Question 1

Because of differences in the expected returns of different securities, the standard deviation is not always an adequate measure of risk.However, the coefficient of variation always will allow an investor to properly compare the relative risks of any two securities.

Accepted Answer

False

Question 2

Risk is defined as the chance (probability) of actually observing outcomes that are less than expected, or unfavorable.Outcomes that are greater than expected are not considered when evaluating risk because such occurrences are desirable.

Accepted Answer

False

Question 3

The expected rate of return of an asset will always equal one of the possible rates of return for that asset.

Accepted Answer

The expected rate of return is the weighted average of all possible rates of return for an asset, so it may not always equal any single possible rate of return.

Question 4

The only condition under which risk can be reduced to zero is to find securities that are perfectly negatively correlated (r = -1.0) with each other.

Accepted Answer

The answer of The only condition under which risk can...

Question 5

Risk is defined as the chance (probability) of actually observing outcomes that are greater than expected, or favorable.Such outcomes are more desirable than observing less-than-expected events, so the possibility that positive outcomes will occur must be emphasised when evaluating risk.

Accepted Answer

Risk is typically associated with the probability of negative or unfavorable outcomes, not positive ones. It involves the potential for loss or harm rather than gain.

Question 6

The tighter the probability distribution, the less variability there is and the less likely it is that the actual outcome will be close to the expected value; consequently the more likely it is that the actual return will be much different from the expected return.

Accepted Answer

The statement is incorrect. The tighter the probability distribution, the less variability there is and the more likely it is that the actual outcome will be close to the expected value. Therefore, the actual return is less likely to be much different from the expected return.

Question 7

A firm cannot change its beta through any managerial decision because betas are completely market determined.

Accepted Answer

The answer of A firm cannot change its beta through...

Question 8

If I know for sure that the market will have a positive return over the next year, to maximise my rate of return, I should increase the beta of my portfolio.

Accepted Answer

The answer of If I know for sure that the...

Question 9

Risk really should not be a significant factor when making financial decision because all business decisions involve predictions about the future, which is unknown.As a result, all decisions automatically include some consideration of risk.

Accepted Answer

Risk is a significant factor when making financial decisions because all decisions involve some element of uncertainty and potential losses. Effective financial decision-making involves evaluating and managing risks, rather than ignoring them.

Question 10

The Y-axis intercept of the SML indicates the return on the individual asset when the realised return on an average share (beta = 1.0) is zero.

Accepted Answer

The Y-axis intercept of the Security Market Line (SML) represents the risk-free rate, not the return on an individual asset when the average share's return is zero.

Question 11

While the portfolio return is a weighted average of realised security returns, portfolio risk is not necessarily a weighted average of the standard deviations of the securities in the portfolio.It is this aspect of portfolios that allows investors to combine shares and actually reduce the riskiness of a portfolio.

Accepted Answer

Portfolio risk can be reduced by diversification, which means investing in securities with low or negative correlations. This reduces the volatility of the portfolio and allows for a potential reduction in risk without sacrificing returns. Therefore, portfolio risk is not necessarily a weighted average of the standard deviations of the securities in the portfolio.

Question 12

A listing of all possible outcomes, or events, with a probability assigned to each is called a probability distribution.

Accepted Answer

This is the definition of a probability distribution.

Question 13

In the real world, the type of security that generates a return that is nearest to a risk-free rate of return is a Treasury bill.

Accepted Answer

Treasury bills are backed by the government and are considered to have a low risk of default, making them a relatively secure investment. As a result, their returns are generally closest to a risk-free rate of return.

Question 14

If we develop a weighted average of the possible return outcomes, multiplying each outcome or "state" by its respective probability of occurrence for a particular share, we can construct a payoff matrix of expected returns.

Accepted Answer

This statement accurately describes how a payoff matrix of expected returns can be constructed using a weighted average of the possible return outcomes multiplied by their respective probabilities of occurrence.

Question 15

Market risk refers to the tendency of a share to move with the general share market.A share with above-average market risk will tend to be more volatile than an average share, and it will have a beta which is greater than 1.0.

Accepted Answer

This statement is true. Market risk refers to the risk inherent in the overall market, and shares with high market risk will tend to move more in line with the market as a whole. Beta, a commonly used measure of market risk, is a measure of how sensitive a share is to movements in the market, with a beta greater than 1.0 indicating above-average market risk.

Question 16

Assume Share A has a standard deviation of 0.21 while Share B has a standard deviation of 0.10.If both Share A and Share B must be held in isolation, and if investors are risk averse, we can conclude that Share A will have a greater required return.However, if the assets could be held in portfolios, it is conceivable that the required return could be higher on the low standard deviation stock.

Accepted Answer

When held in isolation, investors will require a higher return for Share A due to its higher standard deviation. However, when held in a portfolio, diversification can reduce overall risk, and the lower standard deviation of Share B may make it a more attractive investment option, potentially resulting in a higher required return for Share B.

Question 17

Which of the following statements is correct?

Accepted Answer

The Security Market Line (SML) represents the relationship between the expected return of a security and its systematic risk, measured by beta. The slope and intercept of the SML are determined by market conditions and investor expectations, not by financial managers.

Question 18

Risk is indicated by variability, whether the variability is considered positive or negative.Both the positive and negative outcomes must be evaluated when considering risk because all unexpected possibilities should be examined, even the positive ones.

Accepted Answer

When evaluating risk, both positive and negative outcomes must be considered because unexpected possibilities, regardless of whether they are positive or negative, should be explored.

Question 19

Combining shares with perfectly correlated shares returns into a portfolio is less risky than holding an individual share since the portfolio will benefit from diversification.

Accepted Answer

Combining shares with perfectly correlated returns actually does not result in diversification and therefore the portfolio is not less risky than holding an individual share. In fact, the portfolio will have the same risk as holding a single share. True diversification comes from combining shares with uncorrelated or negatively correlated returns.

Question 20

The standard deviation is the weighted average of all the deviations from the expected value, and it indicates how far above or below the expected value the actual value is expected to be.

Accepted Answer

The answer of The standard deviation is the weighted average...

Quiz 8: Risk and Rates of Return