Question 1

Assume you are looking at a security market line graph.Where would an overpriced stock with a beta of .98 plot on that graph?
A)To the right of the market and below the security market line
B)To the left of the market and below the security market line
C)To the right of the market and above the security market line
D)To the left of the market and above the security market line
E)To the right of the market on the security market line

Accepted Answer

An overpriced stock with a beta of .98 would have a lower expected return than the market return for its level of risk (beta). This means it would plot below the security market line. Since its beta is less than 1, it would also plot to the left of the market on the security market line. Therefore, the correct answer is B - to the left of the market and below the security market line.

Question 2

Assume the risk-free rate and the market risk premium are both positive.Trevor currently owns a portfolio comprised of risky and risk-free securities.The portfolio has an expected return of 11.2 percent,a standard deviation of 16.2 percent,and a beta of 1.21.He has decided that he would prefer a higher expected return.Which one of these actions should he take?
A)Replace a stock in his current portfolio with a beta of 1.34 with a stock that has a 1.02 beta
B)Sell a portion of the risky assets and use the proceeds to purchase risk-free securities
C)Lower both the portfolio standard deviation and beta
D)Increase the portfolio weight of the risky assets without affecting the total portfolio value
E)Increase the standard deviation of the portfolio without affecting the portfolio beta

Accepted Answer

Increasing the portfolio weight of the risky assets will increase the expected return, as risky assets typically offer higher returns than risk-free securities.

Question 3

You want your portfolio beta to be 1.3.Currently,the portfolio consists of $100 invested in stock A with a beta of 1.5 and $300 in stock B with a beta of .8.You have another $400 to invest and want to divide it between an asset with a beta of 1.7 and a risk-free asset.How much should you invest in the risk-free asset?
A)$17.65
B)$50.25
C)$200.15
D)$382.35
E)$400.00

Accepted Answer

Portfolio value = $100 + 300 + 400 = $800Beta_Portfolio = 1.3 = ($100/$800 × 1.5)+ ($300/$800 × .8)+ (x/$800 × 1.7)+ (($400 - x)/$800 × 0)x = $382.35Risk-free asset = $400 - 382.35 = $17.65

Question 4

You plotted the monthly rate of return for two securities against time for the past 48 months.If the pattern of the movements of these two sets of returns rose and fell together the majority,but not all of the time,then the securities have:
A)no correlation at all.
B)a weak negative correlation.
C)a strong negative correlation.
D)a strong positive correlation.
E)a perfect positive correlation.

Accepted Answer

If the two sets of returns moved together for the majority of the time, they have a positive correlation. Moreover, a strong positive correlation exists between them because they rose and fell together for most of the time.

Question 5

The combination of the efficient set of portfolios with a riskless lending and borrowing rate results in:
A)the capital market line which shows that investors will only invest in the riskless asset.
B)the capital market line which shows that investors will invest in a combination of the riskless asset and the tangency portfolio.
C)the security market line which shows that all investors will invest in the riskless asset only.
D)the security market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio.
E)the capital market line which shows that investors will invest at the vertical intercept point of that line.

Accepted Answer

The combination of the efficient set of portfolios with a riskless lending and borrowing rate results in the capital market line, which shows that investors will invest in a combination of the riskless asset and the tangency portfolio. This is because the tangent portfolio is the most efficient portfolio in terms of risk and return, and investors can achieve any level of risk and return they desire by combining this portfolio with the riskless asset. Therefore, the optimal portfolio for investors is a combination of the two assets.

Question 6

Well-diversified portfolios have negligible:
A)systematic risks.
B)unsystematic risks.
C)expected returns.
D)variances.
E)covariances.

Accepted Answer

A well-diversified portfolio eliminates or significantly reduces unsystematic risks, also known as idiosyncratic risks, which are specific to individual assets. Systematic risks, such as market risk or interest rate risk, cannot be diversified away but have a lower impact on the portfolio when it is well-diversified. Expected returns, variances, and covariances are not negligible but are important factors to consider in portfolio management.

Question 7

A stock with a beta of zero would be expected to have a rate of return equal to:
A)the prime rate.
B)the average AAA bond.
C)the market rate.
D)the risk-free rate.
E)zero.

Accepted Answer

A beta of zero means that the stock is not correlated with the market, and therefore its rate of return is not affected by market fluctuations. The risk-free rate represents the minimum return an investor can expect for taking on no risk, making it the expected rate of return for a stock with a beta of zero.

Question 8

A portfolio is comprised of five securities that have individual betas of 1.38,.87,1.02,1.49,and .67.You do not know the portfolio weight of each security.What do you know with certainty?
A)The portfolio beta will not be affected by any change in the portfolio weights.
B)The portfolio beta will not change if an additional security with a beta of 1 is added to the portfolio.
C)The portfolio beta will be greater than the market beta.
D)The portfolio beta will be less than 1.49 and greater than .67.
E)The optimal portfolio beta for any investor must be greater than 0 and less than 1.

Accepted Answer

We know with certainty that the portfolio beta will be a weighted average of the individual betas, and thus will be less than 1.49 (the highest individual beta) and greater than 0.67 (the lowest individual beta). This eliminates options A, B, and E. We do not have enough information to determine if the portfolio beta will be greater than the market beta, so option C is not necessarily true.

Question 9

The risk of an individual security that will be compensated by the market depends upon the:
A)standard deviation of that security.
B)covariance of that security with the market.
C)expected rate of return on that security.
D)security's historical variance.
E)industry most associated with that security.

Accepted Answer

Covariance measures the degree to which two variables move in relation to each other. In finance, it is used to measure how closely the returns on a particular security are related to the returns on the overall market. A high covariance with the market indicates that the security's returns are closely tied to the overall market, meaning that its risk will be compensated by the market.

Question 10

The dominant portfolio with the lowest possible level of risk out of a set of portfolios comprised of two securities is referred to as the:
A)efficient frontier.
B)minimum variance portfolio.
C)upper tail of the efficient set.
D)tangency portfolio.
E)risk-free portfolio.

Accepted Answer

The minimum variance portfolio is the portfolio with the lowest possible level of risk in a set of portfolios comprised of two securities. It is the portfolio that provides the highest level of diversification for the given level of expected return.

Question 11

The separation principle states that an investor will:
A)choose any efficient portfolio and invest some amount in the riskless asset to generate the expected return.
B)never choose to invest in the riskless asset because the expected return on the riskless asset is lower over time.
C)invest only in the riskless asset and tangency portfolio choosing the weights of each based on his/her individual risk tolerance.
D)randomly select any efficient portfolio.
E)select a portfolio based solely on his/her desired rate of return while ignoring the associated risks of their selection.

Accepted Answer

The answer of The separation principle states that an investor...

Question 12

A stock with an actual return that lies above the security market line:
A)has less systematic risk than the overall market.
B)has more risk than warranted based on the realized rate of return.
C)has yielded a return equivalent to the level of risk assumed.
D)has more systematic risk than the overall market.
E)has yielded a higher return than expected for the level of risk assumed.

Accepted Answer

The security market line represents the expected rate of return based on the level of systematic risk (beta) assumed by the investors. Any stock that lies above the security market line has provided a higher actual return than what was expected based on its beta. This indicates that the stock has yielded a higher return than expected for the level of risk assumed. Therefore, option E is the correct answer.

Question 13

According to the capital asset pricing model,the expected return on a security is:
A)negatively and linearly related to the security's beta.
B)positively and linearly related to the security's beta.
C)positively and non-linearly related to the security's beta.
D)positively and linearly related to the security's variance.
E)negatively and non-linearly related to the security's beta.

Accepted Answer

The Capital Asset Pricing Model states that the expected return on a security is positively and linearly related to the security's beta. This means that as the beta of a security increases, the expected return also increases. Beta is a measure of the volatility of a security compared to the overall market, and the CAPM assumes that investors require compensation for taking on additional risk.

Question 14

What is the first step an investor takes when making an investment decision according to the separation principle?
A)Determining the mix of risky and risk-free assets he/she will hold
B)Quantifying the amount of risk he/she is willing to accept
C)Estimating future inflation and risk-free rates
D)Determining the portfolio of risky assets that he/she will hold
E)Specifying a desired rate of return

Accepted Answer

The separation principle suggests that the first step is to determine the optimal portfolio of risky assets, independent of the investor's risk preferences.

Question 15

The excess return earned by an asset that has a beta of one over that earned by a risk- free asset is referred to as the:
A)market rate of return.
B)systematic return.
C)real rate of return.
D)market risk premium.
E)total return.

Accepted Answer

The excess return earned by an asset that has a beta of one over that earned by a risk-free asset is referred to as the market risk premium.

Question 16

Mr.Rhoades is the CEO of Daily News.The majority of stockholders do not approve of the decisions made by Mr.Rhoades and have repeatedly requested that he be ousted.Over the last couple of months,it has become apparent that the CEO is going to be replaced by a member of the board,Mr.Bentley,who is highly respected.This morning,the official announcement was made that Mr.Rhoades has stepped down and will be replaced immediately by Mr.Bentley.How is the stock price of the Daily News most apt to react to this announcement?
A)Highly positive and immediate reaction
B)A slow but positive reaction
C)An immediate negative reaction
D)An immediate positive reaction followed by a slight downward drift
E)No reaction

Accepted Answer

The answer of Mr.Rhoades is the CEO of Daily News.The...

Question 17

The market risk premium is computed by:
A)adding the risk-free rate of return to the inflation rate.
B)adding the risk-free rate of return to the market rate of return.
C)subtracting the risk-free rate of return from the inflation rate.
D)subtracting the risk-free rate of return from the market rate of return.
E)multiplying the risk-free rate of return by a beta of one.

Accepted Answer

The market risk premium is the additional return an investor expects to receive for taking on the risk of investing in the stock market compared to a risk-free investment. It is computed by subtracting the risk-free rate of return (such as a treasury bill rate) from the market rate of return, typically measured by a broad stock market index such as the S&P 500. Therefore, the best choice is D, which subtracts the risk-free rate of return from the market rate of return.

Question 18

You have a portfolio of two risky stocks that has no diversification benefit.The lack of any diversification benefit must be due to the fact that:
A)the returns on the two stocks move perfectly in sync with one another.
B)the returns on the two stocks move perfectly opposite of one another.
C)one security must be a risk-free security.
D)the portfolio is equally weighted between the two stocks.
E)the two stocks are completely unrelated to one another.

Accepted Answer

The lack of diversification benefit indicates that the two stocks move perfectly in sync with one another, meaning they have a high positive correlation. When two stocks have a high positive correlation, their returns tend to move up or down together, leading to little to no diversification benefit.

Question 19

Assume two securities are negatively correlated.If these two securities are combined into an equally weighted portfolio,the portfolio standard deviation must be:
A)equal to the standard deviation of the overall market.
B)equal to the arithmetic average of the standard deviations of the individual securities.
C)equal to zero.
D)less than the weighted average of the standard deviations of the individual securities.
E)equal to or greater than the lowest standard deviation of the two securities.

Accepted Answer

When two negatively correlated securities are combined into an equally weighted portfolio, the portfolio standard deviation is less than the weighted average of the standard deviations of the individual securities. This is because the negative correlation between the two securities reduces the overall risk of the portfolio. Hence, option D is the correct answer.

Question 20

Amy has a portfolio with a beta of 1.26.She has decided to lower her investment risk.Adding which one of the following securities to her portfolio is most assuredly going to lower the risk of the portfolio?
A)A stock that has a covariance with the market of .89
B)A security that has a standard deviation of 11 percent
C)A security with a beta of 1.58
D)U.S.Treasury bills
E)A mix of small-company and large-company stocks

Accepted Answer

U.S. Treasury bills are considered risk-free securities and have no beta as they are not influenced by market fluctuations. Adding them to a portfolio will lower the portfolio's overall risk without affecting the expected return. Therefore, adding U.S. Treasury bills is the most assured way to lower the risk of the portfolio.

Quiz 11: Return and Risk: the Capital Asset Pricing Model Capm

Assume you are looking at a security market line graph.Where would an overpriced stock with a beta of .98 plot on that graph?

You plotted the monthly rate of return for two securities against time for the past 48 months.If the pattern of the movements of these two sets of returns rose and fell together the majority,but not all of the time,then the securities have:

The combination of the efficient set of portfolios with a riskless lending and borrowing rate results in:

Well-diversified portfolios have negligible:

A stock with a beta of zero would be expected to have a rate of return equal to:

A portfolio is comprised of five securities that have individual betas of 1.38,.87,1.02,1.49,and .67.You do not know the portfolio weight of each security.What do you know with certainty?

The risk of an individual security that will be compensated by the market depends upon the:

The dominant portfolio with the lowest possible level of risk out of a set of portfolios comprised of two securities is referred to as the:

The separation principle states that an investor will:

A stock with an actual return that lies above the security market line:

According to the capital asset pricing model,the expected return on a security is:

What is the first step an investor takes when making an investment decision according to the separation principle?

The excess return earned by an asset that has a beta of one over that earned by a risk- free asset is referred to as the:

The market risk premium is computed by:

You have a portfolio of two risky stocks that has no diversification benefit.The lack of any diversification benefit must be due to the fact that:

Assume two securities are negatively correlated.If these two securities are combined into an equally weighted portfolio,the portfolio standard deviation must be:

Amy has a portfolio with a beta of 1.26.She has decided to lower her investment risk.Adding which one of the following securities to her portfolio is most assuredly going to lower the risk of the portfolio?