Deck 11: Systematic Risk and the Equity Risk Premium

Question 1

You have invested $12,000 in RBC stock,$8,000 in TD stock,and $6,000 in WestJet stock.If you expect the return on RBC to be 5% in the next year,the return on TD to be 3%,and the return on WestJet to be 8%,what is the expected return for your portfolio?

A) 5.4%
B) 4.8%
C) 5.1%
D) 5.33%
E) 5.2%

Answer 1

5.1%

Question 2

You have invested $25,000 in RBC stock and $18,000 in TD stock.If you expect the return on RBC to be 6% in the next year,and the return on TD to be 4%,what is the expected return for your portfolio?

A) 4%
B) 5%
C) 5.2%
D) 6%
E) 4.8%

Answer 2

5.2%

Question 3

Your investment portfolio contains 200 shares of RBC and 450 shares of Air Canada.The price of RBC is currently $92 per share,and the price of Air Canada is currently $11 per share.If you expect the return on RBC to be 6% in the next year,and the return on Air Canada to be 8%,what is the expected return for your portfolio?

A) 6.4%
B) 7%
C) 6%
D) 8%
E) 6.8%

Answer 3

6.4%

Question 4

Use the information for the question(s) below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share.
The weight of Lowes in your portfolio is:

A) 40%
B) 20%
C) 50%
D) 30%
E) 10%

Question 5

What role does the standard deviations of two assets play in computation of the expected return of the two asset portfolio?

Question 6

Suppose you buy 100 shares of RBC at $85 per share,and 80 shares of TD at $75 per share.If RBC's stock goes up to $88.50 per share and TD's stock goes up to $77 per share,what is your portfolio return?

A) 2%
B) 0%
C) 3.5%
D) 3%
E) 4.5%

Question 7

A portfolio has three stocks - 300 shares of Yahoo (YHOO),300 Shares of General Motors (GM),and 100 shares of Standard and Poor's Index Fund (SPY).If the price of YHOO is $20,the price of GM is $30,and the price of SPY is $150,calculate the portfolio weight of YHOO and GM.

A) 10%, 20%
B) 15%, 25%
C) 20%, 30%
D) 20%, 40%
E) 43%, 43%

Question 8

Suppose over the next year Ball has a return of 12.5%,Lowes has a return of 20%,and Abbott Labs has a return of -10%.The value of your portfolio over the year is:

A) $21,000
B) $20,000
C) $20,700
D) $21,500
E) $22,000

Question 9

You have invested $5,000 in RBC stock,$12,000 in TD stock,and $18,000 in WestJet stock.If you expect the return on RBC to be 4% in the next year,the return on TD to be 5%,and the return on WestJet to be 6%,what is the expected return for your portfolio?

A) 5.4%
B) 5%
C) 4.8%
D) 6%
E) 5.2%

Question 10

Suppose over the next year Ball has a return of 12.5%,Lowes has a return of 20%,and Abbott Labs has a return of -10%.The return on your portfolio over the year is:

A) 0%
B) 7.5%
C) 3.5%
D) 5.0%
E) 2.5%

Question 11

Use the information for the question(s) below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share.
The weight of Abbott Labs in your portfolio is:

A) 50%
B) 40%
C) 30%
D) 20%
E) 10%

Question 12

A portfolio comprises two stocks,A and B,with equal amounts of money invested in each.If stock A's stock price increases and that of stock B decreases,the weight of stock A in the portfolio will increase.

Question 13

Your investment portfolio contains 100 shares of RBC,75 shares of TD,and 200 shares of WestJet.The price of RBC is currently $75 per share,the price of TD is $55 and the price of WestJet is currently $21 per share.If you expect the return on RBC to be 5% in the next year,the return on TD to be 6.5%,and the return on WestJet to be 10%,what is the expected return for your portfolio?

A) 6.4%
B) 6.7%
C) 7.2%
D) 6%
E) 6.5%

Question 14

A portfolio has three stocks - 100 shares of Yahoo (YHOO),200 Shares of General Motors (GM),and 50 shares of Standard and Poor's Index Fund (SPY).If the price of YHOO is $20,the price of GM is $20,and the price of SPY is $130,calculate the portfolio weight of YHOO and GM.

A) 12%, 17%
B) 11%, 31%
C) 15%, 29%
D) 16%, 32%
E) 29%, 57%

Question 15

Suppose you have $10,000 in cash to invest.You decide to sell short $5000 worth of Kinston stock and invest the proceeds from your short sale plus your $10,000 into one-year Treasury bills earning 5%.At the end of the year,you decide to liquidate your portfolio.Kinston Industries has the following realized returns:
The return on your portfolio is closest to:

A) -0.5%
B) 13.5%
C) -2.5%
D) 14.5%
E) 5.0%

Question 16

What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?

Question 17

Suppose you buy 50 shares of RBC at $90 per share,and 70 shares of TD at $78 per share.If RBC's stock goes up to $94 per share and TD's stock falls to $72 per share,what is your portfolio return?

A) -2.2%
B) 0%
C) 6.4%
D) 4.4%
E) -7.7%

Question 18

You have invested $10,000 in RBC stock and $21,000 in TD stock.If you expect the return on RBC to be 5% in the next year,and the return on TD to be 6.5%,what is the expected return for your portfolio?

A) 5.75%
B) 5%
C) 6.5%
D) 6%
E) 5.5%

Question 19

Use the information for the question(s) below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share.
The weight of Ball Corporation in your portfolio is:

A) 50%
B) 40%
C) 20%
D) 30%
E) 10%

Question 20

A portfolio has three stocks - 200 shares of Yahoo (YHOO),100 Shares of General Motors (GM),and 50 shares of Standard and Poor's Index Fund (SPY).If the price of YHOO is $30,the price of GM is $30,and the price of SPY is $130,calculate the portfolio weight of YHOO and GM.

A) 38.7%, 19.4%
B) 21.3%, 35.2%
C) 11.7%, 12.7%
D) 36.2%, 21.6%
E) 57.1%, 28.6%

Question 21

We can reduce volatility by investing in less than perfectly correlated assets through diversification because the expected return of a portfolio is the weighted average of the expected returns of its stocks,but the volatility of a portfolio

A) is higher than the weighted average volatility.
B) is independent of weights in the stocks.
C) is less than the weighted average volatility.
D) depends on the expected return.
E) is the same as the weighted average volatility.

Question 22

Use the table for the question(s) below.
Consider the following returns:

The volatility on Lowes' returns is closest to:

A) 35%
B) 10%
C) 13%
D) 42%
E) 22%

Question 23

Your portfolio has 20% of its value invested in Bombardier and the remainder invested in Lululemon.Bombardier stock has a volatility of 15%,while Lululemon stock has a volatility of 12%.If the correlation between Bombardier and Lululemon is 0,what is the standard deviation of your portfolio?

A) 12.6%
B) 10%
C) 1%
D) 12.7%
E) 12%

Question 24

Diversification reduces the risk of a portfolio because ________ and some of the risks are averaged out of the portfolio.

A) stocks do not move identically
B) stocks have common risks
C) stocks are unpredictable
D) stocks are always affected by the market
E) some stocks have lower returns than others

Question 25

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%.When I hold both stocks in my portfolio with an equal amount in each,and the stocks' returns have a correlation of minus 1,the overall volatility of returns of the portfolio is

A) more than 30%.
B) unchanged at 30%.
C) between 0 and 30%.
D) zero.
E) Cannot say for sure

Question 26

The volatility of Home Depot Share prices is 30% and that of General Motors shares is 30%.When I hold both stocks in my portfolio and the stocks returns have zero correlation,the overall volatility of returns of the portfolio is

A) unchanged at 30%.
B) less than 30%.
C) more than 30%.
D) zero.
E) Cannot say for sure

Question 27

Stocks tend to move together if they are affected by

A) company-specific events.
B) common economic events.
C) events unrelated to the economy.
D) idiosyncratic shocks.
E) unforeseen events.

Question 28

Use the table for the question(s) below.
Consider the following returns:

The covariance between Lowes' and Home Depot's returns is closest to:

A) 0.10
B) 0.29
C) 0.12
D) 0.69
E) 0.41

Question 29

Your portfolio has 25% of its value invested in Bombardier and the remainder invested in Lululemon.Bombardier stock has a volatility of 30%,while Lululemon stock has a volatility of 18%.If the correlation between Bombardier and Lululemon is 0.2,what is the standard deviation of your portfolio?

A) 16.7%
B) 24%
C) 2.8%
D) 21%
E) 46.1%

Question 30

When the returns of two stocks are perfectly positively correlated,then

A) they always move oppositely.
B) they tend to move oppositely.
C) they have no tendency.
D) they tend to move together.
E) they always move together.

Question 31

Your portfolio has 50% of its value invested in Bombardier and the remainder invested in Lululemon.Bombardier stock has a volatility of 25%,while Lululemon stock has a volatility of 10%.If the correlation between Bombardier and Lululemon is -0.1,what is the standard deviation of your portfolio?

A) 16.7%
B) 17.5%
C) 13%
D) 17.4%
E) 1.7%

Question 32

If two stocks are perfectly negatively correlated,a portfolio with equal weighting in each stock will always have a volatility (standard deviation)of 0.

Question 33

When the returns of two stocks are negatively correlated,but not perfectly negatively correlated,then

A) they always move oppositely.
B) they tend to move oppositely.
C) they have no tendency.
D) they tend to move together.
E) they always move together.

Question 34

As we add more uncorrelated stocks to a portfolio where the stocks are held in equal weights,the benefit of diversification is most dramatic

A) after 20 stocks have been added.
B) when there are more than 500 stocks.
C) when there are more than 1000 stocks.
D) at the outset.
E) when there are more than 100 stocks.

Question 35

When we form an equally weighted portfolio of stocks and keep increasing the number of stocks in the portfolio,the volatility of the portfolio also increases.

Question 36

Correlation is the degree to which the returns of two stocks share common risks.

Question 37

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%.When I hold both stocks in my portfolio and the stocks' returns have a correlation of 1,the overall volatility of returns of the portfolio is

A) more than 30%.
B) less than 30%.
C) unchanged at 30%.
D) zero.
E) Cannot say for sure

Question 38

In a two-asset portfolio,what happens to the portfolio weight of the better performing asset?

Question 39

When we combine stocks in a portfolio,the amount of risk that is eliminated depends on the degree to which the stocks face common risks and move together.

Question 40

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%.When I hold both stocks in my portfolio,the overall volatility of the portfolio is:

A) 30%
B) 26%
C) 28%
D) 20%
E) More information needed.

Question 41

A stock market comprises 2000 shares of stock A and 2000 shares of stock B.The share prices for stocks A and B are $20 and $10,respectively.What proportion of the market portfolio is comprised of each stock?

A) Stock A is 66.7% and Stock B is 33.3%
B) Stock A is 33.3% and Stock B is 66.7%
C) Stock A is $40,000 and Stock B is $20,000
D) Stock A is 200% and Stock B is 100%
E) Stock A is 50% and Stock B is 50%

Question 42

Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:

The expected return of a portfolio that is equally invested in Wal-Mart and Duke Energy is closest to:

A) 10.0%
B) 17.8%
C) 26.3%
D) 29.0%
E) 18.5%

Question 43

Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:

The volatility of a portfolio that is equally invested in Wal-Mart and Duke Energy is closest to:

A) 5.0%
B) 0.6%
C) 7.6%
D) 22.4%
E) 10.1%

Question 44

Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:

The volatility of a portfolio that is consists of a long position of $10,000 in Wal-Mart and a short position of $2000 in Microsoft is closest to:

A) 9%
B) 14%
C) 11%
D) 12%
E) 10%

Question 45

If you build a large enough portfolio,you can diversify away all the risks of a portfolio.

Question 46

Stocks that have a higher volatility will always have a higher beta.

Question 47

What diversification,if any,is achieved if two stocks in a portfolio are perfectly positively correlated?

Question 48

Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:

The volatility of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:

A) 8%
B) 9%
C) 11%
D) 6%
E) 7%

Question 49

A stock market comprises 1000 shares of stock A and 3000 shares of stock B.The share prices for stocks A and B are $25 and $30,respectively.What is the capitalization of the market portfolio?

A) $115,000
B) $100,000
C) $98,000
D) $125,000
E) $90,000

Question 50

Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:

The volatility of a portfolio that is equally invested in Wal-Mart and Microsoft is closest to:

A) 7.2%
B) 7.6%
C) 15.4%
D) 17.6%
E) 19.0%

Question 51

A stock market comprises 5000 shares of stock A and 2000 shares of stock B.Assume the share prices for stocks A and B are $20 and $35,respectively.If you have $15,000 to invest and you want to hold the market portfolio,how much of your money will you invest in Stock A?

A) $10,000
B) $8,823.53
C) $6,176.47
D) $5,000
E) $4,403.42

Question 52

Which of the following combinations of stocks would give you the biggest reduction in risk?

A) Duke Energy and Wal-Mart
B) Wal-Mart and Microsoft
C) Microsoft and Duke Energy
D) Duke Energy by itself
E) Wal-Mart by itself

Question 53

Air Canada stock has a standard deviation of 18%,while the market index standard deviation is 8%.If the correlation between Air Canada and the market index is 0.45,what is the beta of Air Canada stock?

A) 1.01
B) 0.03
C) 0.2
D) 2.25
E) 2.5

Question 54

Use the table for the question(s) below.
Consider the following returns:

The volatility on Home Depot's returns is closest to:

A) 35%
B) 31%
C) 42%
D) 18%
E) 22%

Question 55

Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:

The expected return of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:

A) 15%
B) 14%
C) 29%
D) 44%
E) 22%

Question 56

What is the lowest risk possible by selecting two stocks that are perfectly negatively correlated?

Question 57

Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:

The expected return of a portfolio that consists of a long position of $10,000 in Wal-Mart and a short position of $2000 in Microsoft is closest to:

A) 21%
B) 12%
C) 27%
D) 18%
E) 24%

Question 58

A stock market comprises 5000 shares of stock A and 2000 shares of stock B.Assume the share prices for stocks A and B are $20 and $35,respectively.What proportion of the market portfolio is comprised of stock A?

A) 58.8%
B) 41.2%
C) $100,000
D) $70,000
E) 100%

Question 59

A stock market comprises 2000 shares of stock A and 2000 shares of stock B.The share prices for stocks A and B are $20 and $10,respectively.What is the capitalization of the market portfolio?

A) $55,000
B) $60,000
C) $70,000
D) $65,000
E) $50,000

Question 60

A stock market comprises 5000 shares of stock A and 2000 shares of stock B.Assume the share prices for stocks A and B are $20 and $35,respectively.What is the capitalization of the market portfolio?

A) $170,000
B) $150,000
C) $165,000
D) $185,000
E) $100,000

Question 61

A linear regression to estimate the relation between Research in Motion's stock returns and the market's return gives the best-fitting line that represents the relation between the stock and the market.The slope of this line is our estimate of

A) alpha.
B) beta.
C) risk-free rate.
D) volatility.
E) standard deviation.

Question 62

Since total risk is greater than systematic risk,should standard deviation be always greater than beta?

Question 63

You observe the following scatterplot of Ford's weekly returns against the S&P 500.Which of the following statements is true about Ford's beta against the S&P 500?

A) Ford's beta appears to be positive.
B) Ford's beta appears to be negative.
C) Ford's beta appears to be zero- there is no apparent relation between its return and the S&P return.
D) Ford's beta appears to be highly negative.
E) Beta has nothing to do with the relationship seen in this scatterplot.

Question 64

Air Canada stock has a standard deviation of 25%,while the market index standard deviation is 12%.If the correlation between Air Canada and the market index is 0.33,what is the beta of Air Canada stock?

A) 2.08
B) 0.16
C) 0.69
D) 2.75
E) 1.32

Question 65

You expect General Motors (GM)to have a beta of 1 over the next year and the beta of Exxon Mobil (XOM)to be 1.2 over the next year.Also,you expect the volatility of General Motors to be 30% and that of Exxon Mobil to be 40% over the next year.Which stock has more systematic risk? Which stock has more total risk?

A) GM, GM
B) GM, XOM
C) XOM, XOM
D) XOM, GM
E) They both have the same risks.

Question 66

The market or equity risk premium can be estimated by computing the historical average excess return of the market portfolio.

Question 67

Is it possible for a stock to have high total risk but low systematic risk?

Question 68

The market portfolio is the portfolio of all risky investments held

A) in descending weights.
B) in ascending weights.
C) in proportion to their value.
D) based on previous year performance.
E) in equal weights.

Question 69

How does the S&P/TSX Composite index rank in terms of number and market capitalization of Canadian public firms?

Question 70

You expect General Motors (GM)to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM)to be 0.9 over the next year.Also,you expect the volatility of General Motors to be 40% and that of Exxon Mobil to be 30% over the next year.Which stock has more systematic risk? Which stock has more total risk?

A) XOM, GM
B) XOM, XOM
C) GM, XOM
D) GM, GM
E) They both have the same risks.

Question 71

You observe that AT&T stock and the S&P 500 have the following weekly returns:
If this pattern of stock returns is typical of AT&T stock,and you calculated a beta against the S&P 500,which of the following is true?

A) AT&T's beta is negative.
B) AT&T's beta is zero.
C) AT&T's beta is positive.
D) AT&T's beta is highly negative.
E) Beta cannot be calculated from this data.

Question 72

If you build a large enough portfolio,you can diversify away all ________ risk,but you will be left with ________ risk.

A) diversifiable, unsystematic
B) unsystematic, systematic
C) systematic, undiversifiable
D) diversifiable, diversifiable
E) common, unsystematic

Question 73

Air Canada stock has a standard deviation of 10%,while the market index standard deviation is 7%.If the correlation between Air Canada and the market index is 0.85,what is the beta of Air Canada stock?

A) 0.60
B) 1.21
C) 1.43
D) 0.85
E) 1.0

Question 74

The amount of a stock's risk that is diversified away

A) is independent of the portfolio that you add it to.
B) depends on market risk premium.
C) depends on the risk-free rate of interest.
D) depends on the portfolio that you add it to.
E) depends on its market capitalization.

Question 75

You expect General Motors (GM)to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM)to be 1.9 over the next year.Also,you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year.Which stock has more systematic risk? Which stock has more total risk?

A) XOM, GM
B) GM, XOM
C) GM, GM
D) XOM, XOM
E) They both have the same risks.

Question 76

A linear regression was done to estimate the relation between Sprint's stock returns and the market's return.The intercept of the line was found to be 0.23 and the slope was 1.47.Which of the following statements is true regarding Sprint's stock?

A) Sprint's beta is 0.23.
B) Sprint's beta is 1.47.
C) The risk-free rate is 1.47%.
D) The standard deviation of Sprint's excess returns is 23%.
E) Sprint's beta is between 0.23 and 1.47.

Question 77

Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away.These stocks tend to have ________ betas.

A) high
B) low
C) negative
D) zero
E) very high

Question 78

For each 1% change in the market portfolio's excess return,the investment's excess return is expected to change by ________ percent due to risks that it has in common with the market.

A) beta
B) alpha
C) zero
D) more than 1
E) less than 1

Question 79

The beta of the market portfolio is:

A) 0
B) -1
C) 2
D) 1
E) 10

Question 80

The S&P 500 index traditionally is a ________ portfolio of the 500 largest U.S.stocks.

A) value weighted
B) equally weighted
C) chain weighted
D) price weighted
E) reputation weighted