Deck 5: Risk and Portfolio Management

Question 1

Inflation, which is a general decline in prices, is the source of financial risk.

Answer 1

False

Question 2

In a world of certainty, there would be no risk.

Answer 2

True

Question 3

Investors may reduce risk by constructing diversified portfolios but not eliminate risk.

Answer 3

True

Question 4

Portfolio risk is the summation of business and financial risk.

Question 5

A diversified portfolio requires the securities of at least fifty firms.

Question 6

A portfolio consisting of securities whose returns are highly correlated is not truly diversified.

Question 7

Unsystematic risk refers to factors that are unique to the specific asset.

Question 8

Unsystematic risk considers how firms finance their assets and the nature of their operations.

Question 9

Investors seek to minimize risk for a given return.

Question 10

The informed investor can expect consistently to outperform the market.

Question 11

Diversification reduces reinvestment rate risk.

Question 12

Systematic risk is reduced through diversification.

Question 13

While diversification decreases risk, it also increases the chance of a large gain.

Question 14

The tendency of individual stock prices to move together is one source of systematic risk.

Question 15

The negative relationship between interest rates and securities prices is the source of interest rate risk.

Question 16

The dispersion around a stock's return is one measure of risk.

Question 17

Investors must bear the systematic risk associated with fluctuating securities prices.

Question 18

Exchange rate risk refers to fluctuations in the prices of foreign currencies (i.e., foreign exchange).

Question 19

Reinvestment rate risk results from higher stock prices in the future.

Question 20

By accepting more risk, the investor will increase the realized return.

Question 21

Exchange rate risk refers to fluctuations ina. the prices of stocks on the New York Stock Exchangeb. the values of bonds and other debt instrumentsc. the price of one currency relative to other currenciesd. a decline in the value of an investor's portfolio when securities are sold

Question 22

During a rising market, stocks with greater beta coefficients may be preferred.

Question 23

Unsystematic risk is

A) the risk associated with movements in stock prices
B) reduced through diversification
C) higher when interest rates rise
D) the risk of loss of purchasing power

Question 24

Unsystematic risk

A) is increased through diversification
B) is reduced when markets fluctuate less
C) is affected by the nature of how a firm finances its operations
D) increases during periods of volatile interest rates

Question 25

If a beta coefficient is 1.7, that implies the return on the stock tends to be less volatile than the return on the market.

Question 26

If a stock has a beta of 1.0, it is risk free stock.

Question 27

The numerical value of beta for the market equals 1.

Question 28

The expected return on an investment in stock is

A) the expected dividend payments
B) the anticipated capital gains
C) the sum of expected dividends and capital gains
D) less than the realized return

Question 29

Diversification reduces

A) systematic risk
B) unsystematic risk
C) market risk
D) purchasing power risk

Question 30

Sources of risk to an investor include1. loss when funds are reinvested at lower rates2. fluctuations in securities markets3. the financing decisions of the firm

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 31

The "efficient frontier" relates all the combinations of risk and return that represent the same level of satisfaction.

Question 32

Portfolios that offer the highest return for a givenlevel of risk are "efficient."

Question 33

Low beta stocks tend to generate higher returns in rising markets.

Question 34

Sources of unsystematic risk include1. the firm's financing decisions2. the firm's operations3. fluctuating market prices

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 35

If a stock's return has a large standard deviation, that suggests the stock has little risk.

Question 36

A portfolio's beta coefficient tends to be stable over time.

Question 37

If the return on two stocks is highly and positivelycorrelated , combining these stocks will reduce the risk associated with the portfolio.

Question 38

The beta of a portfolio is a weighted average of each asset's beta coefficient.

Question 39

Arbitrage pricing theory is a multi-variable model used to explain securities returns.

Question 40

Arbitrage is the act of buying a high priced asset in one market and simultaneously selling it in another market at a lower price.

Question 41

The security market line does not

A) indicate the relationship between risk and return
B) relate the market return and beta to a stock's return
C) identify the optimal portfolio for the investor
D) use beta coefficients as a measure of risk

Question 42

Portfolio risk encompasses1. a firm's financing decisions2. interest rate risk3. loss of purchasing power

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 43

Beta coefficients1. are a measure of systematic risk2. relate the return on an individual security tothe return on the market3. measure the variability of as asset's return

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 44

Investors who want to bear less risk should acquirestocks whose beta coefficients are

A) greater than 1.5
B) greater than 1.0
C) less than 1.0
D) less than 0.5

Question 45

An efficient portfolio1. maximizes risk for a given return2. minimizes risk for a given return3. maximizes return for a given level of risk4. minimizes return for a given level of risk

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 46

What is the expected return on a portfolio consisting of an equal amount invested in each stock b. What is the expected return on the portfolio if 50 percent of the funds are invested in stock C, 30 percent in stock A, and 20 percent in Stock D

Question 47

For diversification to reduce risk,

A) the returns on the individual securities should be highly correlated
B) the prices of the stocks should be stable
C) the returns on the individual securities should be negatively correlated
D) one firm should offer dividends and the other should offer capital gains

Question 48

Beta coefficients of 1.3 indicate

A) the stock has more unsystematic risk
B) the stock has less unsystematic risk
C) the stock is more volatile than the market
D) the stock is less volatile than the market

Question 49

The efficient frontier in portfolio theory

A) indicates the highest return for a given risk
B) illustrates the optimal trade-off between long and short-term capital gains
C) quantifies systematic and unsystematic risk
D) identifies the optimal portfolio for the investor

Question 50

What is the expected return on a stock that pays a 4 percent annual dividend and whose price is expected to appreciate annually at 6 percent

Question 51

If the dispersion around a stock's return increases

A) the expected return decreases
B) the standard deviation decreases
C) the stock's price increases
D) the stock's risk increases

Question 52

(This problem illustrates the computation of beta coefficients may be solved using a statistics program or Excel.) The returns on the market and stock A and stock B are as follows: Compute the beta coefficient for each stock and interpret the results of the computations.

Question 53

Given the following information: a. What are the expected returns and standard deviations of the following portfolios:1. 100 percent of funds invested in Stock A 2. 100 percent of funds invested in Stock B 3. 50 percent of funds invested in each stock b. What would be the impact if the correlation coefficient were 0.6 instead of 0.2

Question 54

According to the arbitrage pricing theory, the returnon a stock

A) is not related to the expected return on the stock
B) depends on the stock's responsiveness to unexpected changes
C) is reduced through the construction of diversified portfolios
D) equals the market return if the expected rate of inflation is realized