Question 1

Which of the following is true about the market portfolio?

Accepted Answer

A)  The expected return of the market portfolio determines the slope of the security market line. 
B)  It plots below the security market line. 
C)  It has a beta equal to zero. 
D)  It consists of all the stocks on the TSX. 
E)  It has a different reward to risk ratio than the individual assets in the market. 
A)  The expected return of the market portfolio determines the slope of the security market line. 
B)  It plots below the security market line. 
C)  It has a beta equal to zero. 
D)  It consists of all the stocks on the TSX. 
E)  It has a different reward to risk ratio than the individual assets in the market.

Question 2

ABC Investment Corporation is considering a portfolio with 30% weighting in a cyclical stock and 70% weighting in a countercyclical stock. It is expected that there will be three economic states; Good, Average and Bad, each with equal probabilities of occurrence. The cyclical stock is expected to have returns of 12%, 5% and 1% in Good, Average and Bad economies respectively. The countercyclical stock is expected to have returns of -8%, 2% and 14% in Good, Average and Bad economies respectively. Given this information, calculate the portfolio standard deviation.

Accepted Answer

A)  4.97% 
B)  5.97% 
C)  6.97% 
D)  7.97% 
E)  8.97% 
A)  4.97% 
B)  5.97% 
C)  6.97% 
D)  7.97% 
E)  8.97%

Question 3

What is the standard deviation of returns for asset A?

Accepted Answer

A)  1.3% 
B)  1.9% 
C)  2.5% 
D)  2.4% 
E)  6.4% 
A)  1.3% 
B)  1.9% 
C)  2.5% 
D)  2.4% 
E)  6.4%

Question 4

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

A)  Be equal to one-half of 8% if there is a 50% chance of an economic boom. 
B)  Vary inversely with the growth of the economy. 
C)  Increase as the probability of a recession increases. 
D)  Be equal to 75% of 8% if there is a 75% chance of a boom economy. 
E)  Increase as the probability of a boom economy increases. 
A)  Be equal to one-half of 8% if there is a 50% chance of an economic boom. 
B)  Vary inversely with the growth of the economy. 
C)  Increase as the probability of a recession increases. 
D)  Be equal to 75% of 8% if there is a 75% chance of a boom economy. 
E)  Increase as the probability of a boom economy increases.

Question 5

_____ measures total risk.

Accepted Answer

A)  The mean. 
B)  Beta. 
C)  The geometric average. 
D)  The standard deviation. 
E)  The arithmetic average. 
A)  The mean. 
B)  Beta. 
C)  The geometric average. 
D)  The standard deviation. 
E)  The arithmetic average.

Question 6

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

Accepted Answer

A)  Portfolio risk. 
B)  Undiversifiable risk. 
C)  Market risk. 
D)  Unsystematic risk. 
E)  Total risk. 
A)  Portfolio risk. 
B)  Undiversifiable risk. 
C)  Market risk. 
D)  Unsystematic risk. 
E)  Total risk.

Question 7

Provide a graphical representation of the volatility of two positively correlated stocks over time.

Accepted Answer

The graph should clo

Question 8

Total risk - Systematic risk = Unsystematic risk

Accepted Answer

A) True 
 B)False

Question 9

What is the expected return on a portfolio that is equally-weighted amongst A, B, and the risk-free asset? The return on the risk-free asset is 4%.

Accepted Answer

A)  8.9% 
B)  9.3% 
C)  10.1% 
D)  11.8% 
E)  13.8% 
A)  8.9% 
B)  9.3% 
C)  10.1% 
D)  11.8% 
E)  13.8%

Question 10

Which one of the following is an example of diversifiable risk?

Accepted Answer

A)  A decrease in the average cost of living. 
B)  An increase in the prime interest rate. 
C)  An increase in the minimum hourly wage. 
D)  A new government regulation on aircraft engines. 
E)  A decrease in federal income taxes on business incomes. 
A)  A decrease in the average cost of living. 
B)  An increase in the prime interest rate. 
C)  An increase in the minimum hourly wage. 
D)  A new government regulation on aircraft engines. 
E)  A decrease in federal income taxes on business incomes.

Question 11

Low-beta stocks are sold and replaced with high-beta stocks would increase a portfolio's systematic risk.

Accepted Answer

A) True 
 B)False

Question 12

Explain some of the key differences between standard deviation and beta.

Accepted Answer

Standard deviation measures total risk,

Question 13

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.8% and the market risk premium is 8.5%?

Accepted Answer

A)  A 
B)  B 
C)  C 
D)  D 
E)  E 
A)  A 
B)  B 
C)  C 
D)  D 
E)  E

Question 14

The weights that are commonly used when computing the expected return of a portfolio given various economic scenarios are based on the amount invested in each security held in the portfolio.

Accepted Answer

A) True 
 B)False

Question 15

Diversification works because forming stocks into portfolios reduces the standard deviation of returns for each stock.

Accepted Answer

A) True 
 B)False

Question 16

The primary purpose of portfolio diversification is to:

Accepted Answer

A)  Increase returns and risks. 
B)  Eliminate all risks. 
C)  Eliminate asset-specific risk. 
D)  Eliminate systematic risk. 
E)  Lower both returns and risks. 
A)  Increase returns and risks. 
B)  Eliminate all risks. 
C)  Eliminate asset-specific risk. 
D)  Eliminate systematic risk. 
E)  Lower both returns and risks.

Question 17

What is the standard deviation of a portfolio with one-quarter of the funds in A?

Accepted Answer

A)  0.08% 
B)  0.65% 
C)  0.89% 
D)  1.03% 
E)  3.2% 
A)  0.08% 
B)  0.65% 
C)  0.89% 
D)  1.03% 
E)  3.2%

Question 18

You have a portfolio consisting of equal amounts of Royal Bank stock and Treasury bills. If you replace half of the Treasury bills with more Royal Bank stock, the portfolio expected return will likely ___________, all else the same.

Accepted Answer

A)  Increase. 
B)  Decrease. 
C)  Remain unchanged. 
D)  Either increase or decrease. 
E)  Decrease if IBM is considered a small-cap stock. 
A)  Increase. 
B)  Decrease. 
C)  Remain unchanged. 
D)  Either increase or decrease. 
E)  Decrease if IBM is considered a small-cap stock.

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

A)  The expected return is equal to the sum of the returns projected for each state of the economy. 
B)  The probabilities for the states must sum to 1. 
C)  It is safe to ignore any states in which the return is negative. 
D)  If all of the state-returns and probabilities are positive, the total expected return must be higher than the highest state return. 
E)  The lowest projected state-return is guaranteed to be your largest loss if you buy the investment. 
A)  The expected return is equal to the sum of the returns projected for each state of the economy. 
B)  The probabilities for the states must sum to 1. 
C)  It is safe to ignore any states in which the return is negative. 
D)  If all of the state-returns and probabilities are positive, the total expected return must be higher than the highest state return. 
E)  The lowest projected state-return is guaranteed to be your largest loss if you buy the investment.

Question 20

Which of the following is the best definition of arbitrage pricing theory (APT)?

Accepted Answer

A)  A theory showing that the expected return on any risky asset is a linear combination of various factors. 
B)  A risk that affects at most a small number of assets. Also called unique or asset-specific risks. 
C)  A risk that influences a large number of assets. Also called market risk. 
D)  Positively sloped straight line displaying the relationship between expected return and beta. 
E)  Principle stating that spreading an investment across a number of assets eliminates some, but not all, of the risk. 
A)  A theory showing that the expected return on any risky asset is a linear combination of various factors. 
B)  A risk that affects at most a small number of assets. Also called unique or asset-specific risks. 
C)  A risk that influences a large number of assets. Also called market risk. 
D)  Positively sloped straight line displaying the relationship between expected return and beta. 
E)  Principle stating that spreading an investment across a number of assets eliminates some, but not all, of the risk.

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

Which of the following is true about the market portfolio?

What is the standard deviation of returns for asset A?

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:

_____ measures total risk.

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

Provide a graphical representation of the volatility of two positively correlated stocks over time.

Total risk - Systematic risk = Unsystematic risk

What is the expected return on a portfolio that is equally-weighted amongst A, B, and the risk-free asset? The return on the risk-free asset is 4%.

Which one of the following is an example of diversifiable risk?

Low-beta stocks are sold and replaced with high-beta stocks would increase a portfolio's systematic risk.

Explain some of the key differences between standard deviation and beta.

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.8% and the market risk premium is 8.5%?

The weights that are commonly used when computing the expected return of a portfolio given various economic scenarios are based on the amount invested in each security held in the portfolio.

Diversification works because forming stocks into portfolios reduces the standard deviation of returns for each stock.

The primary purpose of portfolio diversification is to:

What is the standard deviation of a portfolio with one-quarter of the funds in A?

You have a portfolio consisting of equal amounts of Royal Bank stock and Treasury bills. If you replace half of the Treasury bills with more Royal Bank stock, the portfolio expected return will likely ___________, all else the same.

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:

Which of the following is the best definition of arbitrage pricing theory (APT)?

Introduction to Corporate Finance

Financial Statements, Cash Flow, and Taxes

Working With Financial Statements

Long-Term Financial Planning and Corporate Growth

Introduction to Valuation: the Time Value of Money

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Stock Valuation

Net Present Value and Other Investment Criteria

Making Capital Investment Decisions

Project Analysis and Evaluation

Lessons From Capital Market History

Cost of Capital

Raising Capital

Financial Leverage and Capital Structure Policy

Dividends and Dividend Policy

Short-Term Finance and Planning

Cash and Liquidity Management

Credit and Inventory Management

International Corporate Finance

Leasing

Mergers and Acquisitions

Enterprise Risk Management

Options and Corporate Securities

Behavioural Finance: Implications for Financial Management

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