Question 1

What type of risk can investors reduce through diversification?
A) All risk
B) Systematic risk only
C) Unsystematic risk only
D) Uncertainty

Accepted Answer

Diversification can only reduce unsystematic risk or specific risk. Systematic risk or market risk cannot be reduced through diversification as it is inherent in the entire market. Therefore, option C is the correct answer. Option A is incorrect as diversification cannot eliminate all risks, and option B is incorrect as systematic risk cannot be eliminated through diversification. Option D is not a type of risk.

Question 2

Currently, the expected return on the market is 12.5% and the required rate of return for Alpha, Inc. is 12.5%. Therefore, Alpha's beta must be
A) less than 1.0.
B) greater than 1.0.
C) equal to 1.0.
D) unknown based on the information provided.

Accepted Answer

Since the required rate of return for Alpha, Inc. is equal to the expected return on the market, it means that Alpha's beta is equal to 1.0 (which is the market beta).

Question 3

Investment risk is
A) the probability of achieving a return that is greater than what was expected.
B) the probability of achieving a beta coefficient that is less than what was expected.
C) the probability of achieving a return that is less than what was expected.
D) the probability of achieving a standard deviation that is less than what was expected.

Accepted Answer

Investment risk is the probability of achieving a return that is less than what was expected. Option A describes a positive outcome, option B refers to an expected level of systematic risk, and option D pertains to variability in returns, but does not address the likelihood of achieving expected returns.

Question 4

You are thinking of adding one of two investments to an already well diversified portfolio. Security A Security B
Expected return = 12% Expected return = 12%
Standard deviation of returns = 20.9% Standard deviation of returns = 10.1%
Beta = .8 Beta = 2
If you are a risk-averse investor
A) security A is the better choice.
B) security B is the better choice.
C) either security would be acceptable.
D) cannot be determined with information given.

Accepted Answer

As a risk-averse investor, you would want to choose the investment with lower risk, which is measured by standard deviation of returns. Security A has a higher standard deviation of returns compared to Security B, which makes it the riskier choice. Therefore, Security B would be the better choice for a risk-averse investor.

Question 5

Which of the following is a good measure of the relationship between an investment's returns and the market's returns?
A) The beta coefficient
B) The standard variation
C) The CPI
D) The S&P 500 Index

Accepted Answer

The beta coefficient is a statistical measure that compares the volatility of returns for a particular investment to the overall market's returns. It measures the investment's sensitivity to market movements, making it a good measure of the relationship between an investment's returns and the market's returns. The other options (standard variation, CPI, S&P 500 Index) do not specifically measure the relationship between an investment's returns and the market's returns.

Question 6

It is impossible to eliminate all risk through diversification.

Accepted Answer

While diversification can help spread risk across different investments, it is not possible to completely eliminate all risk. External factors such as market crashes or economic downturns can still affect all investments in a portfolio.

Question 7

The beta of ABC Co. stock is the slope of
A) the security market line.
B) the characteristic line for a plot of returns on the S&P 500 versus returns on short-term Treasury bills.
C) the arbitrage pricing line.
D) the line of best fit for a plot of ABC Co. returns against the returns of the market portfolio for the same period.

Accepted Answer

Beta is a measure of systematic risk and is calculated as the slope of the line of best fit for a plot of an asset's returns against the returns of the market portfolio for the same period. Therefore, the correct choice is D.

Question 8

Stocks with higher betas are usually more stable than stocks with lower betas.

Accepted Answer

This statement is false. Stocks with higher betas are usually more volatile or risky than stocks with lower betas. Beta is a measure of a stock's volatility in relation to the overall market. A beta of 1 indicates that the stock's price tends to move in line with the market, while a beta greater than 1 indicates that the stock is more volatile than the market, and a beta less than 1 indicates that the stock is less volatile than the market.

Question 9

Your broker mailed you your year-end statement. You have $25,000 invested in Amazon, $18,000 tied up in Boeing, $36,000 in Caterpillar stock, and $11,000 in DuPont. The betas for each of your stocks are 1.43 for Amazon, .79 for Boeing, 1.37 for Caterpillar, and 1.71 for DuPont. What is the beta of your portfolio?
A) 1.33
B) 1.31
C) 1.00
D) 5.30

Accepted Answer

To find the beta of the portfolio, we need to weigh the betas of each stock by the proportion of the total investment that each stock represents.

Weighted beta = (weight of Amazon * beta of Amazon) + (weight of Boeing * beta of Boeing) + (weight of Caterpillar * beta of Caterpillar) + (weight of DuPont * beta of DuPont)

Weight of Amazon = $25,000 / ($25,000 + $18,000 + $36,000 + $11,000) = 0.311
Weight of Boeing = $18,000 / ($25,000 + $18,000 + $36,000 + $11,000) = 0.224
Weight of Caterpillar = $36,000 / ($25,000 + $18,000 + $36,000 + $11,000) = 0.447
Weight of DuPont = $11,000 / ($25,000 + $18,000 + $36,000 + $11,000) = 0.018

Plugging in the values:

Weighted beta = (0.311 * 1.43) + (0.224 * 0.79) + (0.447 * 1.37) + (0.018 * 1.71) = 1.31

Therefore, the beta of the portfolio is 1.31.

Question 10

You are considering a portfolio of three stocks with 30% of your money invested in company X, 45% of your money invested in company Y, and 25% of your money invested in company Z. If the betas for each stock are 1.22 for company X, 1.46 for company Y, and 1.03 for company Z, what is the portfolio beta?
A) 1.24
B) 1.00
C) 1.28
D) 1.33

Accepted Answer

To find the portfolio beta, we need to calculate the weighted average of the individual betas, using the percentage of money invested in each stock as weights. 
Portfolio beta = (0.3 x 1.22) + (0.45 x 1.46) + (0.25 x 1.03) 
Portfolio beta = 0.366 + 0.657 + 0.258 
Portfolio beta = 1.281 
Therefore, the closest option to our calculation is C, 1.28.

Question 11

A stock with a beta greater than 1.0 has returns that are ________ volatile than the market, and a stock with a beta of less than 1.0 exhibits returns which are ________ volatile than those of the market portfolio.
A) more, more
B) more, less
C) less, more
D) less, less

Accepted Answer

A stock with a beta greater than 1.0 is more volatile than the market, indicating that it will typically move more than the market. Conversely, a stock with a beta of less than 1.0 is less volatile than the market, meaning it will typically move less than the market.

Question 12

Beta is a measurement of the relationship between a security's returns and the general market's returns.

Accepted Answer

Beta is a statistical measure of how closely the price of a security is correlated with the overall market. It measures the sensitivity of a security's returns to changes in the market. A higher beta indicates higher volatility and risk, while a lower beta indicates lower volatility and risk.

Question 13

Beta is the slope of a straight line that best fits the returns on an asset plotted against the return on
A) inflation.
B) a portfolio of companies in the same industry.
C) a broad market index.
D) treasury bonds.

Accepted Answer

Beta is calculated by comparing the returns on an asset to the returns on a benchmark, typically a broad market index such as the S&P 500. Therefore, the best choice for what the return on should be plotted against is a broad market index, which is represented by choice C.

Question 14

Which of the following is generally used to measure the market when calculating betas?
A) The Dow Jones Industrial Average
B) The Standard & Poors 500 Index
C) The Value Line Quantam Index
D) The Case Schiller Housing Index

Accepted Answer

The most commonly used index to measure the market is the Standard & Poors 500 Index, which includes 500 large-cap stocks widely considered representative of the overall market. The Dow Jones Industrial Average is also sometimes used, but it only includes 30 stocks and may not be as representative. The Value Line Quantam Index and the Case Schiller Housing Index are not typically used to measure the overall market.

Question 15

Which of the following statements is true?
A) Systematic, or market, risk can be reduced through diversification.
B) Both systematic and unsystematic risk can be reduced through diversification.
C) Unsystematic, or company, risk can be reduced through diversification.
D) Neither systematic nor unsystematic risk can be reduced through diversification.

Accepted Answer

Unsystematic risk, also known as specific or idiosyncratic risk, is unique to a particular company or industry and can be reduced through diversification. Diversification involves spreading investments across various sectors or asset classes to reduce exposure to any single asset or risk. Systematic risk, on the other hand, affects the entire market and cannot be mitigated just by diversifying the portfolio.

Question 16

You hold a portfolio with the following securities: Percent
Security of Portfolio Beta Return
X Corporation 20% 1.35 14%
Y Corporation 35% .95 10%
Z Corporation 45% .75 8%
Compute the expected return and beta for the portfolio.
A) 10.67%, 1.02
B) 9.9%, 1.02
C) 34.4%, .94
D) 9.9%, .94

Accepted Answer

The expected return is calculated as a weighted average of the returns: (0.20*14%) + (0.35*10%) + (0.45*8%) = 9.9%. The portfolio beta is also a weighted average: (0.20*1.35) + (0.35*0.95) + (0.45*0.75) = 0.94.

Question 17

Which of the following statements is true?
A) A stock with a beta less than zero has no exposure to systematic risk.
B) A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.
C) A stock with a beta less than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.
D) A stock with a beta less than 1.0 has higher nondiversifiable risk than a stock with a beta of 1.0.

Accepted Answer

A stock with a beta less than 1.0 means that it is less volatile than the overall market, and therefore has lower nondiversifiable risk than a stock with a beta of 1.0. A beta greater than 1.0 indicates that the stock is more volatile than the market, and therefore has higher nondiversifiable risk. A stock with a beta less than zero is theoretically possible, but it would indicate an inverse relationship with the market, which is not a typical scenario.

Question 18

Which of the following is NOT an example of systematic risk?
A) Inflation
B) Recession
C) Management risk
D) Interest rate risk

Accepted Answer

Systematic risk refers to factors that affect the overall market or economy, and cannot be diversified away. Inflation, recession, and interest rate risk are examples of systematic risk as they affect the entire market or economy. Management risk, on the other hand, is a specific risk that refers to the potential impact of poor managerial decisions on the performance of a specific company or investment. Therefore, choice (C) is not an example of systematic risk.

Question 19

Total risk equals unsystematic risk times systematic risk.

Accepted Answer

Total risk equals unsystematic risk plus systematic risk, not multiplied by each other.

Question 20

The CAPM designates the risk-return tradeoff existing in the market, where risk is defined in terms of beta.

Accepted Answer

This is the fundamental principle of the Capital Asset Pricing Model (CAPM). Beta measures the sensitivity of an asset's returns to market movements, and therefore serves as a proxy for risk in the model. The higher the beta, the higher the expected return, but also the higher the risk.

Quiz 8: Risk and Return-Capital Market Theory

What type of risk can investors reduce through diversification?

Currently, the expected return on the market is 12.5% and the required rate of return for Alpha, Inc. is 12.5%. Therefore, Alpha's beta must be

Investment risk is

You are thinking of adding one of two investments to an already well diversified portfolio. Security A Security B Expected return = 12% Expected return = 12% Standard deviation of returns = 20.9% Standard deviation of returns = 10.1% Beta = .8 Beta = 2 If you are a risk-averse investor

Which of the following is a good measure of the relationship between an investment's returns and the market's returns?

It is impossible to eliminate all risk through diversification.

The beta of ABC Co. stock is the slope of

Stocks with higher betas are usually more stable than stocks with lower betas.

A stock with a beta greater than 1.0 has returns that are volatile than the market, and a stock with a beta of less than 1.0 exhibits returns which are volatile than those of the market portfolio.

Beta is a measurement of the relationship between a security's returns and the general market's returns.

Beta is the slope of a straight line that best fits the returns on an asset plotted against the return on

Which of the following is generally used to measure the market when calculating betas?

Which of the following statements is true?

You hold a portfolio with the following securities: Percent Security of Portfolio Beta Return X Corporation 20% 1.35 14% Y Corporation 35% .95 10% Z Corporation 45% .75 8% Compute the expected return and beta for the portfolio.

Which of the following statements is true?

Which of the following is NOT an example of systematic risk?

Total risk equals unsystematic risk times systematic risk.

The CAPM designates the risk-return tradeoff existing in the market, where risk is defined in terms of beta.