Deck 11: Risk and Return

Question 1

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

A)Inflation exceeding market expectations
B)A warehouse fire
C)Decrease in corporate tax rates
D)Decrease in the value of the dollar
E)Increase in consumer spending

Answer 1

A warehouse fire

Question 2

Which one of the following is the best example of an announcement that is most apt to result in an unexpected return?

A)A news bulletin that the anticipated layoffs by a firm will occur as expected on December 1
B)Announcement that the CFO of the firm is retiring June 1 as previously announced
C)Announcement that a firm will continue its practice of paying a $3 a share annual dividend
D)Statement by a firm that it has just discovered a manufacturing defect and is recalling its product
E)The verification by senior management that the firm is being acquired as had been rumored

Answer 2

Statement by a firm that it has just discovered a manufacturing defect and is recalling its product

Question 3

Which term best refers to the practice of investing in a variety of diverse assets as a means of reducing risk?

A)Systematic
B)Unsystematic
C)Diversification
D)Security market line
E)Capital asset pricing model

Answer 3

Diversification

Question 4

The security market line is defined as a positively sloped straight line that displays the relationship between the:

A)beta and standard deviation of a portfolio.
B)systematic and unsystematic risks of a security.
C)nominal and real rates of return.
D)expected return and beta of either a security or a portfolio.
E)risk premium and beta of a portfolio.

Question 5

Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock.Which one of the following best describes the 16.5 percent rate?

A)Expected return
B)Real return
C)Market rate
D)Systematic return
E)Risk premium

Question 6

Which statement is true?

A)The expected rate of return on any portfolio must be positive.
B)The arithmetic average of the betas for each security held in a portfolio must equal 1.0.
C)The beta of any portfolio must be 1.0.
D)The weights of the securities held in any portfolio must equal 1.0.
E)The standard deviation of any portfolio must equal 1.0.

Question 7

Consider a portfolio comprised of four risky securities.Assume the economy has three economic states with varying probabilities of occurrence.Which one of the following will guarantee that the portfolio variance will equal zero?

A)The portfolio beta must be 1.0.
B)The portfolio expected rate of return must be the same for each economic state.
C)The portfolio risk premium must equal zero.
D)The portfolio expected rate of return must equal the expected market rate of return.
E)There must be equal probabilities that the state of the economy will be a boom or a bust.

Question 8

The slope of the security market line represents the:

A)risk-free rate.
B)market risk premium.
C)beta coefficient.
D)risk premium on an individual asset.
E)market rate of return.

Question 9

Unsystematic risk can be defined by all of the following except:

A)unrewarded risk.
B)diversifiable risk.
C)market risk.
D)unique risk.
E)asset-specific risk.

Question 10

The systematic risk principle states that the expected return on a risky asset depends only on the asset's ___ risk.

A)unique
B)diversifiable
C)asset-specific
D)market
E)unsystematic

Question 11

Which one of the following is the computation of the risk premium for an individual security? E(R) is the expected return on the security, R_f is the risk-free rate, β is the security's beta, and E(R_M) is the expected rate of return on the market.

A)E(R_M) -R_f
B)E(R) - E(R_M)
C)E(R) - [E(R_M) + R_f]
D)β[E(R_M) - R_f]
E)β [E(R) - R_f]

Question 12

A portfolio is:

A)a single risky security.
B)any security that is equally as risky as the overall market.
C)any new issue of stock.
D)a group of assets held by an investor.
E)an investment in a risk-free security.

Question 13

The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is measured by the:

A)squared deviation.
B)beta coefficient.
C)standard deviation.
D)mean.
E)variance.

Question 14

Which one of the following is the minimum required rate of return on a new investment that makes that investment attractive?

A)Risk-free rate
B)Market risk premium
C)Expected return minus the risk-free rate
D)Market rate of return
E)Cost of capital

Question 15

Stock A comprises 28 percent of Susan's portfolio.Which one of the following terms applies to the 28 percent?

A)Portfolio variance
B)Portfolio standard deviation
C)Portfolio weight
D)Portfolio expected return
E)Portfolio beta

Question 16

Which one of the following statements is correct?

A)The risk premium on a risk-free security is generally considered to be one percent.
B)The expected rate of return on any security, given multiple states of the economy, must be positive.
C)There is an inverse relationship between the level of risk and the risk premium given a risky security.
D)If a risky security is correctly priced, its expected risk premium will be positive.
E)If a risky security is priced correctly, it will have an expected return equal to the risk-free rate.

Question 17

Systematic risk is defined as:

A)any risk that affects a large number of assets.
B)the total risk of an individual security.
C)diversifiable risk.
D)asset-specific risk.
E)the risk unique to a firm's management.

Question 18

The expected rate of return on Delaware Shores stock is based on three possible states of the economy.These states are boom, normal, and recession which have probabilities of occurrence of 20 percent, 75 percent, and 5 percent, respectively.Which one of the following statements is correct concerning the variance of the returns on this stock?

A)The variance must decrease if the probability of occurrence for a boom increases.
B)The variance will remain constant as long as the sum of the economic probabilities is 100 percent.
C)The variance can be positive, zero, or negative, depending on the expected rate of return assigned to each economic state.
D)The variance must be positive provided that each state of the economy produces a different expected rate of return.
E)The variance is independent of the economic probabilities of occurrence.

Question 19

The security market line is a linear function that is graphed by plotting data points based on the relationship between the:

A)risk-free rate and beta.
B)market rate of return and beta.
C)market rate of return and the risk-free rate.
D)risk-free rate and the market rate of return.
E)expected return and beta.

Question 20

A stock is expected to return 13 percent in an economic boom, 10 percent in a normal economy, and 3 percent in a recessionary economy.Which one of the following will lower the overall expected rate of return on this stock?

A)An increase in the rate of return in a recessionary economy
B)An increase in the probability of an economic boom
C)A decrease in the probability of a recession occurring
D)A decrease in the probability of an economic boom
E)An increase in the rate of return for a normal economy

Question 21

Diversifying a portfolio across various sectors and industries might do more than one of the following.However, this diversification must do which one of the following?

A)Increase the expected risk premium
B)Reduce the beta of the portfolio to one
C)Increase the security's risk premium
D)Reduce the portfolio's systematic risk level
E)Reduce the portfolio's unique risks

Question 22

The beta of a risky portfolio cannot be less than _____ nor greater than ____.

A)0; 1
B)1; the market beta
C)the lowest individual beta in the portfolio; market beta
D)the market beta; the highest individual beta in the portfolio
E)the lowest individual beta in the portfolio; the highest individual beta in the portfolio

Question 23

Which one of these is the best example of systematic risk?

A)Discovery of a major gas field
B)Decrease in textile imports
C)Increase in agricultural exports
D)Decrease in gross domestic product
E)Decrease in management bonuses for banking executives

Question 24

For a risky security to have a positive expected return but less risk than the overall market, the security must have a beta:

A)of zero.
B)that is > 0 but < 1.
C)of one.
D)that is > 1.
E)that is infinite.

Question 25

Which statement is correct?

A)A portfolio that contains at least 30 diverse individual securities will have a beta of 1.0.
B)Any portfolio that is correctly valued will have a beta of 1.0.
C)A portfolio that has a beta of 1.12 will lie to the left of the market portfolio on a security market line graph.
D)A risk-free security plots at the origin on a security market line graph.
E)An underpriced security will plot above the security market line.

Question 26

Portfolio diversification eliminates:

A)all investment risk.
B)the portfolio risk premium.
C)market risk.
D)unsystematic risk.
E)the reward for bearing risk.

Question 27

Which one of the following represents the amount of compensation an investor should expect to receive for accepting the unsystematic risk associated with an individual security?

A)Security beta multiplied by the market rate of return
B)Market risk premium
C)Security beta multiplied by the market risk premium
D)Risk-free rate of return
E)Zero

Question 28

Which one of these represents systematic risk?

A)Major layoff by a regional manufacturer of power boats
B)Increase in consumption created by a reduction in personal tax rates
C)Surprise firing of a firm's chief financial officer
D)Closure of a major retail chain of stores
E)Product recall by one manufacturer

Question 29

Which one of the following best exemplifies unsystematic risk?

A)Unexpected economic collapse
B)Unexpected increase in interest rates
C)Unexpected increase in the variable costs for a firm
D)Sudden decrease in inflation
E)Expected increase in tax rates

Question 30

The risk premium for an individual security is based on which one of the following types of risk?

A)Total
B)Surprise
C)Diversifiable
D)Systematic
E)Unsystematic

Question 31

Standard deviation measures _____ risk while beta measures _____ risk.

A)systematic; unsystematic
B)unsystematic; systematic
C)total; unsystematic
D)total; systematic
E)asset-specific; market

Question 32

Systematic risk is:

A)totally eliminated when a portfolio is fully diversified.
B)defined as the total risk associated with surprise events.
C)risk that affects a limited number of securities.
D)measured by beta.
E)measured by standard deviation.

Question 33

A portfolio is comprised of 35 securities with varying betas.The lowest beta for an individual security is .74 and the highest of the security betas of 1.51.Given this information, you know that the portfolio beta:

A)must be 1.0 because of the large number of securities in the portfolio.
B)is the geometric average of the individual security betas.
C)must be less than the market beta.
D)will be between 0 and 1.0.
E)will be greater than or equal to .74 but less than or equal to 1.51.

Question 34

Which one of the following is the vertical intercept of the security market line?

A)Market rate of return
B)Individual security rate of return
C)Market risk premium
D)Individual security beta multiplied by the market risk premium
E)Risk-free rate

Question 35

The addition of a risky security to a fully diversified portfolio:

A)must decrease the portfolio's expected return.
B)must increase the portfolio beta.
C)may or may not affect the portfolio beta.
D)will increase the unsystematic risk of the portfolio.
E)will have no effect on the portfolio beta or its expected return.

Question 36

Assume you own a portfolio of diverse securities which are each correctly priced.Given this, the reward-to-risk ratio:

A)for the portfolio must equal 1.0.
B)for the portfolio must be less than the market risk premium.
C)for each security must equal zero.
D)of each security is equal to the risk-free rate.
E)of each security must equal the slope of the security market line.

Question 37

Which one of the following portfolios will have a beta of zero?

A)A portfolio that is equally as risky as the overall market
B)A portfolio that consists of a single stock
C)A portfolio comprised solely of U.S.Treasury bills
D)A portfolio with a zero variance of returns
E)No portfolio can have a beta of zero.

Question 38

Which statement is correct?

A)An underpriced security will plot below the security market line.
B)A security with a beta of 1.54 will plot on the security market line if it is correctly priced.
C)A portfolio with a beta of .93 will plot to the right of the overall market.
D)A security with a beta of .99 will plot above the security market line if it is correctly priced.
E)A risk-free security will plot at the origin.

Question 39

According to the capital asset pricing model, the expected return on a security will be affected by all of the following except the:

A)market risk premium.
B)risk-free rate.
C)market rate of return.
D)security's standard deviation.
E)security's beta.

Question 40

If a security plots to the right and below the security market line, then the security has ____ systematic risk than the market and is ____.

A)more; overpriced
B)more; underpriced
C)less; overpriced
D)less; underpriced
E)less; correctly priced

Question 41

The expected return on a security is not affected by the:

A)security's unique risks.
B)risk-free rate.
C)security's risk premium.
D)security's beta.
E)market rate of return.

Question 42

The capital asset pricing model:

A)assumes the market has a beta of zero and the risk-free rate is positive.
B)rewards investors based on total risk assumed.
C)considers the relationship between the fluctuations in a security's returns versus the market's returns.
D)applies to portfolios but not to individual securities.
E)assumes the market risk premium is constant over time.

Question 43

You own a portfolio consisting of the securities listed below.The expected return for each security is as shown.What is the expected return on the portfolio?

A)13.81 percent
B)12.91 percent
C)13.28 percent
D)14.14 percent
E)13.46 percent

Question 44

Southern Wear stock has an expected return of 15.1 percent.The stock is expected to lose 8 percent in a recession and earn 18 percent in a boom.The probabilities of a recession, a normal economy, and a boom are 2 percent, 87 percent, and 11 percent, respectively.What is the expected return on this stock if the economy is normal?

A)14.79 percent
B)17.04 percent
C)15.26 percent
D)16.43 percent
E)11.08 percent

Question 45

Bernard Companies stock has an expected return of 9.5 percent.The stock is expected to return 11 percent in a normal economy and 13.4 percent in a boom.The probabilities of a recession, normal economy, and a boom are 10 percent, 84 percent, and 6 percent, respectively.What is the expected return if the economy is in a recession?

A)-5.44 percent
B)-2.97 percent
C)--2.46 percent
D)-10.98 percent
E)-6.98 percent

Question 46

You have compiled the following information on your investments.What rate of return should you expect to earn on this portfolio?

A)11.57 percent
B)11.13 percent
C)11.87 percent
D)11.30 percent
E)11.61 percent

Question 47

You own a portfolio that is invested as follows: $22,575 of Stock A, $3,750 of Stock B, $12,500 of Stock C, and $5,800 of Stock D. What is the portfolio weight of Stock B?

A)8.47 percent
B)8.40 percent
C)10.96 percent
D)9.66 percent
E)13.08 percent

Question 48

Bass Clef Music Stores' stock has a risk premium of 7 percent while the inflation rate is 1.9 percent and the risk-free rate is 2.2 percent.What is the expected return on this stock?

A)10.9 percent
B)7.3 percent
C)9.2 percent
D)10.8 percent
E)12.3 percent

Question 49

Assume the economy has an 18 percent chance of booming, a 3 percent chance of being recessionary, and being normal the remainder of the time.A stock is expected to return 16.8 percent in a boom, 12.9 percent in a normal economy, and -4.5 percent in a recession.What is the expected rate of return on this stock?

A)7.98 percent
B)8.63 percent
C)9.17 percent
D)13.08 percent
E)10.68 percent

Question 50

North Around, Inc.stock is expected to return 22percent in a boom, 13percent in a normal economy, and -15 percent in a recession.The probabilities of a boom, normal economy, and a recession are 6 percent, 92 percent, and 2 percent, respectively.What is the standard deviation of the returns on this stock?

A)2.15 percent
B)4.6 percent
C)20.54 percent
D)18.79 percent
E)4.53 percent

Question 51

Midwest Fastener Supply stock is expected to return 16 percent in a booming economy, 12percent in a normal economy, and -3 percent in a recession.The probabilities of an economic boom, normal state, or recession are 12 percent, 80 percent, and 8 percent, respectively.What is the expected rate of return on this stock?

A)11.28 percent
B)10.67 percent
C)10.95 percent
D)11.91 percent
E)11.70 percent

Question 52

The common stock of The Dominic Companies should return 29 percent in a boom, 12 percent in a normal economy, and -15 percent in a recession.The probabilities of a boom, normal economy, and recession are 12percent, 86 percent, and 2 percent, respectively.What is the variance of the returns on this stock?

A).005809
B).005019
C).006047
D).004701
E).006270

Question 53

Blue Bell stock is expected to return 8.4 percent in a boom, 8.9 percent in a normal economy, and 9.2 percent in a recession.The probabilities of a boom, normal economy, and a recession are 6 percent, 92 percent, and 2 percent, respectively.What is the standard deviation of the returns on this stock?

A).38 percent
B).55 percent
C).13 percent
D).42 percent
E).06 percent

Question 54

Malone Imports stock should return 12 percent in a boom, 10 percent in a normal economy, and 2 percent in a recession.The probabilities of a boom, normal economy, and recession are 5 percent, 85 percent, and 10 percent, respectively.What is the variance of the returns on this stock?

A)..000522
B)..000611
C)..024718
D)..006107
E)..015254

Question 55

Julie wants to create a $5,000 portfolio.She also wants to invest as much as possible in a high risk stock with the hope of earning a high rate of return.However, she wants her portfolio to have no more risk than the overall market.Which one of the following portfolios is most apt to meet all of her objectives?

A)Invest the entire $5,000 in a stock with a beta of 1.0
B)Invest $2,500 in a stock with a beta of 1.98 and $2,500 in a stock with a beta of 1.0
C)Invest $2,500 in a risk-free asset and $2,500 in a stock with a beta of 2.0
D)Invest $2,500 in a stock with a beta of 1.0, $1,250 in a risk-free asset, and $1,250 in a stock with a beta of 2.0
E)Invest $2,000 in a stock with a beta of 3, $2,000 in a risk-free asset, and $1,000 in a stock with a beta of 1.0

Question 56

Given the following information, what is the expected return on a portfolio that is invested 30 percent in both Stocks A and C, and 40 percent in Stock B?

A)9.44 percent
B)11.3 percent
C)10.69 percent
D)9.2 percent
E)8.78 percent

Question 57

You own a $58,600 portfolio comprised of four stocks.The values of Stocks A, B, and C are $11,200, $17,400, and $20,400, respectively.What is the portfolio weight of Stock D?

A)16.38 percent
B)15.39 percent
C)10.33 percent
D)12.10 percent
E)12.58 percent

Question 58

Crabby Shores stock is expected to return 15.7 percent in a booming economy, 9.8 percent in a normal economy, and 2.3 percent in a recession.The probabilities of an economic boom, normal state, or recession are 15 percent, 73 percent, and 12 percent, respectively.What is the expected rate of return on this stock?

A)10.07 percent
B)10.74 percent
C)10.61 percent
D)9.79 percent
E)8.68 percent

Question 59

Based on the capital asset pricing model, which one of the following must increase the expected return on an individual security, all else held constant?

A)An increase in the risk level of that security as measured by standard deviation
B)An increase in the risk-free rate given a security beta of 1.42
C)A decrease in the market rate of return given a security beta of 1.13
D)A decrease in the market rate of return given a security beta of .78
E)A decrease in the risk-free rate given a security beta of 1.06

Question 60

World United stock currently plots on the security market line and has a beta of 1.04.Which one of the following will increase that stock's rate of return without affecting the risk level of the stock, all else constant?

A)An increase in the risk-free rate
B)Decrease in the security's beta
C)Overpricing of the stock in the marketplace
D)Increase in the market risk-to-reward ratio
E)Decrease in the market rate of return

Question 61

A stock has a beta of 1.32 and an expected return of 12.8 percent.The risk-free rate is 3.6 percent.What is the slope of the security market line?

A)6.49 percent
B)7.28 percent
C)6.97 percent
D)9.03 percent
E)7.99 percent

Question 62

You currently own a portfolio valued at $52,000 that has a beta of 1.16.You have another $10,000 to invest and would like to invest it in a manner such that the portfolio beta decreases to 1.15.What does the beta of the new investment have to be?

A)1.098
B).889
C).869
D).924
E)1.125

Question 63

Given the following information, what is the standard deviation of the returns on a portfolio that is invested 40 percent in Stock A, 35 percent in Stock B, and the remainder in Stock C?

A)1.68 percent
B)6.72 percent
C)3.16 percent
D)2.43 percent
E)16.57 percent

Question 64

Given the following information, what is the standard deviation of the returns on a portfolio that is invested 35 percent in both Stocks A and C, and 30 percent in Stock B?

A)1.95 percent
B)1.13 percent
C)3.67 percent
D)2.91 percent
E)2.36 percent

Question 65

What is the beta of the following portfolio?

A)1.08
B)1.15
C)1.04
D)1.11
E).99

Question 66

The risk-free rate is 3.7 percent and the expected return on the market is 12.3 percent.Stock A has a beta of 1.1 and an expected return of 13.1 percent.Stock B has a beta of .86 and an expected return of 11.4 percent.Are these stocks correctly priced? Why or why not?

A)No, Stock A is underpriced and Stock B is overpriced.
B)No, Stock A is overpriced and Stock B is underpriced.
C)No, Stock A is overpriced but Stock B is correctly priced.
D)No, Stock A is underpriced but Stock B is correctly priced.
E)No, both stocks are overpriced.

Question 67

Given the following information, what is the expected return on a portfolio that is invested 35 percent in Stock A, 45 percent in Stock B, and the balance in Stock C?

A)12.04 percent
B)12.16 percent
C)12.91 percent
D)13.46 percent
E)11.87 percent

Question 68

Bama Entertainment has common stock with a beta of 1.22.The market risk premium is 8.1 percent and the risk-free rate is 3.9 percent.What is the expected return on this stock?

A)13.31 percent
B)12.67 percent
C)12.40 percent
D)13.78 percent
E)14.13 percent

Question 69

Currently, you own a portfolio comprised of the following three securities.How much of the riskiest security should you sell and replace with risk-free securities if you want your portfolio beta to equal 90 percent of the market beta?

A)$7,023.15
B)$7,811.29
C)$8,666.67
D)$7,753.51
E)$8,318.50

Question 70

A stock has an expected return of 11.3 percent and a beta of 1.08.The risk-free rate is 4.7 percent.What is the slope of the security market line?

A)7.25 percent
B)6.11 percent
C)6.78 percent
D)5.92 percent
E)7.03 percent

Question 71

Stock A has an expected return of 14.4 percent and a beta of 1.21.Stock B has an expected return of 12.87 percent and a beta of 1.06.Both stocks have the same reward-to-risk ratio.What is the risk-free rate?

A)2.06 percent
B)2.28 percent
C)1.79 percent
D)3.35 percent
E)1.92 percent

Question 72

A portfolio has an expected return of 13.4 percent.This portfolio contains two stocks and one risk-free security.The expected return on Stock X is 12.2 percent and on Stock Y it is 19.3 percent.The risk-free rate is 4.1 percent.The portfolio value is $48,000 of which $10,000 is the risk-free security.How much is invested in Stock X?

A)$21,548.19
B)$19,514.14
C)$18,478.87
D)$22,200.14
E)$16,904.72

Question 73

You currently own a portfolio valued at $76,000 that is equally as risky as the market.Given the information below, what is the beta of Stock C?

A).91
B).95
C).81
D)1.03
E)1.06

Question 74

Stock J has a beta of 1.52 and an expected return of 15.76percent.Stock K has a beta of .98 and an expected return of 11.44 percent.What is the risk-free rate if these securities both plot on the security market line?

A)3.60 percent
B)3.34 percent
C)3.57 percent
D)3.52 percent
E)3.64 percent

Question 75

Given the following information, what is the variance of the returns on a portfolio that is invested 40 percent in both Stocks A and B, and 20 percent in Stock C?

A).000602
B).001490
C).000513
D).000205
E).001143

Question 76

What is the beta of the following portfolio?

A).98
B).76
C)1.18
D)1.21
E)1.13

Question 77

You would like to create a portfolio that is equally invested in a risk-free asset and two stocks.One stock has a beta of 1.39.What does the beta of the second stock have to be if you want the portfolio to be equally as risky as the overall market?

A).72
B).97
C)1.23
D)1.55
E)1.61

Question 78

Currently, the risk-free rate is 3.2 percent.Stock A has an expected return of 11.4 percent and a beta of 1.11.Stock B has an expected return of 13.7 percent.The stocks have equal reward-to-risk ratios.What is the beta of Stock B?

A)1.27
B)1.33
C)1.36
D)1.08
E)1.42

Question 79

A $36,000 portfolio is invested in a risk-free security and two stocks.The beta of Stock A is 1.29 while the beta of Stock B is .90.One-half of the portfolio is invested in the risk-free security.How much is invested in Stock A if the beta of the portfolio is .58?

A)$6,000
B)$9,000
C)$12,000
D)$15,000
E)$18,000

Question 80

Stock A has a beta of 1.09 while Stock B has a beta of .76 and an expected return of 8.2 percent.What is the expected return on Stock A if the risk-free rate is 4.6 percent and both stocks have equal reward-to-risk premiums?

A)11.12 percent
B)8.07 percent
C)9.76 percent
D)10.89 percent
E)11.73 percent