of return which corresponds to:

A)the risk-free rate of return.
B)the market rate of return.
C)a value of zero.
D)a value of 1.0.
E)the beta of the market.

Question 29

Diversification can effectively reduce risk.Once a portfolio is diversified, the type of risk remaining is:

A)individual security risk.
B)riskless security risk.
C)risk related to the market portfolio.
D)total standard deviations.
E)None of the above.

Question 30

A security that is fairly priced will have a return _____ the Security Market Line.

A)below
B)on or below
C)on
D)on or above
E)above

Question 31

Which one of the following is an example of unsystematic risk?

A)The inflation rate increases unexpectedly.
B)The federal government lowers income taxes.
C)An oil tanker runs aground and spills its cargo.
D)Interest rates decline by one-half of one percent.
E)The GDP rises by 2% more than anticipated.

Question 32

Which one of the following statements is correct concerning the standard deviation of a portfolio?

A)The greater the diversification of a portfolio, the greater the standard deviation of that
Portfolio.
B)The standard deviation of a portfolio can often be lowered by changing the weights of the
Securities in the portfolio.
C)Standard deviation is used to determine the amount of risk premium that should apply to a
Portfolio.
D)Standard deviation measures only the systematic risk of a portfolio.
E)The standard deviation of a portfolio is equal to a weighted average of the standard
Deviations of the individual securities held within the portfolio.

Question 33

The expected return on a portfolio:

A)can be greater than the expected return on the best performing security in the portfolio.
B)can be less than the expected return on the worst performing security in the portfolio.
C)is independent of the performance of the overall economy.
D)is limited by the returns on the individual securities within the portfolio.
E)is an arithmetic average of the returns of the individual securities when the weights of
Those securities are unequal.

Question 34

Which one of the following would indicate a portfolio is being effectively diversified?

A)an increase in the portfolio beta
B)a decrease in the portfolio beta
C)an increase in the portfolio rate of return
D)an increase in the portfolio standard deviation
E)a decrease in the portfolio standard deviation

Question 35

A share with an actual return that lies above the security market line:

A)has more systematic risk than the overall market.
B)has more risk than warranted based on the realized rate of return.
C)has yielded a higher return than expected for the level of risk assumed.
D)has less systematic risk than the overall market.
E)has yielded a return equivalent to the level of risk assumed.

Question 36

Unsystematic risk:

A)can be effectively eliminated through portfolio diversification.
B)is compensated for, by the risk premium.
C)is measured by beta.
D)cannot be avoided if you wish to participate in the financial markets.
E)is related to the overall economy.

Question 37

If a share portfolio is well diversified, then the portfolio variance:

A)will equal the variance of the most volatile share in the portfolio.
B)may be less than the variance of the least risky share in the portfolio.
C)must be equal to or greater than the variance of the least risky share in the portfolio.
D)will be a weighted average of the variances of the individual securities in the portfolio.
E)will be an arithmetic average of the variance of the individual securities in the portfolio.

Question 38

The systematic risk of the market is measured by:

A)a beta of 1.0.
B)a beta of 0.0.
C)a standard deviation of 1.0.
D)a standard deviation of 0.0.
E)a variance of 1.0.

Question 39

The standard deviation of a portfolio will tend to increase when:

A)a risky asset in the portfolio is replaced with Treasury bills.
B)one of two shares related to the airline industry is replaced with a third share that is
Unrelated to the airline industry.
C)the portfolio concentration in a single cyclical industry increases.
D)the weights of the various diverse securities become more evenly distributed.
E)short-term bonds are replaced with long-term bonds.

Question 40

The primary purpose of portfolio diversification is to:

A)increase returns and risks.
B)eliminate all risks.
C)eliminate asset-specific risk.
D)eliminate systematic risk.
E)lower both returns and risks.

Question 41

You have plotted the data for two securities over time on the same graph, i.e., the month return of each security for the last 5 years.If the pattern of the movements of the two securities rose and fell
As the other did, these two securities would have:

A)no correlation at all.
B)a weak negative correlation.
C)a strong negative correlation.
D)a strong positive correlation.
E)one can not get any idea of the correlation from a graph.

Question 42

You have a portfolio of two risky shares which turns out to have no diversification benefit.The reason you have no diversification is the returns:

A)are too small.
B)move perfectly opposite of one another.
C)are too large to offset.
D)move perfectly with one another.
E)are completely unrelated to one another.

Question 43

The measure of beta associates most closely with:

A)idiosyncratic risk.
B)risk-free return.
C)systematic risk.
D)unexpected risk.
E)unsystematic risk.

Question 44

The correlation between shares A and B is the:

A)covariance between A and B divided by the standard deviation of A times the standard
Deviation of B.
B)standard deviation A divided by the standard deviation of B.
C)standard deviation of B divided by the covariance between A and B.
D)variance of A plus the variance of B dividend by the covariance.
E)None of the above.

Question 45

The Capital Market Line is the pricing relationship between:

A)efficient portfolios and beta.
B)the risk-free asset and standard deviation of the portfolio return.
C)the optimal portfolio and the standard deviation of portfolio return.
D)beta and the standard deviation of portfolio return.
E)None of the above.

Question 46

A portfolio will usually contain:

A)one riskless asset.
B)one risky asset.
C)two or more assets.
D)no assets.
E)None of the above.

Question 47

If the correlation between two shares is +1, then a portfolio combining these two shares will have a variance that is:

A)less than the weighted average of the two individual variances.
B)greater than the weighted average of the two individual variances.
C)equal to the weighted average of the two individual variances.
D)less than or equal to average variance of the two weighted variances, depending on other
Information.
E)None of the above.

Question 48

An efficient set of portfolios is:

A)the complete opportunity set.
B)the portion of the opportunity set below the minimum variance portfolio.
C)only the minimum variance portfolio.
D)the dominant portion of the opportunity set.
E)only the maximum return portfolio.

Question 49

A well-diversified portfolio has negligible:

A)expected return.
B)systematic risk.
C)unsystematic risk.
D)variance.
E)Both C and D.

Question 50

The dominant portfolio with the lowest possible risk is:

A)the efficient frontier.
B)the minimum variance portfolio.
C)the upper tail of the efficient set.
D)the tangency portfolio.
E)None of the above.

Question 51

According to the Capital Asset Pricing Model:

A)the expected return on a security is negatively and non-linearly related to the security's
Beta.
B)the expected return on a security is negatively and linearly related to the security's beta.
C)the expected return on a security is positively and linearly related to the security's
Variance.
D)the expected return on a security is positively and non-linearly related to the security's
Beta.
E)the expected return on a security is positively and linearly related to the security's beta.

Question 52

Beta measures:

A)the ability to diversify risk.
B)how an asset covaries with the market.
C)the actual return on an asset.
D)the standard of the assets' returns.
E)All of the above.

Question 53

When shares with the same expected return are combined into a portfolio:

A)the expected return of the portfolio is less than the weighted average expected return of
The shares.
B)the expected return of the portfolio is greater than the weighted average expected return
Of the shares.
C)the expected return of the portfolio is equal to the weighted average expected return of
The shares.
D)there is no relationship between the expected return of the portfolio and the expected
Return of the shares.
E)None of the above.

Question 54

Total risk can be divided into:

A)standard deviation and variance.
B)standard deviation and covariance.
C)portfolio risk and beta.
D)systematic risk and unsystematic risk.
E)portfolio risk and covariance.

Question 55

The diversification effect of a portfolio of two shares:

A)increases as the correlation between the shares declines.
B)increases as the correlation between the shares rises.
C)decreases as the correlation between the shares rises.
D)Both A and C.
E)None of the above.

Question 56

The separation principle states that an investor will:

A)choose any efficient portfolio and invest some amount in the riskless asset to generate the
Expected return.
B)choose an efficient portfolio based on individual risk tolerance or utility.
C)never choose to invest in the riskless asset because the expected return on the riskless
Asset is lower over time.
D)invest only in the riskless asset and tangency portfolio choosing the weights based on
Individual risk tolerance.
E)All of the above.

Question 57

A share with a beta of zero would be expected to have a rate of return equal to:

A)the risk-free rate.
B)the market rate.
C)the prime rate.
D)the average AAA bond.
E)None of the above.

Question 58

When a security is added to a portfolio the appropriate return and risk contributions are:

A)the expected return of the asset and its standard deviation.
B)the expected return and the variance.
C)the expected return and the beta.
D)the historical return and the beta.
E)these both can not be measured.

Question 59

The combination of the efficient set of portfolios with a riskless lending and borrowing rate results in:

A)the capital market line which shows that all investors will only invest in the riskless asset.
B)the capital market line which shows that all investors will invest in a combination of the
Riskless asset and the market portfolio.
C)the security market line which shows that all investors will invest in the riskless asset only.
D)the security market line which shows that all investors will invest in a combination of the
Riskless asset and the market portfolio.
E)None of the above.

Question 60

If the covariance of share 1 with share 2 is -.0065, then what is the covariance of share 2 with share 1?

A)-.0065
B)+.0065
C)greater than +.0065
D)less than -.0065
E)Need additional information.

Question 61

You are comparing share A to share B. Given the following information, which one of these two shares should you prefer and why?

A)Share A; because it has an expected return of 7% and appears to be more risky.
B)Share A; because it has a higher expected return and appears to be less risky than share B.
C)Share A; because it has a slightly lower expected return but appears to be significantly
Less risky than share B.
D)Share B; because it has a higher expected return and appears to be just slightly more risky
Than share A.
E)Share B; because it has a higher expected return and appears to be less risky than share A.

Question 62

You have a €1,000 portfolio which is invested in shares A and B plus a risk-free asset.€400 is invested in shareA.Share A has a beta of 1.3 and share B has a beta of 0.7.How much needs to be
Invested in share B if you want a portfolio beta of 0.90?

A)€0
B)€268
C)€482
D)€543
E)€600

Question 63

A typical investor is assumed to be:

A)a fair gambler.
B)a gambler.
C)a single security holder.
D)risk averse.
E)risk neutral.

Question 64

You own the following portfolio of shares. what is the portfolio weight of share C?

A)30.8%
B)37.4%
C)42.3%
D)45.2%
E)47.9%

Question 65

For a highly diversified equally weighted portfolio with a large number of securities, the portfolio variance is:

A)the average covariance.
B)the average expected value.
C)the average variance.
D)the weighted average expected value.
E)the weighted average variance.

Question 66

Inferior Goods SpA equity is expected to earn 14% in a boom, 6% in a normal economy, and lose 4% in a recession economy.The probability of a boom is 20% while the probability of a normal
Economy is 55% and the chance of a recession is 25%.What is the expected rate of return on this
Share?

A)5.10%
B)6.72%
C)6.80%
D)7.60%
E)11.33%

Question 67

You recently purchased a share that is expected to earn 12% in a booming economy, 8% in a normal economy and lose 5% in a recessionary economy.There is a 15% probability of a boom, a 75%
Chance of a normal economy, and a 10% chance of a recession.What is your expected rate of return
On this share?

A)5.00%
B)6.45%
C)7.30%
D)7.65%
E)8.30%

Question 68

What is the standard deviation of the returns on a share given the following information?

A)5.80%
B)7.34%
C)8.38%
D)9.15%
E)9.87%

Question 69

The correlation between two shares:

A)can take on positive values.
B)can take on negative values.
C)cannot be greater than 1.
D)cannot be less than −1.
E)All of the above.

Question 70

The total number of variance and covariance terms in portfolio is N2.How many of these would be (including non-unique) covariance's?

A)N
B)N2
C)N2 - N
D)N2 - N/2
E)None of the above.

Question 71

You want your portfolio beta to be 1.20.Currently, your portfolio consists of €100 invested in share A with a beta of 1.4 and €300 in share B with a beta of .6.You have another €400 to invest and
Want to divide it between an asset with a beta of 1.6 and a risk-free asset.How much should you
Invest in the risk-free asset?

A)€0
B)€140
C)€200
D)€320
E)€400

Question 72

Kurt's Adventures SA equity is quite cyclical.In a boom economy, the equity is expected to return 30% in comparison to 12% in a normal economy and a negative 20% in a recessionary period.The
Probability of a recession is 15%.There is a 30% chance of a boom economy.The remainder of the
Time, the economy will be at normal levels.What is the standard deviation of the returns on Kurt's
Adventures SA?

A)10.05%
B)12.60%
C)15.83%
D)17.46%
E)25.04%

Question 73

The elements along the diagonal of the variance/covariance matrix are:

A)covariances.
B)security weights.
C)security selections.
D)variances.
E)None of the above.

Question 74

Zelo NV share has a beta of 1.23.The risk-free rate of return is 4.5% and the market rate of return is 10%.What is the amount of the risk premium on Zelo shares?

A)4.47%
B)5.50%
C)5.54%
D)6.77%
E)12.30%

Question 75

The opportunity set of portfolios is:

A)all possible return combinations of those securities.
B)all possible risk combinations of those securities.
C)all possible risk-return combinations of those securities.
D)the best or highest risk-return combination.
E)the lowest risk-return combination.

Question 76

The elements in the off-diagonal positions of the variance/covariance matrix are:

A)covariances.
B)security selections.
C)variances.
D)security weights.
E)None of the above.

Question 77

The rate of return on the shares of Flowers by Flo is expected to be 14% in a boom economy, 8% in a normal economy, and only 2% in a recessionary economy.The probabilities of these economic
States are 20% for a boom, 70% for a normal economy, and 10% for a recession.What is the
Variance of the returns on the shares of Flowers by Flo?

A).001044
B).001280
C).001863
D).002001
E).002471

Question 78

If the economy booms, RTF AB equity is expected to return 10%.If the economy goes into a recessionary period, then RTF is expected to only return 4%.The probability of a boom is 60% while
The probability of a recession is 40%.What is the variance of the returns on RTF?

A).000200
B).000760
C).000864
D).001594
E).029394

Question 79

If the correlation between two shares is −1, the returns:

A)generally move in the same direction.
B)move perfectly opposite one another.
C)are unrelated to one another as it is < 0.
D)have standard deviations of equal size but opposite signs.
E)None of the above.

Question 80

You have a portfolio consisting solely of share A and share B.The portfolio has an expected return of 10.2%.Share A has an expected return of 12% while share B is expected to return 7%.What is the
Portfolio weight of share A?

A)46%
B)54%
C)58%
D)64%
E)70%