Question 1

The market risk premium can be deﬁned as the:
A) Return on the market plus the risk-free rate of return.
B) Amount of return received for accepting unsystematic risk.
C) Beta multiplied by the risk-free rate of return.
D) Slope of the market portfolio's security market line.
E) Intercept point of the security market line.

Accepted Answer

The market risk premium is the slope of the security market line (SML), which represents the additional return expected from holding a risky market portfolio instead of risk-free assets.

Question 2

Unsystematic risk is also known as _____________________.
A) Total risk.
B) Market risk.
C) Asset-speciﬁc risk.
D) Non-diversiﬁable risk.
E) Speciﬁc risk.

Accepted Answer

The answer of Unsystematic risk is also known as _____________________.
A)...

Question 3

The news that inﬂuences the unanticipated rate of return on a stock is called the:
A) Surprise.
B) Expected rate of return.
C) Beta.
D) Systematic risk.
E) Asset-speciﬁc risk.

Accepted Answer

The news that influences the unanticipated rate of return on a stock is called a surprise. It is unexpected and can cause sudden changes in the market value of the stock. This surprise can be positive or negative, and its impact on the stock's return cannot be predicted with certainty.

Question 4

According to the capital asset pricing model:
A) There is an inverse relationship between risk and return.
B) A stock which earns a higher rate of return than the market should have a beta which is greater than 1.0.
C) An increase in the risk-free rate without a corresponding increase in the market rate of return indicates that the risk premium for a stock with a beta of .8 will increase.
D) A stock with a beta of 1 will see its expected rate of return increase by 20% if its beta rises to 1.2, all else constant.
E) A stock with a beta of 2.0 will see its return decline by 2% should the risk-free rate decline from 3% to 2%, all else constant.

Accepted Answer

The answer of According to the capital asset pricing model:
A)...

Question 5

The slope of the security market line is the ________________.
A) Standard deviation.
B) Portfolio weight.
C) Beta coeﬃcient.
D) Risk-free interest rate.
E) Market risk premium.

Accepted Answer

The slope of the security market line (SML) represents the market risk premium, which is the difference between the expected return on the market portfolio and the risk-free rate.

Question 6

Which one of the following is an example of diversiﬁable risk?
A) A decrease in the average cost of living.
B) An increase in the prime interest rate.
C) An increase in the minimum hourly wage.
D) A new government regulation on aircraft engines.
E) A decrease in federal income taxes on business incomes.

Accepted Answer

A new government regulation on aircraft engines is an example of diversifiable risk because it only affects companies involved in the aircraft industry. Other industries are not affected by this risk, so diversification across multiple industries can help to offset the risk. The other options listed are macroeconomic or systematic risks that affect the entire economy and cannot be diversified away.

Question 7

Which of the following is true concerning diversiﬁcation? Assume that the securities being considered for selection into a portfolio are not perfectly correlated.
A) The risk of the portfolio is certain to be increased as securities are added.
B) As more securities are added to the portfolio, the market risk of the portfolio declines.
C) After about 10 securities are added to the portfolio, additional securities have essentially no impact on reducing risk.
D) As more and more securities are added to the portfolio, the level of risk approaches the level of systematic risk in the market.
E) If you hold more than 100 securities, then the portfolio is risk-free.

Accepted Answer

Diversification reduces unsystematic risk, and as more securities are added, the portfolio's risk approaches the level of systematic risk, which cannot be diversified away.

Question 8

The return anticipated on a risky asset in the future is the ____________ return.
A) Unexpected.
B) Expected.
C) Actual.
D) Unsystematic.
E) Systematic.

Accepted Answer

The return anticipated on a risky asset in the future is referred to as the expected return because it is a prediction based on available information and analysis, and is not a guarantee of actual returns.

Question 9

The pure time value of money is called the:
A) Market rate of return.
B) Risk-free rate of return.
C) Beta adjusted market rate of return.
D) Beta adjusted market risk premium.
E) Beta adjusted risk-free rate of return.

Accepted Answer

The pure time value of money refers to the compensation an investor should receive for the postponement of consumption. This compensation is the risk-free rate of return, which is the return an investor can earn by investing in an asset with no default risk, such as a government bond. Therefore, the best choice is B, the risk-free rate of return.

Question 10

A security that has a rate of return that exceeds the Treasury bill rate but is less than the market rate of return must:
A) Be a risk-free asset.
B) Have a beta that is greater than 1.0 but less than 2.0.
C) Be a risk-free asset with a beta less than .99.
D) Be a risky asset with a standard deviation less than 1.0.
E) Be a risky asset with a beta less than 1.0.

Accepted Answer

A security with a rate of return that exceeds the risk-free rate but is less than the market rate of return is considered a risky asset. The fact that the rate of return is less than the market rate of return suggests that its beta is less than 1.0, as a beta greater than 1.0 would mean that the asset offers a rate of return that is higher than the market. Therefore, the best choice is E - a risky asset with a beta less than 1.0.

Question 11

Which of A and B has the least total risk? The least systematic risk?
A) A; A
B) A; B
C) B
D) B; B
E) Cannot be determined without more information.

Accepted Answer

The answer of Which of A and B has the...

Question 12

A portfolio beta can be deﬁned as the:
A) Weighted average of the betas of the individual securities within the portfolio.
B) Total of the betas of the individual securities within the portfolio.
C) Amount of unsystematic risk remaining after the portfolio is diversiﬁed.
D) Measure of the unsystematic risk of the portfolio relative to the level of market risk.
E) Measure of the total risk of the portfolio in excess of the level of market risk.

Accepted Answer

A portfolio beta is a weighted average of the betas of the individual securities within the portfolio. Beta measures the sensitivity of a security's returns to the market returns and a portfolio's beta measures the sensitivity of the portfolio's return to the market returns. Therefore, it makes sense that the portfolio beta is a weighted average of the individual securities' betas, where the weights are the proportion of each security's value within the portfolio.

Question 13

Which one of the following would tend to indicate that 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.

Accepted Answer

A decrease in the portfolio standard deviation would indicate that the portfolio is being effectively diversified. This means that the portfolio is becoming less risky by spreading investments across different assets, reducing the impact of any single asset on the overall portfolio. A decrease in the portfolio beta could also indicate diversification, but it is not as reliable an indicator as the standard deviation, which directly measures the portfolio's volatility. An increase in portfolio rate of return is not necessarily an indication of diversification, as it could be due to a concentration in a risky asset or sector.

Question 14

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.

Accepted Answer

Unsystematic risk, also known as specific risk or diversifiable risk, pertains to risks that can be mitigated by diversifying one's investments. An oil tanker running aground and spilling its cargo is an example of unsystematic risk as it only affects the specific company or industry involved and not the overall market. The other options listed are examples of systematic risk, which affects the overall market and cannot be diversified away.

Question 15

Diversiﬁable risks:
A) Are measured by beta.
B) Affect the entire market.
C) Are systematic in nature.
D) Are rewarded in the market place.
E) Are also referred to as unique risks.

Accepted Answer

Diversifiable risks, also known as unsystematic risks or unique risks, are risks that are specific to a particular company or industry and can be reduced through diversification. They are not rewarded in the market place and are not measured by beta. Systematic risks, on the other hand, are risks that affect the entire market or a particular segment of the market, and are measured by beta.

Question 16

Brady Lady Cosmetics just announced that earnings for the ﬁrst quarter of the current year grew at an annualized rate of 3%, well above the rate for the same quarter the previous year. Upon the
Announcement, the stock price did not change. (The market in general was unchanged also.) Which
Of the following is most likely correct?
A) Brady's price didn't change since the market was surprised by the announcement.
B) Interest rates in the economy must have increased.
C) Brady's price didn't change because investors likely anticipated the news release.
D) Brady's price didn't change because the market in general was unchanged.
E) Brady must have a beta coeﬃcient equal to 1.

Accepted Answer

The stock price likely didn't change because investors had already anticipated the earnings growth, meaning the information was already reflected in the stock price before the announcement.

Question 17

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.

Accepted Answer

The risk premium for an individual security is computed by multiplying the security's beta by the market risk premium. This calculation is part of the Capital Asset Pricing Model (CAPM), which is used to determine a theoretically appropriate required rate of return of an asset, considering its risk relative to the market.

Question 18

Individual investors:
A) Should expect to earn a rate of return based on the total risk of their portfolios.
B) Need to own at least 50 stocks if they wish to create a diversiﬁed portfolio.
C) Are responsible for eliminating unsystematic risk.
D) Can create a portfolio such that the portfolio beta is less than the lowest beta of any security held in the portfolio.
E) Can generally create a diversiﬁed portfolio of risky assets such that the standard deviation of the portfolio equals zero.

Accepted Answer

Individual investors can eliminate unsystematic risk through diversification, which is the risk specific to individual assets.

Question 19

The principle of diversiﬁcation states that spreading an investment over a number of assets will eliminate:
A) All of the risk.
B) All of the systematic risk and part of the unsystematic risk.
C) All of the unsystematic risk and part of the systematic risk.
D) Most of the systematic risk.
E) Most of the unsystematic risk.

Accepted Answer

Diversification reduces unsystematic risk, which is specific to individual assets, but cannot eliminate systematic risk, which affects the entire market.

Question 20

Asset A, which has an expected return of 12% and a beta of 0.8, plots on the security market line. Which of the following is false about Asset B, another risky asset with a beta of 1.4?
A) If the market is in equilibrium, Asset B also plots on the SML.
B) If Asset B plots on the SML, then Asset B and Asset A have the same reward to risk ratio.
C) Asset B has more systematic risk than both Asset A and the market portfolio.
D) If Asset B plots on the SML with an expected return = 18%, then the risk-free rate must be 4%.
E) If Asset B plots on the SML with an expected return = 18%, the expected return on the market must be 15%.

Accepted Answer

The answer of Asset A, which has an expected return...

Quiz 13: Return, Risk, and the Security Market Line

The market risk premium can be deﬁned as the:

Unsystematic risk is also known as _____________________.

The news that inﬂuences the unanticipated rate of return on a stock is called the:

According to the capital asset pricing model:

The slope of the security market line is the ________________.

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

Which of the following is true concerning diversiﬁcation? Assume that the securities being considered for selection into a portfolio are not perfectly correlated.

The return anticipated on a risky asset in the future is the ____________ return.

The pure time value of money is called the:

A security that has a rate of return that exceeds the Treasury bill rate but is less than the market rate of return must:

Which of A and B has the least total risk? The least systematic risk?

A portfolio beta can be deﬁned as the:

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

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

Diversiﬁable risks:

The risk premium for an individual security is computed by:

Individual investors:

The principle of diversiﬁcation states that spreading an investment over a number of assets will eliminate:

Asset A, which has an expected return of 12% and a beta of 0.8, plots on the security market line. Which of the following is false about Asset B, another risky asset with a beta of 1.4?