Question 1

would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Accepted Answer

The answer of would almost always find that the beta...

Question 2

the returns of two firms are negatively correlated, then one of them must have a negative beta.

Accepted Answer

The answer of the returns of two firms are negatively...

Question 3

slope of the SML is determined by the value of beta.

Accepted Answer

The answer of slope of the SML is determined by...

Question 4

would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

Accepted Answer

The beta of a diversified portfolio is more stable over time than the beta of a single security because a diversified portfolio includes multiple securities with different levels of risk and volatility, which can help offset and reduce the impact of volatility of any one single security.

Question 5

CAPM is built on historic conditions, although in most cases we use expected future data in applying it.Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility.This is one of the strengths of the CAPM.

Accepted Answer

The statement is incorrect. Betas used in the CAPM are calculated using historic data and are subject to changes in future volatility.

Question 6

distributions of rates of return for Companies AA and BB are given below:
$$\begin{array} { l c c c } 
{ \begin{array} { c } 
\text { State of the } \
\text { Economy }
\end{array} } & \begin{array} { c } 
\text { Probability of This } \
\text { State Occurring }
\end{array} & \text { AA } & \text { BB } \
\text { Boom } & 0.2 & 30 \% & - 10 \% \
\text { Normal } & 0.6 & 10 \% & 5 \% \
\text { Recession } & 0.2 & - 5 \% & 50 \%
\end{array}$$

We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Accepted Answer

A rational, risk-averse investor would consider both the expected return and the risk (volatility) of the securities. Security BB has a high return in a recession, which might provide better diversification benefits and risk reduction in a well-diversified portfolio, despite its lower expected return compared to Security AA.

Question 7

is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

Accepted Answer

Beta measures the systematic risk of a firm relative to the overall market, not the correlation between its returns and those of another firm. So, it is possible for a firm to have a positive beta even if the correlation between its returns and those of another firm is negative.

Question 8

stock with a beta equal to -1.0 has zero systematic (or market) risk.

Accepted Answer

The answer of stock with a beta equal to -1.0...

Question 9

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value.Because of its diversification, Portfolio B will by definition be riskless.

Accepted Answer

While Portfolio B is more diversified than Portfolio A, it is not riskless. The overall market can still experience volatility and downturns that can affect all of the stocks held in Portfolio B, causing it to lose value.

Question 10

if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone.

Accepted Answer

The answer of if the correlation between the returns on...

Question 11

stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Accepted Answer

A well-diversified portfolio helps to reduce the specific risk associated with holding individual stocks. Therefore, a single stock's beta would be less relevant to an investor with a well-diversified portfolio as the portfolio's overall risk is determined by a combination of the betas of all the individual securities in the portfolio.

Question 12

Portfolio A has but one security, while Portfolio B has 100 securities.Because of diversification effects, we would expect Portfolio B to have the lower risk.However, it is possible for Portfolio A to be less risky.

Accepted Answer

While diversification generally reduces risk, there may be cases where the single security in Portfolio A has a much lower risk compared to any of the securities in Portfolio B. In such cases, Portfolio A may be less risky.

Question 13

portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio.It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

Accepted Answer

The answer of portfolio's risk is measured by the weighted...

Question 14

an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

Accepted Answer

The answer of an investor buys enough stocks, he or...

Question 15

firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

Accepted Answer

Managerial decisions such as capital budgeting and capital structure can increase or decrease a firm's beta by affecting the level of systematic risk in the firm's operations.

Question 16

change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Accepted Answer

Beta is a measure of the stock's sensitivity to market risk. A higher beta indicates higher volatility and a higher required rate of return to compensate for the added risk. Therefore, a change in beta will likely impact the required rate of return on a stock, which will in turn affect the stock's price.

Question 17

Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk.If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return.

Accepted Answer

The answer of Under the CAPM, the required rate of...

Question 18

managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.

Accepted Answer

Company-specific or unsystematic events can be mitigated by diversification, therefore they do not increase investment risk.

Question 19

slope of the SML is determined by investors' aversion to risk.The greater the average investor's risk aversion, the steeper the SML.

Accepted Answer

This statement is true as investors who are more risk-averse will require a higher return for taking on additional risk, and therefore the SML will have a steeper slope.

Question 20

you plotted the returns of a company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future.

Accepted Answer

The answer of you plotted the returns of a company...

Quiz 6: Risk and Return