Question 1

All of the following statements about risk are correct EXCEPT:

Accepted Answer

A)  Risk can be defined as the chance for financial loss. 
B)  The term risk is used interchangeably with uncertainty. 
C)  Risk refers to the certainty of returns associated with a given asset. 
D)  The more certain the return from an asset, the less variability and therefore less risk. 
A)  Risk can be defined as the chance for financial loss. 
B)  The term risk is used interchangeably with uncertainty. 
C)  Risk refers to the certainty of returns associated with a given asset. 
D)  The more certain the return from an asset, the less variability and therefore less risk.

Question 2

Given the following information on securities E and F, calculate the expected return and standard deviation of returns on a portfolio consisting of 40% invested in E and 60% invested in F.

Accepted Answer

A)  13.5%; 15% 
B)  13.8%; 14.4% 
C)  13.8%; 10.6% 
D)  13.5%; 8.7% 
A)  13.5%; 15% 
B)  13.8%; 14.4% 
C)  13.8%; 10.6% 
D)  13.5%; 8.7%

Question 3

Jim Bowles is an investor who believes the economy is gaining strength and, therefore, wishes to increase the risk of his 14 security portfolio. Each security has a current market value of $5,000 and the current beta of the portfolio is 1.02. The beta of the least risky security is .76. If Jim replaces the least risky security with another security with the same market value but a beta of 1.45, what will the portfolio beta be then?

Accepted Answer

A)  1.03 
B)  1.07 
C)  1.08 
D)  1.04 
A)  1.03 
B)  1.07 
C)  1.08 
D)  1.04

Question 4

The slope of the characteristic line for a specific security is an estimate of ____ for that security.

Accepted Answer

A)  beta 
B)  systematic risk 
C)  total risk 
D)  both beta and systematic risk 
A)  beta 
B)  systematic risk 
C)  total risk 
D)  both beta and systematic risk

Question 5

An investor, by investing in combinations of stocks, develops a ____ portfolio

Accepted Answer

A)  simple 
B)  structured 
C)  diversified 
D)  energetic 
A)  simple 
B)  structured 
C)  diversified 
D)  energetic

Question 6

The security market line

Accepted Answer

A)  is defined as the slope of a line relating an individual security's return to the returns of other securities in that firm's primary industry. 
B)  provides a picture of the risk-return tradeoff required by diversified investors considering various risky assets. 
C)  has as its slope the beta of the security 
D)  is determined by the prevailing level of risk-free interest rates minus a risk premium 
A)  is defined as the slope of a line relating an individual security's return to the returns of other securities in that firm's primary industry. 
B)  provides a picture of the risk-return tradeoff required by diversified investors considering various risky assets. 
C)  has as its slope the beta of the security 
D)  is determined by the prevailing level of risk-free interest rates minus a risk premium

Question 7

Christy is considering investing in the common stock of One Liberty and Heico. The following data are available for these two securities:  
If she invests 30% of her funds in Heico and 70% in One Liberty, and if the correlation of returns between these securities is +0.65, what is the portfolio's expected return and standard deviation?

Accepted Answer

A)  14% and 15.67% 
B)  14.8% and 9.44% 
C)  13.2% and 10.54% 
D)  13.1% and 9.67% 
A)  14% and 15.67% 
B)  14.8% and 9.44% 
C)  13.2% and 10.54% 
D)  13.1% and 9.67%

Question 8

____ can be achieved by investing in a set of securities that have different risk-return characteristics.

Accepted Answer

A)  Indexing 
B)  Capital Asset pricing 
C)  Diversification 
D)  Asset allocation 
A)  Indexing 
B)  Capital Asset pricing 
C)  Diversification 
D)  Asset allocation

Question 9

On the capital market line (CML), any risk-return combination beyond the Market Portfolio (m) is obtained by ____.

Accepted Answer

A)  lending money 
B)  borrowing money 
C)  reducing risk 
D)  investing in index funds 
A)  lending money 
B)  borrowing money 
C)  reducing risk 
D)  investing in index funds

Question 10

Assume you want to construct a portfolio with a 14 percent return from the following two securities:  
What percentage of your portfolio should be invested in Security 1?

Accepted Answer

A)  57% 
B)  47% 
C)  43% 
D)  53% 
A)  57% 
B)  47% 
C)  43% 
D)  53%

Question 11

In general, when the correlation coefficient between the returns on two securities is ____, the risk of a portfolio is ____ the weighted average of the total risk of the two individual securities.

Accepted Answer

A)  equal to +1.0; equal to 
B)  less than +1.0; less than 
C)  a and b 
D)  none of the above 
A)  equal to +1.0; equal to 
B)  less than +1.0; less than 
C)  a and b 
D)  none of the above

Question 12

If the return on U.S. Treasury bills is 7.02%, the risk premium is 2.32%, and the inflation rate is 4.16%, then the real rate of return is:

Accepted Answer

A)  2.86% 
B)  7.02% 
C)  4.70% 
D)  6.48% 
A)  2.86% 
B)  7.02% 
C)  4.70% 
D)  6.48%

Question 13

When comparing two equal-sized investments, the ____ is an appropriate measure of total risk.

Accepted Answer

A)  standard deviation 
B)  coefficient of variation 
C)  correlation 
D)  covariance 
A)  standard deviation 
B)  coefficient of variation 
C)  correlation 
D)  covariance

Question 14

The risk-free rate of return can be thought of as consisting of the following two components:

Accepted Answer

A)  a real rate of return, a default premium 
B)  unanticipated inflation, bond default premium 
C)  a real rate of return, an inflation premium 
D)  a zero beta component, an expectation premium 
A)  a real rate of return, a default premium 
B)  unanticipated inflation, bond default premium 
C)  a real rate of return, an inflation premium 
D)  a zero beta component, an expectation premium

Question 15

What is the beta of the following project?

Accepted Answer

A)  1.11 
B)  .95 
C)  2.15 
D)  1.43 
A)  1.11 
B)  .95 
C)  2.15 
D)  1.43

Question 16

Explain marketability risk and marketability premium.

Accepted Answer

Marketability risk refers to the ability

Question 17

The real rate of interest is expected to be 3 percent and the expected rate of inflation for next year is expected to be 5.5 percent. If the default risk premium is 1.1 percentage points, and the seniority risk premium is 0.4 percentage points, what is the required return on a 1 year U.S. Treasury security?

Accepted Answer

A)  9.6% 
B)  10.0% 
C)  8.5% 
D)  8.9% 
A)  9.6% 
B)  10.0% 
C)  8.5% 
D)  8.9%

Question 18

An investor plans to invest 75 percent of her funds in the common stock of Gamma Industries and 25 percent in Epsilon Company. The expected return on Gamma is 12 percent and the expected return on Epsilon is 16 percent. The standard deviation of returns for Gamma is 8 percent and for Epsilon is 12 percent. The correlation between the returns for Gamma and Epsilon is +0.8.
-An investor plans to invest 75 percent of her funds in the common stock of Gamma Industries and 25 percent in Epsilon Company. The expected return on Gamma is 12 percent and the expected return on Epsilon is 16 percent. The standard deviation of returns for Gamma is 8 percent and for Epsilon is 12 percent. The correlation between the returns for Gamma and Epsilon is +0.8.Determine the standard deviation of returns for this investor's portfolio.

Accepted Answer

A)  73.8% 
B)  6.71% 
C)  3.00% 
D)  8.59% 
A)  73.8% 
B)  6.71% 
C)  3.00% 
D)  8.59%

Question 19

The expected rate of return for the coming year on FTC common stock is normally distributed with a mean of 14% and a standard deviation of 7%. Determine the probability of earning more than 21% on FTC common stock.

Accepted Answer

A)  1.00 
B)  0.8413 
C)  0.0013 
D)  0.1587
(Note: Table V is required to work this problem.) 
A)  1.00 
B)  0.8413 
C)  0.0013 
D)  0.1587
(Note: Table V is required to work this problem.)

Question 20

Over the 10-year period from 1978 through 1987, the compound annual rate of return on U.S. Treasury bills was 9.17 percent. Over the same time period, the average annual inflation rate was 6.39 percent. Therefore,

Accepted Answer

A)  the inflation premium was 2.78 percentage points 
B)  the real expected rate of return was 9.17 percentage points 
C)  the realized real rate of return was 2.78 percentage points 
D)  the required rate of return was 6.39 percentage points 
A)  the inflation premium was 2.78 percentage points 
B)  the real expected rate of return was 9.17 percentage points 
C)  the realized real rate of return was 2.78 percentage points 
D)  the required rate of return was 6.39 percentage points

Exam 8: Analysis of Risk and Return

All of the following statements about risk are correct EXCEPT:

Given the following information on securities E and F, calculate the expected return and standard deviation of returns on a portfolio consisting of 40% invested in E and 60% invested in F.

The slope of the characteristic line for a specific security is an estimate of ____ for that security.

An investor, by investing in combinations of stocks, develops a ____ portfolio

The security market line

____ can be achieved by investing in a set of securities that have different risk-return characteristics.

On the capital market line (CML), any risk-return combination beyond the Market Portfolio (m) is obtained by ____.

Assume you want to construct a portfolio with a 14 percent return from the following two securities: What percentage of your portfolio should be invested in Security 1?

In general, when the correlation coefficient between the returns on two securities is ____, the risk of a portfolio is ____ the weighted average of the total risk of the two individual securities.

If the return on U.S. Treasury bills is 7.02%, the risk premium is 2.32%, and the inflation rate is 4.16%, then the real rate of return is:

When comparing two equal-sized investments, the ____ is an appropriate measure of total risk.

The risk-free rate of return can be thought of as consisting of the following two components:

What is the beta of the following project?

Explain marketability risk and marketability premium.

The expected rate of return for the coming year on FTC common stock is normally distributed with a mean of 14% and a standard deviation of 7%. Determine the probability of earning more than 21% on FTC common stock.

Over the 10-year period from 1978 through 1987, the compound annual rate of return on U.S. Treasury bills was 9.17 percent. Over the same time period, the average annual inflation rate was 6.39 percent. Therefore,

The Role and Objective of Financial Management

The Domestic and International Financial Marketplace

Evaluation of Financial Performance

Financial Planning and Forecasting

The Time Value of Money

Fixed Income Securities: Characteristics and Valuation

Common Stock: Characteristics, Valuation, and Issuance

Capital Budgeting and Cash Flow Analysis

Capital Budgeting: Decision Criteria and Real Option Considerations

Capital Budgeting and Risk

The Cost of Capital

Capital Structure Concepts

Capital Structure Management in Practice

Dividend Policy

Working Capital Policy and Short-term Financing

The Management of Cash and Marketable Securities

Management of Accounts Receivable and Inventories

Lease and Intermediate-term Financing

Financing With Derivatives

Risk Management

International Financial Management

Corporate Restructuring

Continuous Compounding and Discounting

Mutually Exclusive Investments Having Unequal Lives

Breakeven Analysis

Bond Refunding Analysis

Taxes

Filters

In general, when the correlation coefficient between the returns on two securities is , the risk of a portfolio is the weighted average of the total risk of the two individual securities.