Multiple Choice Questions

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the:
  • risk premium
  • risk-free rate.
  • the risk-free rate.
  • risk premium.
Standard deviation measures which type of risk?
  • total
  • a beta of 1.0.
  • beta
  • portfolio
Which one of the following statements is correct concerning unsystematic risk?
  • This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.
  • A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio.
  • Eliminating unsystematic risk is the responsibility of the individual investor.
  • The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
Which one of the following statements related to risk is correct?
  • systematic
  • The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
  • investors panic causing security prices around the globe to fall precipitously
  • This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.
Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?
  • reward-to-risk ratio
  • expected rate of return
  • market risk premium
  • security market line
The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.
  • risk premium
  • unsystematic
  • expected rate of return
  • systematic risk principle
A portfolio beta is a weighted average of the betas of the individual securities which comprise the portfolio. However, the standard deviation is not a weighted average of the standard deviations of the individual securities which comprise the portfolio. Explain why this difference exists.
  • Standard deviation measures total risk. The unsystematic portion of the total risk can be eliminated by diversification. Therefore, the total risk of a diversified portfolio is less than the total risk of the component parts. Beta, on the other hand, measures systematic risk, which cannot be eliminated by diversification. Thus, the systematic risk of a portfolio is the summation of the systematic risk of the component parts.
  • standard deviation; beta
  • I and IV only
  • II and IV only
The principle of diversification tells us that:
  • subtracting the risk-free rate of return from the market rate of return.
  • spreading an investment across many diverse assets will eliminate some of the total risk.
  • can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.
  • The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset?I. asset's standard deviationII. asset's betaIII. risk-free rate of returnIV. market risk premium
  • I, III, and IV only
  • I, II and III only
  • I and IV only
  • II and IV only
Which one of the following events would be included in the expected return on Sussex stock?
  • This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.
  • A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio.
  • The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
  • reducing the number of stocks held in the portfolio
The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock:
  • is underpriced.
  • II and IV only
  • I, II, III, and IV
  • I and IV only
Total risk is measured by _____ and systematic risk is measured by _____.
  • market risk premium
  • standard deviation; beta
  • systematic risk principle
  • expected rate of return
Explain how the slope of the security market line is determined and why every stock that is correctly priced, according to CAPM, will lie on this line.
  • The market risk premium is the slope of the security market line. Slope is the rise over the run, which in this case is the difference between the market return and the risk-free rate divided by a beta of 1.0 minus a beta of zero. If a stock is correctly priced the reward-to-risk ratio will be constant and equal to the slope of the security market line. Thus, every stock that is correctly priced will lie on the security market line.
  • reward-to-risk ratio
  • Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.
  • market risk premium
Which of the following statements are correct concerning diversifiable risks?I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities.II. There is no reward for accepting diversifiable risks.III. Diversifiable risks are generally associated with an individual firm or industry.IV. Beta measures diversifiable risk.
  • I, II and III only
  • I, II, and III only
  • I and IV only
  • I, III, and IV only
Which one of the following is most directly affected by the level of systematic risk in a security?
  • stock with a beta of 1.38
  • capital asset pricing model
  • unsystematic risk
  • expected rate of return
Which one of the following statements is correct concerning a portfolio beta?
  • A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio.
  • investors panic causing security prices around the globe to fall precipitously
  • stock with a beta of 1.38
  • Eliminating unsystematic risk is the responsibility of the individual investor.
Which one of the following risks is irrelevant to a well-diversified investor?
  • expected rate of return
  • market risk premium
  • The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
  • unsystematic risk
You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?
  • II and IV only
  • I, II and III only
  • is underpriced.
  • expected return
The primary purpose of portfolio diversification is to:
  • Eliminating unsystematic risk is the responsibility of the individual investor.
  • eliminate asset-specific risk.
  • stock with a beta of 1.38
  • capital asset pricing model
The systematic risk of the market is measured by:
  • is underpriced.
  • risk-free rate.
  • a beta of 1.0.
  • beta
The expected return on a portfolio:I. can never exceed the expected return of the best performing security in the portfolio.II. must be equal to or greater than the expected return of the worst performing security in the portfolio.III. is independent of the unsystematic risks of the individual securities held in the portfolio.IV. is independent of the allocation of the portfolio amongst individual securities.
  • I, II, and III only
  • I, II and III only
  • I, II, III, and IV
  • I, III, and IV only
The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:
  • market risk premium and the amount of systematic risk inherent in the security.
  • market value of the investment in each stock.
  • expected rate of return
  • risk-free rate.
Unsystematic risk:
  • can be effectively eliminated by portfolio diversification.
  • consumer spending on entertainment decreased nationally
  • can be less than the standard deviation of the least risky security in the portfolio.
  • beta
Which one of the following is a risk that applies to most securities?
  • The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
  • stock with a beta of 1.38
  • systematic
  • unsystematic risk
The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.This information implies that:
  • market risk premium and the amount of systematic risk inherent in the security.
  • either stock A is overpriced or stock B is underpriced or both.
  • weighted average of the returns for each economic state.
  • market value of the investment in each stock.
The expected risk premium on a stock is equal to the expected return on the stock minus the:
  • the risk-free rate.
  • risk-free rate.
  • risk premium.
  • risk premium
Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset?
  • market risk premium
  • beta
  • Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.
  • unsystematic risk
The intercept point of the security market line is the rate of return which corresponds to:
  • the risk-free rate.
  • expected rate of return
  • security market line
  • reward-to-risk ratio
A stock with an actual return that lies above the security market line has:
  • a mathematical expectation based on a weighted average and not an actual anticipated outcome.
  • a higher return than expected for the level of risk assumed.
  • may be less than the variance of the least risky stock in the portfolio.
  • consumer spending on entertainment decreased nationally
Which one of the following is an example of systematic risk?
  • Eliminating unsystematic risk is the responsibility of the individual investor.
  • investors panic causing security prices around the globe to fall precipitously
  • Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.
  • consumer spending on entertainment decreased nationally
Which one of the following is an example of unsystematic risk?
  • consumer spending on entertainment decreased nationally
  • reducing the number of stocks held in the portfolio
  • investors panic causing security prices around the globe to fall precipitously
  • This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.
Which one of the following statements is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights?
  • Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.
  • This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.
  • The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
  • Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.
Which one of the following should earn the most risk premium based on CAPM?
  • security market line
  • reducing the number of stocks held in the portfolio
  • unsystematic risk
  • stock with a beta of 1.38
Which one of the following is represented by the slope of the security market line?
  • market risk premium
  • stock with a beta of 1.38
  • systematic
  • capital asset pricing model
According to CAPM, the expected return on a risky asset depends on three components. Describe each component and explain its role in determining expected return.
  • Standard deviation measures total risk. The unsystematic portion of the total risk can be eliminated by diversification. Therefore, the total risk of a diversified portfolio is less than the total risk of the component parts. Beta, on the other hand, measures systematic risk, which cannot be eliminated by diversification. Thus, the systematic risk of a portfolio is the summation of the systematic risk of the component parts.
  • market risk premium and the amount of systematic risk inherent in the security.
  • capital asset pricing model
  • CAPM suggests the expected return is a function of (1) the risk-free rate of return, which is the pure time value of money, (2) the market risk premium, which is the reward for bearing systematic risk, and (3) beta, which is the amount of systematic risk present in a particular asset. Better answers will point out that both the pure time value of money and the reward for bearing systematic risk are exogenously determined and can change on a daily basis, while the amount of systematic risk for a particular asset is determined by the firm's decision-makers.
Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?
  • D. a firm's sales decrease
  • a decrease in the portfolio standard deviation
  • security market line
  • capital asset pricing model
Which one of the following indicates a portfolio is being effectively diversified?
  • reducing the number of stocks held in the portfolio
  • market risk premium
  • a decrease in the portfolio standard deviation
  • expected rate of return
The expected return on a stock computed using economic probabilities is:
  • can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.
  • risk-free rate.
  • a mathematical expectation based on a weighted average and not an actual anticipated outcome.
  • A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio.
Which of the following are examples of diversifiable risk?I. earthquake damages an entire townII. federal government imposes a $100 fee on all business entitiesIII. employment taxes increase nationallyIV. toymakers are required to improve their safety standards
  • I and III only
  • I and IV only
  • I, II, and III only
  • is underpriced.
If a stock portfolio is well diversified, then the portfolio variance:
  • may be less than the variance of the least risky stock in the portfolio.
  • market risk premium and the amount of systematic risk inherent in the security.
  • a higher return than expected for the level of risk assumed.
  • can be less than the standard deviation of the least risky security in the portfolio.
A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent?
  • unsystematic
  • unsystematic risk
  • portfolio
  • systematic
The expected return on a portfolio considers which of the following factors?I. percentage of the portfolio invested in each individual securityII. projected states of the economyIII. the performance of each security given various economic statesIV. probability of occurrence for each state of the economy
  • I, III, and IV only
  • I, II, III, and IV
  • I, II and III only
  • I and III only
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Multiple Choice Questions
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