Deck 11: Risk and Return

Question 1

You are assigned the task of computing the expected return on a portfolio containing several individual stocks. Which one of the following statements is correct concerning this task?

A) The expected rate of return on the portfolio must be positive.
B) The arithmetic average of the betas for each security held in the portfolio must equal 1.0.
C) The portfolio beta must be 1.0.
D) The summation of the return deviation from the portfolio expected return for each economic state must equal zero.
E) The standard deviation of the portfolio must equal 1.0.

Answer 1

The summation of the return deviation from the portfolio expected return for each economic state must equal zero.

Question 2

A stock is expected to return 13 percent in an economic boom, 10 percent in a normal economy, and 3 percent in a recessionary economy. Which one of the following will lower the overall expected rate of return on this stock?

A) An increase in the rate of return in a recessionary economy
B) An increase in the probability of an economic boom
C) A decrease in the probability of a recession occurring
D) A decrease in the probability of an economic boom
E) An increase in the rate of return for a normal economy

Answer 2

A decrease in the probability of an economic boom

Question 3

The expected rate of return on Delaware Shores, Inc. stock is based on three possible states of the economy. These states are boom, normal, and recession which have probabilities of occurrence of 20 percent, 75 percent, and 5 percent, respectively. Which one of the following statements is correct concerning the variance of the returns on this stock?

A) The variance must decrease if the probability of occurrence for a boom increases.
B) The variance will remain constant as long as the sum of the economic probabilities is 100 percent.
C) The variance can be positive, zero, or negative, depending on the expected rate of return assigned to each economic state.
D) The variance must be positive provided that each state of the economy produces a different expected rate of return.
E) The variance is independent of the economic probabilities of occurrence.

Answer 3

The variance must be positive provided that each state of the economy produces a different expected rate of return.

Question 4

Which one of the following is the slope of the security market line?

A) Risk-free rate
B) Market risk premium
C) Beta coefficient
D) Risk premium on an individual asset
E) Market rate of return

Question 5

The security market line is defined as a positively sloped straight line that displays the relationship between which two of the following variables?

A) Beta and standard deviation
B) Systematic and unsystematic risk
C) Nominal and real returns
D) Expected return and beta
E) Risk premium and beta

Question 6

Which one of the following is the computation of the risk premium for an individual
security? is the expected return on the security, is the risk-free rate, is the security's
beta, and is the expected rate of return on the market.

A)
B)
C)
D)
E)

Question 7

Which one of the following terms best refers to the practice of investing in a variety of diverse assets as a means of reducing risk?

A) Systematic
B) Unsystematic
C) Diversification
D) Security market line
E) Capital asset pricing model

Question 8

Which one of the following describes systemic risk?

A) Risk that affects a large number of assets
B) An individual security's total risk
C) Diversifiable risk
D) Asset specific risk
E) Risk unique to a firm's management

Question 9

Which one of the following is the minimum required rate of return on a new investment that makes that investment attractive?

A) Risk-free rate
B) Market risk premium
C) Expected return minus the risk-free rate
D) Market rate of return
E) Cost of capital

Question 10

The systematic risk principle states that the expected return on a risky asset depends only on which one of the following?

A) Unique risk
B) Diversifiable risk
C) Asset-specific risk
D) Market risk
E) Unsystematic risk

Question 11

Which one of the following best describes a portfolio?

A) Risky security
B) Security equally as risky as the overall market
C) New issue of stock
D) Group of assets held by an investor
E) Investment in a risk-free security

Question 12

Which one of the following is the best example of an announcement that is most apt to result in an unexpected return?

A) A news bulletin that the anticipated layoffs by a firm will occur as expected on December 1
B) Announcement that the CFO of the firm is retiring June as previously announced
C) Announcement that a firm will continue its practice of paying a $3 a share annual dividend
D) Statement by a firm that it has just discovered a manufacturing defect and is recalling its product
E) The verification by senior management that the firm is being acquired as had been rumored

Question 13

The expected return on a security is currently based on a 22 percent chance of a 15 percent return given an economic boom and a 78 percent chance of a 12 percent return given a normal economy. Which of the following changes will decrease the expected return on this security? I. an increase in the probability of an economic boom
II) a decrease in the rate of return given a normal economy
III) an increase in the probability of a normal economy
IV) an increase in the rate of return given an economic boom

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

Question 14

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to that in an average risky asset?

A) Squared deviation
B) Beta coefficient
C) Standard deviation
D) Mean
E) Variance

Question 15

Consider a portfolio comprised of four risky securities. Assume the economy has three states with varying probabilities of occurrence. Which one of the following will guarantee that the portfolio variance will equal zero?

A) The portfolio beta must be 1.0.
B) The portfolio expected rate of return must be the same for each economic state.
C) The portfolio risk premium must equal zero.
D) The portfolio expected rate of return must equal the expected market rate of return.
E) There must be equal probabilities that the state of the economy will be a boom or a bust.

Question 16

Which one of the following statements is correct?

A) The risk premium on a risk-free security is generally considered to be one percent.
B) The expected rate of return on any security, given multiple states of the economy, must be positive.
C) There is an inverse relationship between the level of risk and the risk premium given a risky security.
D) If a risky security is correctly priced, its expected risk premium will be positive.
E) If a risky security is priced correctly, it will have an expected return equal to the risk-free rate.

Question 17

Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies to the 28 percent?

A) Portfolio variance
B) Portfolio standard deviation
C) Portfolio weight
D) Portfolio expected return
E) Portfolio beta

Question 18

The security market line is a linear function which is graphed by plotting data points based on the relationship between which two of the following variables?

A) Risk-free rate and beta
B) Market rate of return and beta
C) Market rate of return and the risk-free rate
D) Risk-free rate and the market rate of return
E) Expected return and beta

Question 19

Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock. Which one of the following best describes the 16.5 percent rate?

A) Expected return
B) Real return
C) Market rate
D) Systematic return
E) Risk premium

Question 20

Which of the following terms can be used to describe unsystematic risk? I. asset-specific risk
II) diversifiable risk
III) market risk
IV) unique risk

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

Question 21

A risky security has less risk than the overall market. What must the beta of this security be?

A) 0
B) > 0 but < 1
C) 1
D) > 1
E) The beta cannot be determined based on the information provided.

Question 22

Which one of the following is the vertical intercept of the security market line?

A) Market rate of return
B) Individual security rate of return
C) Market risk premium
D) Individual security beta multiplied by the market risk premium
E) Risk-free rate

Question 23

The beta of a risky portfolio cannot be less than _____ nor greater than _____.

A) 0; 1
B) 1; the market beta
C) the lowest individual beta in the portfolio; market beta
D) the market beta; the highest individual beta in the portfolio
E) the lowest individual beta in the portfolio; the highest individual beta in the portfolio

Question 24

Standard deviation measures _____ risk while beta measures _____ risk.

A) systematic; unsystematic
B) unsystematic; systematic
C) total; unsystematic
D) total; systematic
E) asset-specific; market

Question 25

Assume you own a portfolio of diverse securities which are each correctly priced. Given this, the reward-to-risk ratio:

A) for the portfolio must equal 1.0.
B) for the portfolio must be less than the market risk premium.
C) for each security must equal zero.
D) of each security is equal to the risk-free rate.
E) of each security must equal the slope of the security market line.

Question 26

The risk premium for an individual security is based on which one of the following types of risk?

A) Total
B) Surprise
C) Diversifiable
D) Systematic
E) Unsystematic

Question 27

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

A) Discovery of a major gas field
B) Decrease in textile imports
C) Increase in agricultural exports
D) Decrease in gross domestic product
E) Decrease in management bonuses for banking executives

Question 28

The addition of a risky security to a fully diversified portfolio:

A) must decrease the portfolio's expected return.
B) must increase the portfolio beta.
C) may or may not affect the portfolio beta.
D) will increase the unsystematic risk of the portfolio.
E) will have no effect on the portfolio beta or its expected return.

Question 29

Which one of the following statements is correct?

A) A portfolio that contains at least 30 diverse individual securities will have a beta of 1.0.
B) Any portfolio that is correctly valued will have a beta of 1.0.
C) A portfolio that has a beta of 1.12 will lie to the left of the market portfolio on a security market line graph.
D) A risk-free security plots at the origin on a security market line graph.
E) An underpriced security will plot above the security market line.

Question 30

Which one of the following best exemplifies unsystematic risk?

A) Unexpected economic collapse
B) Unexpected increase in interest rates
C) Unexpected increase in the variable costs for a firm
D) Sudden decrease in inflation
E) Expected increase in tax rates

Question 31

If a security plots to the right and below the security market line, then the security has ____ systematic risk than the market and is _____.

A) more; overpriced
B) more; underpriced
C) less; overpriced
D) less; underpriced
E) less; correctly priced

Question 32

Which one of the following statements related to the security market line is correct?

A) An underpriced security will plot below the security market line.
B) A security with a beta of 1.54 will plot on the security market line if it is correctly priced.
C) A portfolio with a beta of 0.93 will plot to the right of the overall market.
D) A security with a beta of 0.99 will plot above the security market line if it is correctly priced.
E) A risk-free security will plot at the origin.

Question 33

Which one of the following portfolios will have a beta of zero?

A) A portfolio that is equally as risky as the overall market.
B) A portfolio that consists of a single stock.
C) A portfolio comprised solely of U. S. Treasury bills.
D) A portfolio with a zero variance of returns.
E) No portfolio can have a beta of zero.

Question 34

Which one of the following represents the amount of compensation an investor should expect to receive for accepting the unsystematic risk associated with an individual security?

A) Security beta multiplied by the market rate of return
B) Market risk premium
C) Security beta multiplied by the market risk premium
D) Risk-free rate of return
E) Zero

Question 35

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

A) Major layoff by a regional manufacturer of power boats
B) Increase in consumption created by a reduction in personal tax rates
C) Surprise firing of a firm's chief financial officer
D) Closure of a major retail chain of stores
E) Product recall by one manufacturer

Question 36

Portfolio diversification eliminates which one of the following?

A) Total investment risk
B) Portfolio risk premium
C) Market risk
D) Unsystematic risk
E) Reward for bearing risk

Question 37

A portfolio is comprised of 35 securities with varying betas. The lowest beta for an individual security is 0.74 and the highest of the security betas of 1.51. Given this information, you know that the portfolio beta:

A) must be 1.0 because of the large number of securities in the portfolio.
B) is the geometric average of the individual security betas.
C) must be less than the market beta.
D) will be between 0 and 1.0.
E) will be greater than or equal to 0.74 but less than or equal to 1.51.

Question 38

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

A) Inflation exceeding market expectations
B) A warehouse fire
C) Decrease in corporate tax rates
D) Decrease in the value of the dollar
E) Increase in consumer spending

Question 39

Systematic risk is:

A) totally eliminated when a portfolio is fully diversified.
B) defined as the total risk associated with surprise events.
C) risk that affects a limited number of securities.
D) measured by beta.
E) measured by standard deviation.

Question 40

Diversifying a portfolio across various sectors and industries might do more than one of the following. However, this diversification must do which one of the following?

A) Increase the expected risk premium
B) Reduce the beta of the portfolio to zero
C) Increase the security's risk premium
D) Reduce the portfolio's systematic risk level
E) Reduce the portfolio's unique risks

Question 41

The expected return on a security depends on which of the following? I. risk-free rate of return
II) amount of the security's unique risk
III market rate of return
IV) standard deviation of returns

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

Question 42

Given the following information, what is the variance of the returns on this stock?

A) 0.021387
B) 0.021449
C) 0.021506
D) 0.021538
E) 0.0215641

Question 43

You own a portfolio of two stocks, A and B. Stock A is valued at $6,540 and has an expected return of 11.2 percent. Stock B has an expected return of 8.1 percent. What is the expected return on the portfolio if the portfolio value is $9,500?

A) 9.58 percent
B) 9.62 percent
C) 9.74 percent
D) 9.97 percent
E) 10.23 percent

Question 44

Given the following information, what is the standard deviation of the returns on this stock?

A) 19.90 percent
B) 20.52 percent
C) 22.41 percent
D) 23.79 percent
E) 25.52 percent

Question 45

You own a portfolio that is invested 38 percent in stock A, 43 percent in stock B, and the remainder in stockC. The expected returns on these stocks are 10.7 percent, 15.4 percent, and 9.1 percent, respectively. What is the expected return on the portfolio?

A) 10.55 percent
B) 11.02 percent
C) 11.67 percent
D) 12.42 percent
E) 13.01 percent

Question 46

World United stock currently plots on the security market line and has a beta of 1.04. Which one of the following will increase that stock's rate of return without affecting the risk level of the stock, all else constant?

A) An increase in the risk-free rate
B) Decrease in the security's beta
C) Overpricing of the stock in the market place
D) Increase in the market risk-to-reward ratio
E) Decrease in the market rate of return

Question 47

Julie wants to create a $5,000 portfolio. She also wants to invest as much as possible in a high risk stock with the hope of earning a high rate of return. However, she wants her portfolio to have no more risk than the overall market. Which one of the following portfolios is most apt to meet all of her objectives?

A) Invest the entire $5,000 in a stock with a beta of 1.0
B) Invest $2,500 in a stock with a beta of 1.98 and $2,500 in a stock with a beta of 1.0
C) Invest $2,500 in a risk-free asset and $2,500 in a stock with a beta of 2.0
D) Invest $2,500 in a stock with a beta of 1.0, $1,250 in a risk-free asset, and $1,250 in a stock with a beta of 2.0
E) Invest $2,000 in a stock with a beta of 3, $2,000 in a risk-free asset, and $1,000 in a stock with a beta of 1.0

Question 48

Candy and More stock is expected to produce the following returns given the various states of the economy. What is the expected return on this stock?

A) 7.89 percent
B) 8.56 percent
C) 9.43 percent
D) 9.90 percent
E) 10.02 percent

Question 49

Based on the capital asset pricing model, which one of the following must increase the expected return on an individual security, all else constant?

A) An increase in the risk level of that security as measured by the standard deviation
B) An increase in the risk-free rate given a security beta of 1.42
C) A decrease in the market rate of return given a security beta of 1.13
D) A decrease in the market rate of return given a security beta of .78
E) A decrease in the risk-free rate given a security beta of 1.06

Question 50

You own a $46,000 portfolio comprised of four stocks. The values of stocks A, B, and C are $5,600, $16,700, and $11,400, respectively. What is the portfolio weight of stock D?

A) 26.74 percent
B) 28.39 percent
C) 30.33 percent
D) 32.10 percent
E) 32.58 percent

Question 51

Given the following information, what is the standard deviation of the returns on this stock?

A) 7.38 percent
B) 7.55 percent
C) 7.80 percent
D) 7.91 percent
E) 8.06 percent

Question 52

You own a portfolio that is invested as follows: $11,600 of stock A, $7,800 of stock B, $14,900 of stock C, and $3,200 of stock D. What is the portfolio weight of stock C?

A) 38.47 percent
B) 39.73 percent
C) 41.26 percent
D) 41.94 percent
E) 43.08 percent

Question 53

Given the following information, what is the variance of the returns on this stock?

A) 0.002453
B) 0.002663
C) 0.002691
D) 0.002759
E) 0.002914

Question 54

The capital asset pricing model:

A) assumes the market has a beta of zero.
B) rewards investors based on total risk.
C) considers the time value of money.
D) applies to portfolios but not to individual securities.
E) assumes the market risk premium is constant over time.

Question 55

Northern Wear stock has an expected return of 14.6 percent. Given the information below, what is the expected return on this stock if the economy is normal?

A) 13 percent
B) 16 percent
C) 18 percent
D) 21 percent
E) 23 percent

Question 56

Based on the capital asset pricing model, investors are compensated based on which of the following? I. market risk premium
II) portfolio standard deviation
III) portfolio beta
IV) risk-free rate

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

Question 57

Hal Enterprises stock has an expected return of 10.2 percent. Given the information below, what is the expected return if the economy is in a recession?

A) -12.94 percent
B) -11.71 percent
C) -11.28 percent
D) -10.76 percent
E) -10.03 percent

Question 58

Neighborhood Stores' stock has a risk premium of 9.6 percent while the inflation rate is 3.1 percent and the risk-free rate is 3.8 percent. What is the expected return on this stock?

A) 12.3 percent
B) 12.7 percent
C) 13.4 percent
D) 13.6 percent
E) 16.5 percent

Question 59

Blue Lagoon stock is expected to produce the following returns given the various states of the economy. What is the expected return on this stock?

A) 3.90 percent
B) 4.23 percent
C) 4.51 percent
D) 5.47 percent
E) 5.92 percent

Question 60

What is the expected return on a security given the following information?

A) 8.78 percent
B) 9.43 percent
C) 9.97 percent
D) 10.11 percent
E) 11.38 percent

Question 61

What is the beta of the following portfolio?

A) 0.98
B) 1.02
C) 1.11
D) 1.14
E) 1.20

Question 62

A portfolio has an expected return of 12.3 percent. This portfolio contains two stocks and one risk-free security. The expected return on stock X is 9.7 percent and on stock Y it is 17.7 percent. The risk-free rate is 3.8 percent. The portfolio value is $78,000 of which $18,000 is the risk-free security. How much is invested in stock X?

A) $18,600
B) $19,667
C) $21,375
D) $22,204
E) $24,800

Question 63

You currently own a portfolio valued at $80,000 that is equally as risky as the market. Given the information below, what is the beta of stock C?

A) 0.91
B) 0.95
C) 1.04
D) 1.13
E) 1.18

Question 64

Currently, you own a portfolio comprised of the following three securities. How much of the riskiest security should you sell and replace with risk-free securities if you want your portfolio beta to equal 90 percent of the market beta?

A) $7,023.15
B) $7,811.29
C) $8,666.67
D) $9,613.64
E) $10,318.50

Question 65

You currently own a portfolio valued at $56,000 that has a beta of 1.25. You have another $10,000 to invest and would like to invest it in a manner such that the portfolio beta decreases to 1.20. What does the beta of the new investment have to be?

A) 0.74
B) 0.79
C) 0.86
D) 0.92
E) 1.00

Question 66

A $36,000 portfolio is invested in a risk-free security and two stocks. The beta of stock A is 1.29 while the beta of stock B is 0.90. One-half of the portfolio is invested in the risk-free security. How much is invested in stock A if the beta of the portfolio is 0.58?

A) $6,000
B) $9,000
C) $12,000
D) $15,000
E) $18,000

Question 67

You own a portfolio consisting of the securities listed below. The expected return for each security is as shown. What is the expected return on the portfolio?

A) 9.97 percent
B) 10.86 percent
C) 11.23 percent
D) 12.09 percent
E) 14.20 percent

Question 68

You want to create a $48,000 portfolio that consists of three stocks and has an expected return of 14.5 percent. Currently, you own $16,700 of stock A and $24,200 of stockB. The expected return for stock A is 18.7 percent, and for stock B it is 11.2 percent. What is the expected rate of return for stock C?

A) 13.67 percent
B) 14.14 percent
C) 15.38 percent
D) 15.87 percent
E) 16.11 percent

Question 69

You would like to create a portfolio that is equally invested in a risk-free asset and two stocks. One stock has a beta of 1.14. What does the beta of the second stock have to be if you want the portfolio to be equally as risky as the overall market?

A) 0.62
B) 0.97
C) 1.23
D) 1.55
E) 1.86

Question 70

You want to create a $65,000 portfolio comprised of two stocks plus a risk-free security. Stock A has an expected return of 14.2 percent and stock B has an expected return of 17.8 percent. You want to own $20,000 of stockB. The risk-free rate is 4.8 percent and the expected return on the market is 13.1 percent. If you want the portfolio to have an expected return equal to that of the market, how much should you invest in the risk-free security?

A) $11,921
B) $13,509
C) $15,265
D) $17,314
E) $18,775

Question 71

Given the following information, what is the standard deviation of the returns on a portfolio that is invested 35 percent in both stocks A and C, and 30 percent in stock B?

A) 2.77 percent
B) 4.13 percent
C) 6.67 percent
D) 8.91 percent
E) 9.36 percent

Question 72

You own a $210,000 portfolio that is invested in stock A andB. The portfolio beta is equal to the market beta. Stock A has an expected return of 18.7 percent and has a beta of 1.42. Stock B has a beta of 0.88. What is the value of your investment in stock A?

A) $38,600
B) $42,333
C) $44,499
D) $46,666
E) $47,200

Question 73

Given the following information, what is the expected return on a portfolio that is invested 30 percent in both stocks A and C, and 40 percent in stock B?

A) 11.97 percent
B) 12.94 percent
C) 13.33 percent
D) 13.84 percent
E) 14.42 percent

Question 74

Given the following information, what is the standard deviation of the returns on a portfolio that is invested 40 percent in stock A, 35 percent in stock B, and the remainder in stock C?

A) 11.86 percent
B) 12.72 percent
C) 13.16 percent
D) 13.43 percent
E) 13.57 percent

Question 75

Stock A has an expected return of 15.6 percent and a beta of 1.27. Stock B has an expected return of 11.4 percent and a beta of 0.89. Both stocks have the same reward-to-risk ratio. What is the risk-free rate?

A) 1.56 percent
B) 2.28 percent
C) 2.79 percent
D) 3.35 percent
E) 3.92 percent

Question 76

You have compiled the following information on your investments. What rate of return should you expect to earn on this portfolio?

A) 9.54 percent
B) 9.83 percent
C) 10.01 percent
D) 10.27 percent
E) 10.58 percent

Question 77

You would like to invest $18,000 and have a portfolio expected return of 12.3 percent. You are considering two securities, A and B. Stock A has an expected return of 15.6 percent and B has an expected return of 10.3 percent. How much should you invest in stock A if you invest the balance in stock B?

A) $5,807
B) $6,792
C) $7,410
D) $7,936
E) $8,626

Question 78

What is the beta of the following portfolio?

A) 1.08
B) 1.14
C) 1.17
D) 1.21
E) 1.23

Question 79

Given the following information, what is the variance of the returns on a portfolio that is invested 40 percent in both stocks A and B, and 20 percent in stock C?

A) 0.002102
B) 0.002490
C) 0.002513
D) 0.005746
E) 0.006143

Question 80

Given the following information, what is the expected return on a portfolio that is invested 35 percent in Stock A, 45 percent in stock B, and the balance in Stock C?

A) 11.84 percent
B) 12.53 percent
C) 12.91 percent
D) 13.46 percent
E) 13.87 percent