Question 1

The risk of a portfolio is simply equal to the weighted average return variance of the securities that comprise it.

Accepted Answer

The risk of a portfolio is not equal to the weighted average return variance of the securities that comprise it. It is affected by the correlation among the securities in the portfolio and how their returns move together. This is known as diversification, and it can help to reduce overall risk. Therefore, the statement is false.

Question 2

Most nondiversifiable risk can be eliminated by creating a portfolio of around 30 stocks.

Accepted Answer

Nondiversifiable risk, also known as systematic risk, cannot be eliminated through diversification. It is inherent to the entire market or economy, affecting all investments. Diversification primarily reduces unsystematic risk, which is specific to individual stocks or sectors.

Question 3

A stock that went from $40 per share at the beginning of the year to $45 at the end of the year and paid a $2 dividend provided an investor with a ____ return.

Accepted Answer

To calculate the return on investment, we use the formula:

Total return = (End Price - Start Price + Dividend) / Start Price

Plugging in the values given, we get:

Total return = (45 - 40 + 2) / 40 
Total return = 7/40

To convert this into a percentage, we multiply by 100:

Total return = 17.5%

Therefore, the correct answer is (C) 17.5%.

Question 4

If a market is semi-strong form efficient, it also is by definition weak-form efficient.

Accepted Answer

This is true because a market that is semi-strong form efficient must also be weak-form efficient as it already reflects all publicly available information, including historical prices and trading volumes.

Question 5

Most market risk can be eliminated through diversification.

Accepted Answer

Diversification can help to reduce the impact of specific risks on a portfolio, but it cannot completely eliminate overall market risk. Factors such as economic conditions and geopolitical events can affect the entire market, and diversification cannot protect against these systemic risks.

Question 6

In general, securities with lower returns have lower historical standard deviations.

Accepted Answer

This is generally true as lower returns usually indicate less volatility and therefore lower standard deviations. However, outliers or extreme events can still occur and impact the standard deviation even for lower returning securities.

Question 7

A weak-form efficient market is one in which prices reflect all public knowledge, including past and current information.

Accepted Answer

A weak-form efficient market is one in which prices reflect all past market trading information such as price and volume, but not necessarily all public knowledge or information.

Question 8

The return on a portfolio is simply equal to the weighted average return of the securities that comprise it.

Accepted Answer

This is true. The return on a portfolio is calculated by taking the weighted average of the returns of individual securities within the portfolio.

Question 9

As defined in accordance with efficient markets notions, a weak-form efficient market would be a market in which asset prices reflect all:

Accepted Answer

The answer of As defined in accordance with efficient markets...

Question 10

Unsystematic risk is also known as:

Accepted Answer

Unsystematic risk is also known as firm-specific risk, which includes risks that are unique to a particular company, such as management issues, operational problems, and legal challenges. It can be mitigated to some extent through diversification, but cannot be eliminated entirely. Market risk (A) is also known as systematic risk and affects the entire market or a specific sector. Nondiversifiable risk (B) is another name for systematic risk, which cannot be eliminated through diversification. Macroeconomic risk (D) refers to broad economic factors such as inflation, interest rates, and GDP growth, which affect the overall economy and all firms within it.

Question 11

As defined in accordance with efficient markets notions, a strong-form efficient market would be a market in which asset prices reflect all:

Accepted Answer

A strong-form efficient market implies that asset prices reflect not only public information but also private information, making it the most complete and all-encompassing form of efficiency. Therefore, the correct option is D, which includes both public and private information.

Question 12

The only relevant risk for investors that hold diversified portfolios of securities is nondiversifiable risk.

Accepted Answer

Nondiversifiable risk, also known as systematic risk, affects the overall market and cannot be eliminated by diversification. Therefore, it is the only relevant risk for investors holding diversified portfolios. Diversifiable risk, also known as unsystematic risk, can be reduced through diversification.

Question 13

After controlling for risk, iIf someone were able to earn greater than the average returns for the market on a consistent basis using publicly available information, which form of market efficiency is violated?

Accepted Answer

The answer of After controlling for risk, iIf someone were...

Question 14

The market portfolio would have a beta of:

Accepted Answer

The market portfolio by definition has a beta of 1, because it represents the overall market and serves as the benchmark for measuring the risk and return of other stocks or portfolios. A beta of 0 would mean no correlation with the market, and a beta of 0.8 would imply less sensitivity to market movements than the average stock. The formula provided in option C is not relevant to this question.

Question 15

If prices in a particular market fully reflect all public and private knowledge, the market is efficient in the:

Accepted Answer

If prices in a market fully reflect all public and private knowledge, it means that not only all public information but every private insider information has been included, and the investors cannot have an extra edge with any information. Therefore, the market is efficient in strong form. Weak form efficiency, includes only the past market data, while semi-strong form efficiency includes all public information.

Question 16

The Security Market Line describes the relationship between the:

Accepted Answer

The Security Market Line (SML) is a graphical representation of the Capital Asset Pricing Model (CAPM), which shows the linear relationship between the expected return of a security and its systematic or market risk. The SML is derived from the CAPM equation, which states that the expected return of a security equals the risk-free rate plus the market risk premium multiplied by the security's beta coefficient. Therefore, the SML describes the expected return on securities based on their systematic risk, and it provides a benchmark for evaluating whether an investment is fairly priced, overpriced, or underpriced.

Question 17

The greatest level of risk reduction through diversification can be achieved when combining two securities whose returns are perfectly negatively correlated.

Accepted Answer

When two securities have perfectly negative correlation, they move in opposite directions. This means that when one goes up, the other always goes down, and vice versa. By combining such securities in a portfolio, an investor can cancel out the risks associated with each security, resulting in a portfolio with the lowest possible level of risk.

Question 18

An aggressive (that is, higher risk) portfolio would have a beta of:

Accepted Answer

Beta measures the volatility of a stock or portfolio compared to the overall market. A beta of 1 means that the stock or portfolio has the same volatility as the market. A beta of less than 1 but greater than 0 indicates less volatility than the market, while a beta of more than 1 indicates higher volatility than the market. Therefore, an aggressive portfolio, which is expected to have higher risk and volatility, would have a beta of more than 1.

Question 19

An asset's beta can be estimated by regressing its returns against the returns for the market portfolio.

Accepted Answer

This is known as the market model or the capital asset pricing model (CAPM) and is a common method for estimating an asset's beta.

Question 20

The slope of the linear relation between the returns on a stock and the returns on the market portfolio is called the:

Accepted Answer

The slope of the linear relation between the returns on a stock and the returns on the market portfolio is called the beta. This measures the stock's systematic risk or the stock's sensitivity to market movements. Alpha measures the excess return of the stock, covariance measures the joint variability of two assets, and coefficient of variance measures the relative volatility of an investment.

Quiz 12: Financial Return and Risk Concepts