Question 1

According to the capital asset pricing model,the expected return on a security is:

Accepted Answer

A) negatively and linearly related to the security's beta. 
B) positively and linearly related to the security's beta. 
C) positively and non-linearly related to the security's beta. 
D) positively and linearly related to the security's variance. 
E) negatively and non-linearly related to the security's beta. 
A) negatively and linearly related to the security's beta. 
B) positively and linearly related to the security's beta. 
C) positively and non-linearly related to the security's beta. 
D) positively and linearly related to the security's variance. 
E) negatively and non-linearly related to the security's beta.

Question 2

The market risk premium is computed by:

Accepted Answer

A) adding the risk-free rate of return to the inflation rate. 
B) adding the risk-free rate of return to the market rate of return. 
C) subtracting the risk-free rate of return from the inflation rate. 
D) subtracting the risk-free rate of return from the market rate of return. 
E) multiplying the risk-free rate of return by a beta of one. 
A) adding the risk-free rate of return to the inflation rate. 
B) adding the risk-free rate of return to the market rate of return. 
C) subtracting the risk-free rate of return from the inflation rate. 
D) subtracting the risk-free rate of return from the market rate of return. 
E) multiplying the risk-free rate of return by a beta of one.

Question 3

Draw the security market line (SML)and plot asset C such that it has less risk than the market but plots above the SML,and asset D such that it has more risk than the market and plots below the SML.(Be sure to indicate where the market portfolio is on your graph. )Explain how assets like C or D can plot as they do and explain why such pricing cannot persist in a market that is in equilibrium.

Accepted Answer

The student should correctly draw a SML

Question 4

The variance of Stock A is .003969,the variance of Stock B is .007056,and the covariance between the two is .0026.What is the correlation coefficient?

Accepted Answer

A) .9284 
B) .8542 
C) .5010 
D) .4913 
E) .3510 
A) .9284 
B) .8542 
C) .5010 
D) .4913 
E) .3510

Question 5

The excess return earned by an asset that has a beta of one over that earned by a risk- free asset is referred to as the:

Accepted Answer

A) market rate of return. 
B) systematic return. 
C) real rate of return. 
D) market risk premium. 
E) total return. 
A) market rate of return. 
B) systematic return. 
C) real rate of return. 
D) market risk premium. 
E) total return.

Question 6

The beta of a security is calculated by dividing the:

Accepted Answer

A) variance of the market by the covariance of the security with the market. 
B) correlation of the security with the market by the variance of the security. 
C) variance of the market by the correlation of the security with the market. 
D) covariance of the security with the market by the variance of the market. 
E) covariance of the security with the market by the variance of the security. 
A) variance of the market by the covariance of the security with the market. 
B) correlation of the security with the market by the variance of the security. 
C) variance of the market by the correlation of the security with the market. 
D) covariance of the security with the market by the variance of the market. 
E) covariance of the security with the market by the variance of the security.

Question 7

Why are some risks diversifiable and some nondiversifiable? Give an example of each.

Accepted Answer

A reasonable answer would,at a minimum,e

Question 8

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) lower both returns and risks. 
E) eliminate systematic risk. 
A) increase returns and risks. 
B) eliminate all risks. 
C) eliminate asset-specific risk. 
D) lower both returns and risks. 
E) eliminate systematic risk.

Question 9

Assume two securities are negatively correlated.If these two securities are combined into an equally weighted portfolio,the portfolio standard deviation must be:

Accepted Answer

A) equal to the standard deviation of the overall market. 
B) equal to the arithmetic average of the standard deviations of the individual securities. 
C) equal to zero. 
D) less than the weighted average of the standard deviations of the individual securities. 
E) equal to or greater than the lowest standard deviation of the two securities. 
A) equal to the standard deviation of the overall market. 
B) equal to the arithmetic average of the standard deviations of the individual securities. 
C) equal to zero. 
D) less than the weighted average of the standard deviations of the individual securities. 
E) equal to or greater than the lowest standard deviation of the two securities.

Question 10

A portfolio consists of two stocks with Stock A having a weight of 64 percent.Stock A has a standard deviation of 21.22 percent.Stock B has a standard deviation of 16.44 percent.The stocks have a covariance of -.027.What is the portfolio variance?

Accepted Answer

A) .0012 
B) .0095 
C) .0049 
D) .0190 
E) .0344 
A) .0012 
B) .0095 
C) .0049 
D) .0190 
E) .0344

Question 11

A stock with an actual return that lies above the security market line:

Accepted Answer

A) has less systematic risk than the overall market. 
B) has more risk than warranted based on the realized rate of return. 
C) has yielded a return equivalent to the level of risk assumed. 
D) has more systematic risk than the overall market. 
E) has yielded a higher return than expected for the level of risk assumed. 
A) has less systematic risk than the overall market. 
B) has more risk than warranted based on the realized rate of return. 
C) has yielded a return equivalent to the level of risk assumed. 
D) has more systematic risk than the overall market. 
E) has yielded a higher return than expected for the level of risk assumed.

Question 12

The economy has a 14 percent chance of booming.Otherwise,the economy will be normal.Stock G will return 15 percent in a boom and 8 percent in a normal economy.Stock H will return 9 percent in a boom and 6 percent in a normal economy.What is the variance of a portfolio consisting of $2,500 of stock G and $7,500 of stock H?

Accepted Answer

A) .000167 
B) .000193 
C) .002098 
D) .013879 
E) .014002 
A) .000167 
B) .000193 
C) .002098 
D) .013879 
E) .014002

Question 13

The risk of an individual security that will be compensated by the market depends upon the:

Accepted Answer

A) standard deviation of that security. 
B) covariance of that security with the market. 
C) expected rate of return on that security. 
D) security's historical variance. 
E) industry most associated with that security. 
A) standard deviation of that security. 
B) covariance of that security with the market. 
C) expected rate of return on that security. 
D) security's historical variance. 
E) industry most associated with that security.

Question 14

The separation principle states that an investor will:

Accepted Answer

A) choose any efficient portfolio and invest some amount in the riskless asset to generate the expected return. 
B) never choose to invest in the riskless asset because the expected return on the riskless asset is lower over time. 
C) invest only in the riskless asset and tangency portfolio choosing the weights of each based on his/her individual risk tolerance. 
D) randomly select any efficient portfolio. 
E) select a portfolio based solely on his/her desired rate of return while ignoring the associated risks of their selection. 
A) choose any efficient portfolio and invest some amount in the riskless asset to generate the expected return. 
B) never choose to invest in the riskless asset because the expected return on the riskless asset is lower over time. 
C) invest only in the riskless asset and tangency portfolio choosing the weights of each based on his/her individual risk tolerance. 
D) randomly select any efficient portfolio. 
E) select a portfolio based solely on his/her desired rate of return while ignoring the associated risks of their selection.

Question 15

The Inferior Goods Co.stock is expected to earn 22 percent in a recession,7 percent in a normal economy,and lose 14 percent in a booming economy.The probability of a boom is 20 percent while the probability of a normal economy is 55 percent.What is the expected rate of return on this stock?

Accepted Answer

A) 6.55% 
B) 12.15% 
C) 4.75% 
D) 8.60% 
E) 11.75% 
A) 6.55% 
B) 12.15% 
C) 4.75% 
D) 8.60% 
E) 11.75%

Question 16

A portfolio is equally weighted.Security One has a standard deviation of 10 percent.Security Two has a standard deviation of 8 percent.The securities have a covariance of .4254.What is the portfolio variance?

Accepted Answer

A) .2209 
B) .0061 
C) .8549 
D) .8590 
E) .2168 
A) .2209 
B) .0061 
C) .8549 
D) .8590 
E) .2168

Question 17

Mr.Rhoades is the CEO of Daily News.The majority of stockholders do not approve of the decisions made by Mr.Rhoades and have repeatedly requested that he be ousted.Over the last couple of months,it has become apparent that the CEO is going to be replaced by a member of the board,Mr.Bentley,who is highly respected.This morning,the official announcement was made that Mr.Rhoades has stepped down and will be replaced immediately by Mr.Bentley.How is the stock price of the Daily News most apt to react to this announcement?

Accepted Answer

A) Highly positive and immediate reaction 
B) A slow but positive reaction 
C) An immediate negative reaction 
D) An immediate positive reaction followed by a slight downward drift 
E) No reaction 
A) Highly positive and immediate reaction 
B) A slow but positive reaction 
C) An immediate negative reaction 
D) An immediate positive reaction followed by a slight downward drift 
E) No reaction

Question 18

Stock A will return 15 percent in a normal economy and lose 14 percent in a recession.Stock B deals with inferior goods and will return 7 percent in a normal economy and 18 percent in a recession.There is a 20 percent chance of a recession occurring.What is the standard deviation of a portfolio that is equally weighted between the two stocks?

Accepted Answer

A) 3.60% 
B) 6.50% 
C) 1.30% 
D) .13% 
E) .36% 
A) 3.60% 
B) 6.50% 
C) 1.30% 
D) .13% 
E) .36%

Question 19

You have a 2-stock portfolio with an expected return of 10.6 percent.Stock A has an expected return of 12 percent while Stock B is expected to return 8 percent.What is the portfolio weight of Stock A?

Accepted Answer

A) 76% 
B) 72% 
C) 61% 
D) 65% 
E) 68% 
A) 76% 
B) 72% 
C) 61% 
D) 65% 
E) 68%

Question 20

You plotted the monthly rate of return for two securities against time for the past 48 months.If the pattern of the movements of these two sets of returns rose and fell together the majority,but not all of the time,then the securities have:

Accepted Answer

A) no correlation at all. 
B) a weak negative correlation. 
C) a strong negative correlation. 
D) a strong positive correlation. 
E) a perfect positive correlation. 
A) no correlation at all. 
B) a weak negative correlation. 
C) a strong negative correlation. 
D) a strong positive correlation. 
E) a perfect positive correlation.

According to the capital asset pricing model,the expected return on a security is:

The market risk premium is computed by:

The variance of Stock A is .003969,the variance of Stock B is .007056,and the covariance between the two is .0026.What is the correlation coefficient?

The excess return earned by an asset that has a beta of one over that earned by a risk- free asset is referred to as the:

The beta of a security is calculated by dividing the:

Why are some risks diversifiable and some nondiversifiable? Give an example of each.

The primary purpose of portfolio diversification is to:

Assume two securities are negatively correlated.If these two securities are combined into an equally weighted portfolio,the portfolio standard deviation must be:

A portfolio consists of two stocks with Stock A having a weight of 64 percent.Stock A has a standard deviation of 21.22 percent.Stock B has a standard deviation of 16.44 percent.The stocks have a covariance of -.027.What is the portfolio variance?

A stock with an actual return that lies above the security market line:

The risk of an individual security that will be compensated by the market depends upon the:

The separation principle states that an investor will:

The Inferior Goods Co.stock is expected to earn 22 percent in a recession,7 percent in a normal economy,and lose 14 percent in a booming economy.The probability of a boom is 20 percent while the probability of a normal economy is 55 percent.What is the expected rate of return on this stock?

A portfolio is equally weighted.Security One has a standard deviation of 10 percent.Security Two has a standard deviation of 8 percent.The securities have a covariance of .4254.What is the portfolio variance?

You have a 2-stock portfolio with an expected return of 10.6 percent.Stock A has an expected return of 12 percent while Stock B is expected to return 8 percent.What is the portfolio weight of Stock A?

You plotted the monthly rate of return for two securities against time for the past 48 months.If the pattern of the movements of these two sets of returns rose and fell together the majority,but not all of the time,then the securities have:

Introduction to Corporate Finance

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Interest Rates and Bond Valuation

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Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options, and Capital Budgeting

Risk and Return Lessons From Market History

Risk, Cost of Capital, and Valuation

Efficient Capital Markets and Behavioral Challenges

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Exam 11: Return and Risk: the Capital Asset Pricing Model Capm

According to the capital asset pricing model,the expected return on a security is:

The market risk premium is computed by:

The variance of Stock A is .003969,the variance of Stock B is .007056,and the covariance between the two is .0026.What is the correlation coefficient?

The excess return earned by an asset that has a beta of one over that earned by a risk- free asset is referred to as the:

The beta of a security is calculated by dividing the:

Why are some risks diversifiable and some nondiversifiable? Give an example of each.

The primary purpose of portfolio diversification is to:

Assume two securities are negatively correlated.If these two securities are combined into an equally weighted portfolio,the portfolio standard deviation must be:

A portfolio consists of two stocks with Stock A having a weight of 64 percent.Stock A has a standard deviation of 21.22 percent.Stock B has a standard deviation of 16.44 percent.The stocks have a covariance of -.027.What is the portfolio variance?

A stock with an actual return that lies above the security market line:

The risk of an individual security that will be compensated by the market depends upon the:

The separation principle states that an investor will:

The Inferior Goods Co.stock is expected to earn 22 percent in a recession,7 percent in a normal economy,and lose 14 percent in a booming economy.The probability of a boom is 20 percent while the probability of a normal economy is 55 percent.What is the expected rate of return on this stock?

A portfolio is equally weighted.Security One has a standard deviation of 10 percent.Security Two has a standard deviation of 8 percent.The securities have a covariance of .4254.What is the portfolio variance?

You have a 2-stock portfolio with an expected return of 10.6 percent.Stock A has an expected return of 12 percent while Stock B is expected to return 8 percent.What is the portfolio weight of Stock A?

You plotted the monthly rate of return for two securities against time for the past 48 months.If the pattern of the movements of these two sets of returns rose and fell together the majority,but not all of the time,then the securities have:

Introduction to Corporate Finance

Financial Statements and Cash Flow

Financial Statements Analysis and Financial Models

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Stock Valuation

Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, Real Options, and Capital Budgeting

Risk and Return Lessons From Market History

Risk, Cost of Capital, and Valuation

Efficient Capital Markets and Behavioral Challenges

Capital Structure: Basic Concepts

Capital Structure: Limits to the Use of Debt

Dividends and Other Payouts

Options and Corporate Finance

Short-Term Finance and Planning

Raising Capital

International Corporate Finance

Mergers and Acquisitions Web Only

Filters