Question 1

The beta of any portfolio can be computed as the
A) slope of the security market line
B) sum of the betas for each asset held in the portfolio divided by the number of assets in the portfolio.
C) the standard deviation of the expected returns of the portfolio minus the risk-free rate.
D) weighted average of the betas for each asset held in the portfolio.

Accepted Answer

The beta of a portfolio is a weighted average of the betas of the individual assets held in the portfolio. The weights are determined by the proportion of each asset in the portfolio. Therefore, the correct choice is D – weighted average of the betas for each asset held in the portfolio.

Question 2

Assume there are only three possible states of nature for the economy in the future: boom,normal,and recession.If there is a 25% chance of a recession and a 30% chance of a boom,then what is the probability of a normal economy in the future?
A) 45%
B) 30%
C) 25%
D) 100%

Accepted Answer

The probability of all possible outcomes (boom, normal, recession) must sum to 100%. Given a 25% chance of recession and a 30% chance of a boom, the probability of a normal economy is 100% - 25% - 30% = 45%.

Question 3

Suppose that two firms,A and B,have identical expected returns but Firm A has the possibility of a much higher return than Firm B.We can conclude from this that Firm A will have a higher coefficient of variation than Firm B.

Accepted Answer

The answer of Suppose that two firms,A and B,have identical...

Question 4

The realized portfolio return is the weighted average of the relative weights of securities in the portfolio multiplied by their respective expected returns.

Accepted Answer

The realized portfolio return is the actual return earned on the portfolio, reflecting the weighted average of the actual returns of the securities in the portfolio, not their expected returns.

Question 5

The ____ the probability distribution,the ____ variability there is and the ____ likely it is that the actual outcome will approach the expected value.
A) looser;less;more
B) tighter;more;less
C) tighter;less;more
D) looser;more;less
E) both c and d are correct.

Accepted Answer

The answer of The ____ the probability distribution,the ____ variability...

Question 6

When combining many assets into a portfolio the correlation between the variables has a(n)____ impact on the overall risk of the portfolio than the overall risk of each asset.
A) larger
B) equal
C) smaller
D) none of the above

Accepted Answer

Correlation measures how assets move in relation to each other. When combining many assets into a portfolio, the correlation between the variables has a larger impact on the overall risk of the portfolio than the overall risk of each asset. This is because if assets are highly correlated, they tend to move in the same direction, increasing the overall risk of the portfolio. Conversely, if assets are negatively correlated, they tend to move in opposite directions, reducing the overall risk of the portfolio. Therefore, it is important to consider correlation when constructing a portfolio to manage risk.

Question 7

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

Accepted Answer

A firm can influence its beta through decisions related to its capital structure, investment projects, and operational changes, which can affect its risk profile and thus its beta.

Question 8

Businesses earn returns for security holders by purchasing and operating physical assets.The relevant risk of any physical asset must be measured in terms of its effect on the risk of the firm's securities.

Accepted Answer

The statement accurately describes how businesses generate returns for security holders by acquiring and managing physical assets. The risk associated with these assets must be evaluated in relation to the broader risk of the firm's securities to determine their impact on overall returns.

Question 9

The biggest reduction in risk would be achieved by combining two assets into a portfolio with a correlation coefficient equal to ____.
A) −1.0
B) −0.5
C) 0
D) 0.5
E) 1.0

Accepted Answer

The correlation coefficient ranges from -1 to +1, with -1 indicating a perfect negative correlation and +1 indicating a perfect positive correlation. When two assets have a correlation coefficient of -1, they move in opposite directions, i.e., when one asset goes up, the other goes down. Therefore, combining two assets with a correlation coefficient of -1 would create a perfectly hedged portfolio that eliminates all risk.

Question 10

If investors become more averse to risk,the slope of the Security Market Line (SML)will increase.

Accepted Answer

When investors become more averse to risk, they require a higher return for taking on additional risk. This results in an increase in the slope of the SML, as the expected return on a given investment must increase to compensate for the higher level of risk.

Question 11

Here are the expected returns on two stocks:  If you form a 50−50 portfolio of the two stocks,what is the portfolio's standard deviation?
A) 8.1%
B) 10.5%
C) 13.4%
D) 16.5%
E) 20.0%

Accepted Answer

The answer of Here are the expected returns on two...

Question 12

Assume Stock A has a standard deviation of 0.21 while Stock B has a standard deviation of 0.10.If both Stock A and Stock B must be held in isolation,and if investors are risk averse,we can conclude that Stock 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 investors can hold a portfolio of stocks, they can diversify their risk, and the overall risk of the portfolio will depend not only on the individual stock's risk but also on the correlation between the stocks. Therefore, the required return on the low standard deviation stock could be higher if it has a low correlation with other stocks in the portfolio. This is known as the diversification effect. However, if the stocks must be held in isolation, the stock with a higher standard deviation will have a higher required return due to its higher risk.

Question 13

When considering stock and bond valuation models,we implicitly assume that the marginal investor is risk averse,which means that he or she requires a higher rate of return for a given level of risk than a risk neutral individual,other things held constant.

Accepted Answer

The statement accurately describes the assumption made in stock and bond valuation models. Marginal investors are typically assumed to be risk averse, meaning they require a higher rate of return in exchange for taking on greater risk. This assumption helps to explain why certain investments may be priced higher or lower based on their perceived level of risk.

Question 14

Risk averse investors require ____ rates of return for investments with ____ risk.
A) higher;lower
B) lower;higher
C) lower;lower
D) higher;higher
E) both c and d are correct

Accepted Answer

Risk averse investors are not comfortable taking high risks and hence they require higher rates of return for the same amount of risk. Lower rates of return only attract investors who are willing to take more risk.

Question 15

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

Accepted Answer

This statement is correct. Market risk, also known as systematic risk, refers to the risk that is inherent in the overall market. A stock with a high market risk will tend to move in the same direction as the broader market, and its price will be more volatile than that of an average stock. The beta coefficient measures a stock's market risk, and a beta greater than 1.0 indicates that the stock is more volatile than the market as a whole.

Question 16

____ is the appropriate measure for stand-alone risk and ____ is the appropriate measure of risk when adding an asset to a diversified portfolio.
A) beta;variance
B) beta;standard deviation
C) standard deviation;beta
D) standard deviation;variance

Accepted Answer

Standard deviation is a measure of total risk, including both diversifiable and non-diversifiable risk, and is appropriate for stand-alone risk. Beta, on the other hand, measures only systematic risk and is therefore appropriate for measuring the risk of an asset only within a diversified portfolio.

Question 17

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 stock,we can construct a payoff matrix of expected returns.

Accepted Answer

This statement is true. A weighted average of possible return outcomes can be multiplied by the probability of occurrence to construct a payoff matrix of expected returns.

Question 18

Which type of risk can be eliminated through diversification?
A) total risk
B) market risk
C) firm specific risk
D) none of the above

Accepted Answer

Diversification helps to eliminate firm-specific risk, which is unique to a particular company and can be reduced by investing in a variety of stocks or securities. However, it does not eliminate total risk or market risk, which are inherent in the entire market or economy.

Question 19

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

The answer of Because of differences in the expected returns...

Question 20

Portfolio A contains only one security,while Portfolio B contains 100 securities.Because of diversification effects,we would expect Portfolio B to have the lower relevant risk,but it is possible for Portfolio A to be less risky.

Accepted Answer

Diversification reduces unsystematic risk, but if Portfolio A's single security is inherently less volatile or risky than the securities in Portfolio B, then Portfolio A could indeed be less risky overall.

Quiz 11: Risk and Rates of Return

The beta of any portfolio can be computed as the

Assume there are only three possible states of nature for the economy in the future: boom,normal,and recession.If there is a 25% chance of a recession and a 30% chance of a boom,then what is the probability of a normal economy in the future?

Suppose that two firms,A and B,have identical expected returns but Firm A has the possibility of a much higher return than Firm B.We can conclude from this that Firm A will have a higher coefficient of variation than Firm B.

The realized portfolio return is the weighted average of the relative weights of securities in the portfolio multiplied by their respective expected returns.

The the probability distribution,the variability there is and the likely it is that the actual outcome will approach the expected value.

When combining many assets into a portfolio the correlation between the variables has a(n) ____ impact on the overall risk of the portfolio than the overall risk of each asset.

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

Businesses earn returns for security holders by purchasing and operating physical assets.The relevant risk of any physical asset must be measured in terms of its effect on the risk of the firm's securities.

The biggest reduction in risk would be achieved by combining two assets into a portfolio with a correlation coefficient equal to ____.

If investors become more averse to risk,the slope of the Security Market Line (SML)will increase.

Here are the expected returns on two stocks: If you form a 50−50 portfolio of the two stocks,what is the portfolio's standard deviation?

When considering stock and bond valuation models,we implicitly assume that the marginal investor is risk averse,which means that he or she requires a higher rate of return for a given level of risk than a risk neutral individual,other things held constant.

Risk averse investors require rates of return for investments with risk.

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

is the appropriate measure for stand-alone risk and is the appropriate measure of risk when adding an asset to a diversified portfolio.

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 stock,we can construct a payoff matrix of expected returns.

Which type of risk can be eliminated through diversification?

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.

Portfolio A contains only one security,while Portfolio B contains 100 securities.Because of diversification effects,we would expect Portfolio B to have the lower relevant risk,but it is possible for Portfolio A to be less risky.