Question 1

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:

Accepted Answer

The overall expected rate of return on stock S will increase as the probability of a boom economy increases because a higher probability of a boom implies a higher weighted contribution of the 8% return to the overall expected return.

Question 2

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

Accepted Answer

The expected return on a portfolio of stocks is calculated based on the market value of the total shares held in each stock. This approach takes into account the current value of the investments, reflecting the proportion of each stock's value relative to the total portfolio value, which is crucial for accurately assessing expected returns.

Question 3

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

Accepted Answer

Diversification can reduce the overall risk of a portfolio to a level that is lower than the risk of the least risky stock in the portfolio, due to the benefits of combining uncorrelated or negatively correlated assets.

Question 4

Which of the following does NOT describe the risk that exists in a well-diversified portfolio?

Accepted Answer

Asset-specific risk, also known as unsystematic risk, can be eliminated through diversification, so it does not exist in a well-diversified portfolio.

Question 5

An asset that has an expected rate of return above the security market line:

Accepted Answer

An asset with an expected rate of return above the security market line (SML) is considered underpriced according to the Capital Asset Pricing Model (CAPM). This is because the SML represents the expected return for a given level of risk (beta), and any asset above this line offers a higher return for its level of risk than what the market typically offers, indicating it is a good value or underpriced.

Question 6

Which of the following statements is false?

Accepted Answer

Market risk is synonymous with systematic or non-diversifiable risk and does not include asset-specific risk, which is a component of unique or unsystematic risk.

Question 7

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:

Accepted Answer

The beta coefficient measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset. It is a key concept in finance used to assess the risk and expected return of investments.

Question 8

Unsystematic risk:

Accepted Answer

Unsystematic risk is specific to a company or industry and can be reduced or eliminated through diversification, unlike systematic risk which affects the entire market.

Question 9

Risk that affects at most a small number of assets is called:

Accepted Answer

Unsystematic risk, also known as specific risk, diversifiable risk, or idiosyncratic risk, affects at most a small number of assets. It is unique to a particular company or industry and can be reduced through diversification.

Question 10

What relationship are the volatilities of stock A and B exhibiting?

Accepted Answer

The answer of What relationship are the volatilities of stock...

Question 11

A portfolio is comprised of five risky stocks. The standard deviations of these stocks are 5.6%, 12.8%, 2.3%, 8.9%, and 10.2%. The standard deviation of the portfolio:

Accepted Answer

The standard deviation of a portfolio depends on the correlation between the returns of the assets in the portfolio, in addition to their individual standard deviations. Without information on the weights of the stocks in the portfolio or the correlation between their returns, the exact standard deviation of the portfolio cannot be determined.

Question 12

In a highly competitive market, all stocks should:

Accepted Answer

In a highly competitive market, all stocks should plot on the same security market line according to the Capital Asset Pricing Model (CAPM). This line represents a market equilibrium where each security's expected return is proportional to its risk (beta).

Question 13

All else the same, actions or events that cause firm returns to be less correlated with changes in the economy will _______ the firm's systematic risk.

Accepted Answer

Decreasing the correlation of a firm's returns with changes in the economy reduces the firm's exposure to market-wide, or systematic, risk. This is because systematic risk is the risk inherent to the entire market or market segment, and a lower correlation means the firm's returns are less affected by market-wide changes.

Question 14

Which of the following is true about the market portfolio?

Accepted Answer

The expected return of the market portfolio is indeed a key determinant of the slope of the security market line (SML) in the Capital Asset Pricing Model (CAPM). The SML plots expected return of assets against their beta (risk relative to the market), and the slope of this line is determined by the market risk premium, which is the difference between the expected return of the market portfolio and the risk-free rate.

Question 15

What relationship are the volatilities of stock A and B exhibiting?

Accepted Answer

The answer of What relationship are the volatilities of stock...

Question 16

The expected return on a portfolio:

Accepted Answer

The expected return on a portfolio is limited by the returns on the individual securities within the portfolio, as it is a weighted average of the returns of the securities.

Question 17

Which one of the following statements concerning beta is correct?

Accepted Answer

The beta of a portfolio measures the systematic risk of the portfolio relative to the market as a whole. It can indeed be less than, equal to, or greater than the beta of any individual security within the portfolio, depending on the weights and betas of the individual securities. However, it does not measure unsystematic risk, and there is no inherent rule that it cannot exceed the highest individual security's beta within the portfolio, making D the correct choice.

Question 18

The steeper the slope of the security market line, the:

Accepted Answer

The steeper the slope of the security market line (SML), the higher the risk premium. The slope of the SML represents the market risk premium, which is the additional return over the risk-free rate that investors demand for taking on higher risk. A steeper slope indicates a higher risk premium.

Question 19

When computing the expected return on a share of common stock (or other asset) where you have projected returns for each state of the economy along with associated probabilities of occurrence:

Accepted Answer

The expected return on an asset is calculated by multiplying each possible return by its probability and then summing these products. The probabilities of all possible outcomes must sum to 1 to represent a complete range of outcomes. Choices A, C, D, and E contain misconceptions about how expected returns are calculated or misunderstandings about investment outcomes.

Question 20

What relationship are the volatilities of stock A and B exhibiting?

Accepted Answer

The answer of What relationship are the volatilities of stock...

Quiz 13: Return, Risk, and the Security Market Line

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:

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

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

Which of the following does NOT describe the risk that exists in a well-diversified portfolio?

An asset that has an expected rate of return above the security market line:

Which of the following statements is false?

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:

Unsystematic risk:

Risk that affects at most a small number of assets is called:

What relationship are the volatilities of stock A and B exhibiting?

A portfolio is comprised of five risky stocks. The standard deviations of these stocks are 5.6%, 12.8%, 2.3%, 8.9%, and 10.2%. The standard deviation of the portfolio:

In a highly competitive market, all stocks should:

All else the same, actions or events that cause firm returns to be less correlated with changes in the economy will _______ the firm's systematic risk.

Which of the following is true about the market portfolio?

What relationship are the volatilities of stock A and B exhibiting?

The expected return on a portfolio:

Which one of the following statements concerning beta is correct?

The steeper the slope of the security market line, the:

When computing the expected return on a share of common stock (or other asset) where you have projected returns for each state of the economy along with associated probabilities of occurrence:

What relationship are the volatilities of stock A and B exhibiting?