Deck 11: Return and Risk: the Capital Asset Pricing Model

Question 1

Risk that affects at most a small number of assets is called _____ risk.

A)portfolio
B)nondiversifiable
C)market
D)unsystematic
E)total

Answer 1

unsystematic

Question 2

Risk that affects a large number of assets,each to a greater or lesser degree,is called _____ risk.

A)idiosyncratic
B)diversifiable
C)systematic
D)asset-specific
E)total

Answer 2

systematic

Question 3

Which one of the following statements is correct concerning the expected rate of return on an individual stock given various states of the economy?

A)The expected return is a geometric average where the probabilities of the economic states are used as the exponential powers.
B)The expected return is an arithmetic average of the individual returns for each state of the economy.
C)The expected return is a weighted average where the probabilities of the economic states are used as the weights.
D)The expected return is equal to the summation of the values computed by dividing the expected return for each economic state by the probability of the state.
E)As long as the total probabilities of the economic states equal 100%,then the expected return on the stock is a geometric average of the expected returns for each economic state.

Answer 3

The expected return is a weighted average where the probabilities of the economic states are used as the weights.

Question 4

You are considering purchasing stock S.This stock has an expected return of 8% if the economy booms and 3% if the economy goes into a recessionary period.The overall expected rate of return on this stock will:

A)be equal to one-half of 8% if there is a 50% chance of an economic boom.
B)vary inversely with the growth of the economy.
C)increase as the probability of a recession increases.
D)be equal to 75% of 8% if there is a 75% chance of a boom economy.
E)increase as the probability of a boom economy increases.

Question 5

The amount of systematic risk present in a particular risky asset,relative to the systematic risk present in an average risky asset,is called the particular asset's:

A)beta coefficient.
B)reward-to-risk ratio.
C)total risk.
D)diversifiable risk.
E)Treynor index.

Question 6

The slope of an asset's security market line is the:

A)reward-to-risk ratio.
B)portfolio weight.
C)beta coefficient.
D)risk-free interest rate.
E)market risk premium.

Question 7

The expected return on a stock that is computed using economic probabilities is:

A)guaranteed to equal the actual average return on the stock for the next five years.
B)guaranteed to be the minimal rate of return on the stock over the next two years.
C)guaranteed to equal the actual return for the immediate twelve month period.
D)a mathematical expectation based on a weighted average and not an actual anticipated outcome.
E)the actual return you will receive.

Question 8

The characteristic line is graphically depicted as:

A)the plot of the relationship between beta and expected return.
B)the plot of the returns of the security against the beta.
C)the plot of the security returns against the market index returns.
D)the plot of the beta against the market index returns.
E)None of the above.

Question 9

The beta of a security is calculated by:

A)dividing the covariance of the security with the market by the variance of the market.
B)dividing the correlation of the security with the market by the variance of the market.
C)dividing the variance of the market by the covariance of the security with the market.
D)dividing the variance of the market by the correlation of the security with the market.
E)None of the above.

Question 10

Standard deviation measures _____ risk.

A)total
B)nondiversifiable
C)unsystematic
D)systematic
E)economic

Question 11

If investors possess homogeneous expectations over all assets in the market portfolio,when riskless lending and borrowing is allowed,the market portfolio is defined to:

A)be the same portfolio of risky assets chosen by all investors.
B)have the securities weighted by their market value proportions.
C)be a diversified portfolio.
D)All of the above.
E)None of the above.

Question 12

A portfolio is:

A)a group of assets,such as stocks and bonds,held as a collective unit by an investor.
B)the expected return on a risky asset.
C)the expected return on a collection of risky assets.
D)the variance of returns for a risky asset.
E)the standard deviation of returns for a collection of risky assets.

Question 13

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.

A)Efficient Markets Hypothesis (EMH)
B)systematic risk principle
C)Open Markets Theorem
D)Law of One Price
E)principle of diversification

Question 14

The principle of diversification tells us that:

A)concentrating an investment in two or three large stocks will eliminate all of your risk.
B)concentrating an investment in three companies all within the same industry will greatly reduce your overall risk.
C)spreading an investment across five diverse companies will not lower your overall risk at all.
D)spreading an investment across many diverse assets will eliminate all of the risk.
E)spreading an investment across many diverse assets will eliminate some of the risk.

Question 15

The risk premium for an individual security is computed by:

A)multiplying the security's beta by the market risk premium.
B)multiplying the security's beta by the risk-free rate of return.
C)adding the risk-free rate to the security's expected return.
D)dividing the market risk premium by the quantity (1 - beta).
E)dividing the market risk premium by the beta of the security.

Question 16

Which one of the following is an example of a nondiversifiable risk?

A)a well-respected president of a firm suddenly resigns
B)a well-respected chairman of the Federal Reserve suddenly resigns
C)a key employee suddenly resigns and accepts employment with a key competitor
D)a well-managed firm reduces its work force and automates several jobs
E)a poorly managed firm suddenly goes out of business due to lack of sales

Question 17

The percentage of a portfolio's total value invested in a particular asset is called that asset's:

A)portfolio return.
B)portfolio weight.
C)portfolio risk.
D)rate of return.
E)investment value.

Question 18

When computing the expected return on a portfolio of stocks the portfolio weights are based on the:

A)number of shares owned in each stock.
B)price per share of each stock.
C)market value of the total shares held in each stock.
D)original amount invested in each stock.
E)cost per share of each stock held.

Question 19

The portfolio expected return considers which of the following factors?
I.the amount of money currently invested in each individual security
II.various levels of economic activity
III.the performance of each stock given various economic scenarios
IV.the probability of various states of the economy

A)I and III only
B)II and IV only
C)I,III,and IV only
D)II,III,and IV only
E)I,II,III,and IV

Question 20

The linear relation between an asset's expected return and its beta coefficient is the:

A)reward-to-risk ratio.
B)portfolio weight.
C)portfolio risk.
D)security market line.
E)market risk premium.

Question 21

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

A)has more systematic risk than the overall market.
B)has more risk than warranted based on the realized rate of return.
C)has yielded a higher return than expected for the level of risk assumed.
D)has less systematic risk than the overall market.
E)has yielded a return equivalent to the level of risk assumed.

Question 22

Diversification can effectively reduce risk.Once a portfolio is diversified,the type of risk remaining is:

A)individual security risk.
B)riskless security risk.
C)risk related to the market portfolio.
D)total standard deviations.
E)None of the above.

Question 23

The intercept point of the security market line is the rate of return which corresponds to:

A)the risk-free rate of return.
B)the market rate of return.
C)a value of zero.
D)a value of 1.0.
E)the beta of the market.

Question 24

Systematic risk is measured by:

A)the mean.
B)beta.
C)the geometric average.
D)the standard deviation.
E)the arithmetic average.

Question 25

Which one of the following would indicate a portfolio is being effectively diversified?

A)an increase in the portfolio beta
B)a decrease in the portfolio beta
C)an increase in the portfolio rate of return
D)an increase in the portfolio standard deviation
E)a decrease in the portfolio standard deviation

Question 26

The primary purpose of portfolio diversification is to:

A)increase returns and risks.
B)eliminate all risks.
C)eliminate asset-specific risk.
D)eliminate systematic risk.
E)lower both returns and risks.

Question 27

The expected return on a portfolio:

A)can be greater than the expected return on the best performing security in the portfolio.
B)can be less than the expected return on the worst performing security in the portfolio.
C)is independent of the performance of the overall economy.
D)is limited by the returns on the individual securities within the portfolio.
E)is an arithmetic average of the returns of the individual securities when the weights of those securities are unequal.

Question 28

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 1.0.

Question 29

The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is referred to as the:

A)market rate of return.
B)market risk premium.
C)systematic return.
D)total return.
E)real rate of return.

Question 30

The Capital Market Line is the pricing relationship between:

A)efficient portfolios and beta.
B)the risk-free asset and standard deviation of the portfolio return.
C)the optimal portfolio and the standard deviation of portfolio return.
D)beta and the standard deviation of portfolio return.
E)None of the above.

Question 31

Unsystematic risk:

A)can be effectively eliminated through portfolio diversification.
B)is compensated for by the risk premium.
C)is measured by beta.
D)cannot be avoided if you wish to participate in the financial markets.
E)is related to the overall economy.

Question 32

Which one of the following is an example of systematic risk?

A)the price of lumber declines sharply
B)airline pilots go on strike
C)the Federal Reserve increases interest rates
D)a hurricane hits a tourist destination
E)people become diet conscious and avoid fast food restaurants

Question 33

The systematic risk of the market is measured by:

A)a beta of 1.0.
B)a beta of 0.0.
C)a standard deviation of 1.0.
D)a standard deviation of 0.0.
E)a variance of 1.0.

Question 34

Which one of the following statements is correct concerning the standard deviation of a portfolio?

A)The greater the diversification of a portfolio,the greater the standard deviation of that portfolio.
B)The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio.
C)Standard deviation is used to determine the amount of risk premium that should apply to a portfolio.
D)Standard deviation measures only the systematic risk of a portfolio.
E)The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the individual securities held within the portfolio.

Question 35

A security that is fairly priced will have a return _____ the Security Market Line.

A)below
B)on or below
C)on
D)on or above
E)above

Question 36

Which one of the following measures is relevant to the systematic risk principle?

A)variance
B)alpha
C)standard deviation
D)theta
E)beta

Question 37

If a stock portfolio is well diversified,then the portfolio variance:

A)will equal the variance of the most volatile stock in the portfolio.
B)may be less than the variance of the least risky stock in the portfolio.
C)must be equal to or greater than the variance of the least risky stock in the portfolio.
D)will be a weighted average of the variances of the individual securities in the portfolio.
E)will be an arithmetic average of the variances of the individual securities in the portfolio.

Question 38

The majority of the benefits from portfolio diversification can generally be achieved with just _____ diverse securities.

A)3
B)6
C)30
D)50
E)75

Question 39

The standard deviation of a portfolio will tend to increase when:

A)a risky asset in the portfolio is replaced with U.S.Treasury bills.
B)one of two stocks related to the airline industry is replaced with a third stock that is unrelated to the airline industry.
C)the portfolio concentration in a single cyclical industry increases.
D)the weights of the various diverse securities become more evenly distributed.
E)short-term bonds are replaced with Treasury Bills.

Question 40

Which one of the following is an example of unsystematic risk?

A)the inflation rate increases unexpectedly
B)the federal government lowers income taxes
C)an oil tanker runs aground and spills its cargo
D)interest rates decline by one-half of one percent
E)the GDP rises by 2% more than anticipated

Question 41

If the covariance of stock 1 with stock 2 is - .0065,then what is the covariance of stock 2 with stock 1?

A)-.0065
B)+.0065
C)greater than +.0065
D)less than -.0065
E)Need additional information.

Question 42

Beta measures:

A)the ability to diversify risk.
B)how an asset covaries with the market.
C)the actual return on an asset.
D)the standard deviation of the assets' returns.
E)All of the above.

Question 43

Diversification can effectively reduce risk.Once a portfolio is diversified the type of risk remaining is:

A)individual security risk.
B)riskless security risk.
C)risk related to the market portfolio.
D)total standard deviations.
E)None of the above.

Question 44

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

A)the risk-free rate.
B)the market rate.
C)the prime rate.
D)the average AAA bond.
E)None of the above.

Question 45

Total risk can be divided into:

A)standard deviation and variance.
B)standard deviation and covariance.
C)portfolio risk and beta.
D)systematic risk and unsystematic risk.
E)portfolio risk and covariance.

Question 46

You have plotted the data for two securities over time on the same graph,i.e. ,the monthly return of each security for the last 5 years.If the pattern of the movements of each of the two securities rose and fell as the other did,these two securities would have:

A)no correlation at all.
B)a weak negative correlation.
C)a strong negative correlation.
D)a strong positive correlation.
E)one cannot get any idea of the correlation from a graph.

Question 47

The opportunity set of portfolios is:

A)all possible return combinations of those securities.
B)all possible risk combinations of those securities.
C)all possible risk-return combinations of those securities.
D)the best or highest risk-return combination.
E)the lowest risk-return combination.

Question 48

The correlation between two stocks:

A)can take on positive values.
B)can take on negative values.
C)cannot be greater than 1.
D)cannot be less than -1.
E)All of the above.

Question 49

If the correlation between two stocks is +1,then a portfolio combining these two stocks will have a variance that is:

A)less than the weighted average of the two individual variances.
B)greater than the weighted average of the two individual variances.
C)equal to the weighted average of the two individual variances.
D)less than or equal to average variance of the two weighted variances,depending on other information.
E)None of the above.

Question 50

A portfolio will usually contain:

A)one riskless asset.
B)one risky asset.
C)two or more assets.
D)no assets.
E)None of the above.

Question 51

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)choose an efficient portfolio based on individual risk tolerance or utility.
C)never choose to invest in the riskless asset because the expected return on the riskless asset is lower over time.
D)invest only in the riskless asset and tangency portfolio choosing the weights based on individual risk tolerance.
E)All of the above.

Question 52

An efficient set of portfolios is:

A)the complete opportunity set.
B)the portion of the opportunity set below the minimum variance portfolio.
C)only the minimum variance portfolio.
D)the dominant portion of the opportunity set.
E)only the maximum return portfolio.

Question 53

If the correlation between two stocks is -1,the returns:

A)generally move in the same direction.
B)move perfectly opposite one another.
C)are unrelated to one another as it is < 0.
D)have standard deviations of equal size but opposite signs.
E)None of the above.

Question 54

You have a portfolio of two risky stocks which turns out to have no diversification benefit.The reason you have no diversification is the returns:

A)are too small.
B)move perfectly opposite of one another.
C)are too large to offset.
D)move perfectly with one another.
E)are completely unrelated to one another.

Question 55

When a security is added to a portfolio the appropriate return and risk contributions are:

A)the expected return of the asset and its standard deviation.
B)the expected return and the variance.
C)the expected return and the beta.
D)the historical return and the beta.
E)these both cannot be measured.

Question 56

According to the Capital Asset Pricing Model:

A)the expected return on a security is negatively and non-linearly related to the security's beta.
B)the expected return on a security is negatively and linearly related to the security's beta.
C)the expected return on a security is positively and linearly related to the security's variance.
D)the expected return on a security is positively and non-linearly related to the security's beta.
E)the expected return on a security is positively and linearly related to the security's beta.

Question 57

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 all investors will only invest in the riskless asset.
B)the capital market line which shows that all 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)None of the above.

Question 58

The dominant portfolio with the lowest possible risk is:

A)the efficient frontier.
B)the minimum variance portfolio.
C)the upper tail of the efficient set.
D)the tangency portfolio.
E)None of the above.

Question 59

When stocks with the same expected return are combined into a portfolio:

A)the expected return of the portfolio is less than the weighted average expected return of the stocks.
B)the expected return of the portfolio is greater than the weighted average expected return of the stocks.
C)the expected return of the portfolio is equal to the weighted average expected return of the stocks.
D)there is no relationship between the expected return of the portfolio and the expected return of the stocks.
E)None of the above.

Question 60

The measure of beta associates most closely with:

A)idiosyncratic risk.
B)risk-free return.
C)systematic risk.
D)unexpected risk.
E)unsystematic risk.

Question 61

You want your portfolio beta to be 1.20.Currently,your portfolio consists of $100 invested in stock A with a beta of 1.4 and $300 in stock B with a beta of .6.You have another $400 to invest and want to divide it between an asset with a beta of 1.6 and a risk-free asset.How much should you invest in the risk-free asset?

A)$0
B)$140
C)$200
D)$320
E)$400

Question 62

For a highly diversified equally weighted portfolio with a large number of securities,the portfolio variance is:

A)the average covariance.
B)the average expected value.
C)the average variance.
D)the weighted average expected value.
E)the weighted average variance.

Question 63

If the economy booms,RTF,Inc.stock is expected to return 10%.If the economy goes into a recessionary period,then RTF is expected to only return 4%.The probability of a boom is 60% while the probability of a recession is 40%.What is the variance of the returns on RTF,Inc.stock?

A).000200
B).000760
C).000864
D).001594
E).029394

Question 64

The total number of variance and covariance terms in a portfolio is N².How many of these would be (including non-unique)covariances?

A)N
B)N²
C)N²- N
D)N²- N/2
E)None of the above.

Question 65

The elements along the diagonal of the variance/covariance matrix are:

A)covariances.
B)security weights.
C)security selections.
D)variances.
E)None of the above.

Question 66

Diversification will not lower the ____ risk:

A)total risk.
B)systematic risk.
C)unsystematic risk.
D)variance risk.
E)standard error.

Question 67

The relationship between the covariance of the security with the market to the variance is called the:

A)alpha.
B)beta.
C)total risk.
D)standard deviation.
E)expected return.

Question 68

Zelo,Inc.stock has a beta of 1.23.The risk-free rate of return is 4.5% and the market rate of return is 10%.What is the amount of the risk premium on Zelo stock?

A)4.47%
B)5.50%
C)5.54%
D)6.77%
E)12.30%

Question 69

A risk that affects a large number of assets,each to a greater or lesser degree is called:

A)total risk.
B)systematic risk.
C)unsystematic risk.
D)economic risk.
E)standard error.

Question 70

The beta of an individual security is calculated by:

A)dividing the covariance of the security with the market by the variance of the market.
B)dividing the correlation of the security with the market by the variance of the market.
C)multiplying the variance of the market by the covariance of the security with the market.
D)multiplying the variance of the market by the correlation of the security with the market.
E)None of the above.

Question 71

The elements in the off-diagonal positions of the variance/covariance matrix are:

A)covariances.
B)security selections.
C)variances.
D)security weights.
E)None of the above.

Question 72

The rate of return on the common stock of Flowers by Flo is expected to be 14% in a boom economy,8% in a normal economy,and only 2% in a recessionary economy.The probabilities of these economic states are 20% for a boom,70% for a normal economy,and 10% for a recession.What is the variance of the returns on the common stock of Flowers by Flo?

A).001044
B).001280
C).001863
D).002001
E).002471

Question 73

You own the following portfolio of stocks.What is the portfolio weight of stock C?

A)30.8%
B)37.4%
C)42.3%
D)45.2%
E)47.9%

Question 74

The Rotor Co.stock is expected to earn 14% in a recession,6% in a normal economy,and lose 4% in a booming economy.The probability of a boom is 20% while the probability of a normal economy is 55% and the chance of a recession is 25%.What is the expected rate of return on this stock?

A)6.00%
B)6.72%
C)6.80%
D)7.60%
E)11.33%

Question 75

A typical investor is assumed to be:

A)a fair gambler.
B)a gambler.
C)a single security holder.
D)risk averse.
E)risk neutral.

Question 76

Kali's Ski Resort,Inc.stock is quite cyclical.In a boom economy,the stock is expected to return 30% in comparison to 12% in a normal economy and a negative 20% in a recessionary period.The probability of a recession is 15%.There is a 30% chance of a boom economy.The remainder of the time,the economy will be at normal levels.What is the standard deviation of the returns on Kali's Ski Resort,Inc.stock?

A)10.05%
B)12.60%
C)15.83%
D)17.46%
E)25.04%

Question 77

You recently purchased a stock that is expected to earn 12% in a booming economy,8% in a normal economy and lose 5% in a recessionary economy.There is a 15% probability of a boom,a 75% chance of a normal economy,and a 10% chance of a recession.What is your expected rate of return on this stock?

A)5.00%
B)6.45%
C)7.30%
D)7.65%
E)8.30%

Question 78

According to the CAPM:

A)the expected return on a security is negatively and non-linearly related to the security's beta.
B)the expected return on a security is negatively and linearly related to the security's beta.
C)the expected return on a security is positively and linearly related to the security's variance.
D)the expected return on a security is positively and non-linearly related to the security's beta.
E)the expected return on a security is positively related to the security's beta.

Question 79

As we add more securities to a portfolio,the ____ will decrease:

A)total risk.
B)systematic risk.
C)unsystematic risk.
D)economic risk.
E)standard error.

Question 80

What is the standard deviation of the returns on a stock given the following information?

A)5.80%
B)7.34%
C)8.38%
D)9.15%
E)9.87%