Deck 12: Return, Risk, and the Security Market Line

Question 1

According to the systematic risk principle, the reward for bearing risk is based on which one of the following types of risk?

A)unsystematic
B)firm-specific
C)expected
D)systematic
E)diversifiable

Answer 1

D

Question 2

Which one of the following terms is another name for systematic risk?

A)unique risk
B)firm risk
C)market risk
D)asset-specific risk
E)diversifiable risk

Answer 2

C

Question 3

Which one of the following is the type of risk that only affects either a single firm or a small number of firms?

A)unexpected
B)market
C)systematic
D)unsystematic
E)expected

Answer 3

D

Question 4

Which of the following is expressed as E(RM)− Rƒ?

A)market risk premium
B)individual security risk premium
C)real rate of return
D)total expected rate of return
E)market rate of return

Question 5

The security market line depicts the graphical relationship between which of the following pairs?
I. expected return
II. surprise return
III. systematic risk
IV. unsystematic risk

A)I and III
B)I and IV
C)II and III
D)II and IV
E)I and II

Question 6

Which one of the following betas represents the greatest level of systematic risk?

A).05
B).68
C)1.00
D)1.19
E)1.27

Question 7

A stock with which one of the following betas has an expected return that most resembles the overall market expected rate of return?

A).33
B).74
C).99
D)1.06
E)1.22

Question 8

What is the beta of a risk-free security?

A)0
B).50
C)1.00
D)1.50
E)2.00

Question 9

Which one of the following qualifies as diversifiable risk?

A)market risk
B)systematic risk associated with an individual security
C)market crash
D)the systematic portion of an expected return
E)the unsystematic portion of an unexpected return

Question 10

Which one of the following is the best example of systematic risk?

A)there is a shortage of nurses
B)a fire destroys a warehouse
C)gas prices rise sharply
D)the cost of sugar increases
E)two firms merge their operations

Question 11

Which one of the following terms is a measure of the tendency of two things to move or vary together?

A)variance
B)squared deviation
C)standard deviation
D)alpha
E)covariance

Question 12

Which one of the following stocks has the highest expected risk premium?
$\begin{array}{lcr}\text { Stock}& \text { Standard deviation }&\text { Beta }\\\text { A } & 148 & 1.36 \\\text { B } & 21 & .98 \\\text { C } & 34 & 1.02 \\\text { D } & 8 & 1.18\\\text { E }&17&1.27\end{array}$

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

Question 13

Which one of the following statements applies to unsystematic risk?

A)It can be eliminated through portfolio diversification.
B)It is also called market risk.
C)It is a type of risk that applies to most, if not all, securities.
D)Investors receive a risk premium as compensation for accepting this risk.
E)This risk is related to expected returns.

Question 14

Which one of the following measures systematic risk?

A)beta
B)alpha
C)variance
D)standard deviation
E)correlation coefficient

Question 15

Which one of the following is the best example of a risk associated with stock ownership?

A)The stock paid a regular quarterly dividend.
B)The firm's net income decreased by 4% for the quarter, as expected.
C)One of the firm's patent applications was unexpectedly rejected.
D)The firm's cost of debt increased as the result of an expected tax cut.
E)The firm's production costs increased in line with previous years.

Question 16

Retail Specialties just announced that its Chief Operating Officer is retiring at the end of this month. This announcement will cause the firm's stock price to:

A)increase.
B)either increase or remain constant.
C)remain constant.
D)decrease.
E)either increase, decrease, or remain constant.

Question 17

Of the following, Stock ________ has the greatest level of total risk and Stock ________ has the highest risk premium.
$\begin{array}{ccc}\text { Stock}&\text { Beta } &\text { Standard deviation }\\\text { A } & 1.09 & 11\% \\\text { B } & .96 & 13\% \\\text { C } & 1.24 & 18 \% \\\text { D } & 1.13 & 26\% \\\text { E } & .87 & 9\%\end{array}$

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

Question 18

Which one of the following announcements is most apt to cause the price of a firm's stock to increase?

A)The firm met its quarterly earnings forecast.
B)An unpopular CEO unexpectedly announced he is resigning effective immediately.
C)A firm officially confirmed the rumors that it is merging with a competitor.
D)The firm just lowered its projected earnings per share for next year.
E)Analysts are expected to lower the firm's credit rating on its debt.

Question 19

Which one of the following is the theory that states that the value of a security is dependent upon the pure time value of money, the reward for bearing systematic risk, and the amount of systematic risk?

A)reward-to-risk theory
B)capital asset pricing model
C)risk premium proposal
D)market slope hypothesis
E)security market line proposition

Question 20

Which one of the following is the best example of unsystematic risk?

A)decrease in company sales
B)increase in market interest rates
C)change in corporate tax rates
D)increase in inflation
E)decrease in market interest rates

Question 21

You own a portfolio which is invested equally in two stocks and a risk-free security. Beta is .89 for Stock A and 1.26 for Stock B. Which one of the following will increase the portfolio beta, all else being constant?

A)increasing the amount invested in the risk-free security
B)decreasing the weight of Stock B and increasing the weight of Stock A
C)replacing Stock A with a security that has a beta of .77
D)increasing the weight of Stock A and decreasing the weight of the risk-free security
E)replacing Stock B with Stock C, which has a beta equal to that of the market

Question 22

Which one of the following is most commonly used as the measure of the overall market rate of return?

A)DJIA
B)S&P 500
C)NASDAQ 100
D)Wilshire 5000
E)Wilshire 3000

Question 23

According to the capital asset pricing model, which of the following will increase the expected rate of return on a security that has a beta that is less than that of the market? Assume the market rate of return is greater than the risk-free rate and both rates are positive.
I. increase in the risk-free rate
II. decrease in the risk-free rate
III. increase in the market risk premium
IV. decrease in the market rate of return

A)I and III only
B)II and III only
C)I and IV only
D)II and IV only
E)II, III, and IV only

Question 24

Which one of the following will increase the slope of the security market line? Assume all else constant.

A)increasing the beta of an efficiently-priced portfolio
B)increasing the risk-free rate
C)increasing the market risk premium
D)decreasing the market rate of return
E)replacing a low-beta stock with a high-beta stock within a portfolio

Question 25

All else held constant, which of the following will increase the expected return on a security based on CAPM? Assume the market return exceeds the risk-free rate and both values are positive. Also assume the beta exceeds 1.0.
I. decrease in the security beta
II. increase in the market risk premium
III. decrease in the risk-free rate
IV. increase in the market rate of return

A)I and III only
B)II and IV only
C)I, II, and IV only
D)II, III, and IV only
E)I, II, III, and IV

Question 26

A security has a zero covariance with the market. This means that:

A)the return on the security is always equal to that of the market.
B)the return on the security moves in the same direction as the market return.
C)the security is a risk-free security.
D)there is no identifiable relationship between the return on the security and that of the market.
E)the return on the security must vary more than that of the market.

Question 27

Which of the following will affect the beta value of an individual security?
I. interval of time frequency used for the data sample
II. length of time period used for the data sample
III. particular time period selected for the sampling
IV. choice of index used as the measure of the market

A)I and II only
B)I and III only
C)II and IV only
D)II, III, and IV only
E)I, II, III, and IV

Question 28

Stocks D, E, and F have actual reward-to-risk ratios of 7.1, 6.8, and 7.4, respectively. Given this, you know for certain that:

A)Stock E is preferable to Stock F.
B)Stock D has a higher beta than Stock F.
C)the market risk premium is greater than 6.8 and less than 7.4.
D)Stock F is riskier than Stock D.
E)at least two of the securities are mispriced.

Question 29

Which one of the following has the highest expected risk premium?

A)stock portfolio with a beta of 1.06
B)U.S. Treasury bill
C)individual stock with a beta of 1.46
D)a stock mutual fund with a beta of .89
E)individual stock with a beta of .94

Question 30

The slope of the security market line is equal to the:

A)market risk premium.
B)risk-free rate of return.
C)market rate of return.
D)market rate of return multiplied by any security's beta, given an inefficient market.
E)market rate of return multiplied by the risk-free rate.

Question 31

A portfolio of securities has a beta of 1.14. Given this, you know that:

A)adding another security to the portfolio must lower the portfolio beta.
B)the portfolio has more risk than a risk-free asset but less risk than the market.
C)each of the securities in the portfolio has more risk than an average security.
D)the portfolio has 14% more risk than a risk-free security.
E)the expected return on the portfolio is greater than the expected market return.

Question 32

Where will a security plot in relation to the security market line (SML)if it has a beta of 1.1 and is overvalued?

A)to the right of the overall market and above the SML
B)to the right of the overall market and below the SML
C)to the left of the overall market and above the SML
D)to the left of the overall market and below the SML
E)on the SML

Question 33

The amount of risk premium allocated to Security A is dependent upon which one of the following?

A)unsystematic risk associated only with Security A
B)total risk associated with Security A's classification
C)total surprise associated with Security A
D)the difference between the expected return and the actual return on Security A
E)systematic risk associated with Security A

Question 34

What is the beta of an average asset?

A)0
B)> 0 but < 1.0
C)< 1.0
D)1.0
E)> 1.0

Question 35

You own three stocks which have betas of 1.16, 1.34, and 1.02. You would like to add a fourth security such that your portfolio beta will match that of the market. Given this situation, the new security:

A)must have a beta of 1.0.
B)must have a beta of zero.
C)could be a U.S. Treasury bill.
D)could have any beta greater than 1.0.
E)must have a portfolio weight of 50% or more.

Question 36

Where will a security plot in relation to the security market line (SML)if it is considered to be a good purchase because it is underpriced?

A)above the SML
B)either on or above the SML
C)on the SML
D)on or below the SML
E)below the SML

Question 37

Which two of the following determine how sensitive a security is relative to movements in the overall market?
I. the standard deviation of the security
II. correlation between the security's return and the market return
III. the volatility of the security relative to the market
IV. the amount of unsystematic risk inherent in the security

A)I and III only
B)I and IV only
C)II and III only
D)II and IV only
E)III and IV only

Question 38

A portfolio beta is computed as which one of the following?

A)weighted average
B)arithmetic average
C)geometric average
D)correlated value
E)covariance value

Question 39

Which one of the following must be equal for two individual securities with differing betas if those securities are correctly priced according to the capital asset pricing model?

A)standard deviation
B)rate of return
C)beta
D)risk premium
E)reward-to-risk ratio

Question 40

Which of the following are needed to compute the beta of an individual security?
I. average return on the market for the period
II. standard deviation of the security and the market
III. returns on the security and the market for multiple time periods
IV. correlation of the security to the market

A)I and III only
B)I and IV only
C)II and III only
D)II and IV only
E)I, II, and III only

Question 41

The following portfolio has an expected return of ________% and a beta of ________.
$\begin{array}{llll}\text { Security }&\$ \text { Invested } & E(R) &\text { Beta }\\\mathrm{A} & \$ 30,000 & 16.20 \% & 1.12 \\\mathrm{~B} & \$ 24,000 & 10.50 \% & 1.38 \\\mathrm{C} & \$ 26.000 & 11.80 \% & 1.33\end{array}$

A)12.45; 1.38
B)12.84; 1.39
C)13.06; 1.27
D)13.39; 1.40
E)13.45; 1.32

Question 42

Which one of the following statements is true?

A)Risk and return are inversely related.
B)Investors are compensated only for diversifiable risk.
C)The beta of a portfolio may be lower than the lowest beta of any individual security held within the portfolio.
D)How a security affects the risk of a portfolio is less important than the actual risk of the security itself.
E)Investing has two dimensions: risk and return.

Question 43

Pat realized a total return of 13.2%, which is more than his expected return of 12.5%. What is the amount of his unexpected return?

A)−1.4%
B)−.7%
C).7%
D)1.4%
E)1.8%

Question 44

A portfolio is comprised of two stocks. Stock A comprises 65% of the portfolio and has a beta of 1.21. Stock B has a beta of .95. What is the portfolio beta?

A).96
B)1.05
C)1.12
D)1.19
E)1.21

Question 45

A risky asset has a beta of 1.40 and an expected return of 17.6%. What is the risk-free rate if the risk-to-reward ratio is 8.4%?

A)2.74%
B)4.03%
C)4.33%
D)5.32%
E)5.84%

Question 46

Stock A is a risky asset that has a beta of 1.4 and an expected return of 13.2%. Stock B is also a risky asset and has a beta of 1.25. The risk-free rate is 5.5%. Assuming both stocks are correctly priced, what is the expected return on Stock B?

A)11.90%
B)12.11%
C)12.29%
D)12.38%
E)12.46%

Question 47

Reed Plastics just announced the earnings per share for the quarter just ended were $.45. Analysts were expecting $.51. What is the amount of the surprise portion of the announcement?

A)−$.12
B)−$.06
C)$.06
D)$.00
E)$.03

Question 48

Laura has one risk-free asset and one risky stock in her portfolio. The risk-free asset has an expected return of 3.2%. The risky asset has a beta of 1.3 and an expected return of 14.9%. What is the expected return on the portfolio if the portfolio beta is .975?

A)7.65%
B)9.83%
C)10.73%
D)11.98%
E)12.37%

Question 49

The risk-free rate is 4.0% and the expected return on the market is 8%. Stock A has a beta of 1.35. For a given year, Stock A returned 12.0% while the market returned 8.80%. The systematic portion of Stock A's unexpected return was ________% and the unsystematic portion was ________%.

A).80; 1.30
B).90; 1.40
C)1.08; 1.52
D)1.40; .90
E)4.62; 1.41

Question 50

Which of the following correctly identifies the factors included in the Fama-French three-factor model?

A)standard deviation, beta, and company size
B)the risk-free rate, beta, and the market risk premium
C)company size, company industry, and beta
D)price-earnings ratios, beta, and book-to-market ratios
E)beta, company size, and book-to-market ratios

Question 51

The reward-to-risk ratio is 6.0% and the risk-free rate is 1.4%. What is the expected return on a risky asset if the beta of that asset is 1.30?

A)8.23%
B)8.40%
C)9.20%
D)10.23%
E)11.30%

Question 52

The following portfolio has an expected return of ________% and a beta of ________.
$\begin{array}{cccc}\text { Security }&\text {Amount Invested }&\text {Expected Return}&\text { Beta }\\\mathrm{X} & \$ 17,000 & 14.28 & .98 \\\mathrm{Y} & \$ 12,000 & 7.8 & 1.33 \\\mathrm{Z} & \$ 11,000 & 9.5 & 1.07\end{array}$

A)10.53; 1.13
B)10.99; 1.11
C)11.03; 1.28
D)11.16; 1.11
E)11.11; 1.16

Question 53

Which one of the following combinations will tend to produce the highest rate of return according to the Fama-French three-factor model? Assume beta is constant in all cases.

A)large market capitalization and high book-to-market ratio
B)large market capitalization and low book-to-market ratio
C)small market capitalization and high book-to-market ratio
D)small market capitalization and a book-to-market ratio of 1.0
E)small market capitalization and a low book-to-market ratio

Question 54

What is the beta of a portfolio that consists of the following?
$$\begin{array} { c r r } \text { Security } & \text {\$ Inveted } & \text { Beta } \\\text { A } & \$ 5,000 & .79 \\\text { B } & \$ 3,000 & 1.36 \\\text { C } & \$ 5,000 & 1.01 \\\text { D } & \$ 7,000 & 1.95\end{array}$$

A)1.01
B)1.24
C)1.26
D)1.29
E)1.32

Question 55

A portfolio consists of one risky asset and one risk-free asset. The risky asset has an expected return of 13.2% and a beta of 1.32. The risk-free asset has an expected return of 1.5%. How much of the portfolio is invested in the risk-free asset if the portfolio beta is 1.02?

A)16%
B)23%
C)32%
D)45%
E)54%

Question 56

What is the beta of a portfolio that consists of the following?
$\begin{array}{ccc}\text { Security } &\$ \text { Invested}& \text { Beta }\\\text { A } & \$ 2,000 & 1.38 \\\text { B } & 5,000 & .47 \\\text { C } & 9,000 & 1.70 \\\text { D } & 4,000 & 1.08\end{array}$

A)1.18
B)1.22
C)1.24
D)1.32
E)1.37

Question 57

A risky asset has a beta of 1.30 and an expected return of 10.3%. What is the reward-to-risk ratio if the risk-free rate is 1.34%?

A)3.98%
B)5.23%
C)6.89%
D)7.23%
E)8.23%

Question 58

Brooke invested $4,500 in the stock market with the expectation of earning 6.25%. She actually earned 7.15% for the year. What is the amount of her unexpected return?

A)−1.2%
B)−.6%
C).9%
D)1.9%
E)2.4%

Question 59

The risk-free rate is 3.4% and the expected return on the market is 10.8%. Stock A has a beta of 1.18. For a given year, Stock A returned 13.6% while the market returned 11.8%. The systematic portion of the unexpected return was ________% and the unsystematic portion was ________%.

A)1.045; .207
B)1.145; .126
C)1.180; .288
D)1.344; 1.443
E)1.500; 1.449

Question 60

A portfolio consists of two stocks and has a beta of 1.20. The first stock has a beta of 1.02 and comprises 30% of the portfolio. What is the beta of the second stock?

A).41
B).66
C).82
D)1.28
E)1.35

Question 61

Wilson Farms' stock has a beta of .73 and an expected return of 9.0%. The risk-free rate is 1.9% and the market risk premium is 7.3%. This stock is ________ because the CAPM return for the stock is ________%.

A)undervalued; 7.23
B)undervalued; 7.53
C)undervalued; 7.46
D)overvalued; 7.23
E)overvalued; 7.53

Question 62

The stock of Healthy Eating, Inc., has a beta of 1.31. The risk-free rate is 1.12% and the market return is 12.32%. What is the expected return on Healthy Eating's stock?

A)8.90%
B)12.32%
C)13.23%
D)14.15%
E)15.79%

Question 63

Western Exports stock has a standard deviation of 15.6% and a covariance with the market of .0150. The market has a standard deviation of 13.7%. What is the correlation of this stock with the market?

A).581
B).613
C).689
D).702
E).774

Question 64

A stock has a standard deviation of 21.0% and a covariance with the market of .0110. The market has a standard deviation of 12.0%. What is the beta of this stock?

A).294
B).572
C).764
D).973
E)1.075

Question 65

A risky security has a variance of .023983 and a covariance with the market of .0323. The variance of the market is .01839. What is the correlation of the risky security to the market?

A)1.54
B)1.65
C)1.72
D)1.83
E)1.85

Question 66

The common stock of Blasco Books has a standard deviation of 13.3% as compared to the market standard deviation of 11.3%. The covariance of this stock with the market is .0193. What is the beta of Blasco Books' stock?

A)1.03
B)1.20
C)1.28
D)1.35
E)1.51

Question 67

Uptown Markets stock has a standard deviation of 16.8% and a covariance with the market of .02. The market has a standard deviation of 13.7%. What is the correlation of this stock with the market?

A).743
B).781
C).869
D).894
E).915

Question 68

Stock X has a beta of .88 and an expected return of 10.8%. Stock Y has a beta of 1.15 and an expected return of 13.1%. What is the risk-free rate of return assuming that both Stock X and Stock Y are correctly priced?

A)1.10%
B)1.20%
C)2.06%
D)3.30%
E)3.50%

Question 69

What is the covariance of Security A to the market given the following information?
$$\begin{array} { c c c } \text { Year } & \text { Security A Returns } & \text { Market Returns } \\1 & 1\% & - 6\% \\2 & 9 & 14 \\3 & - 2 & 7 \\4 & 18 & 12\end{array}$$

A)23.14
B)29.88
C)48.83
D)99.18
E)114.01

Question 70

The common stock of Industrial Technologies has an expected return of 12.4%. The market return is 9.2% and the risk-free return is 3.87%. What is the stock's beta?

A).42
B)1.00
C)1.32
D)1.42
E)1.60

Question 71

What is the covariance of Security A to the market given the following information?
$$\begin{array} { c c c } \text { Year } & \text { R(a) } & R ( m ) \\1 & 20.00 & 17.00 \\2 & - 30.00 & - 7.00 \\3 & 36.00 & 20.00\end{array}$$

A)505.0
B)514.1
C)517.5
D)523.5
E)540.6

Question 72

What is the covariance of Security A to the market given the following information?
$\begin{array}{ccc}\text { Year } & \text { Security A Returna } & \text { Market Returns } \\1 & 18 \% & 10\% \\2 & -6 & -2\\3&9&7\end{array}$

A)75.0
B)80.1
C)83.8
D)87.0
E)91.1

Question 73

The risk-free rate is 2.1%, the market rate is 11.5%, and the expected return on a stock is 17.32%. What is the beta of the stock?

A).62
B)1.03
C)1.33
D)1.62
E)1.88

Question 74

Dinner Foods stock has a beta of 1.45 and an expected return of 13.43%. Edwards' Meals stock has a beta of .95 and an expected return of 10.27%. Assume that both stocks are correctly priced. Given this, the risk-free rate is ________% and the market rate of return is ________%.

A)4.02; 11.53
B)4.09; 12.35
C)4.10; 11.53
D)4.27; 10.59
E)4.41; 10.25

Question 75

A stock has a beta of 1.58 and an expected return of 16.2%. The risk-free rate is 3.8%. What is the market risk premium?

A)7.85%
B)10.01%
C)11.72%
D)12.50%
E)13.40%

Question 76

The market has an expected return of 11.3% and a risky asset with a beta of 1.18 has an expected return of 13%. Based on this information, what is the pure time value of money?

A)1.86%
B)1.90%
C)2.38%
D)2.51%
E)2.90%

Question 77

The market has a standard deviation of 10.8% while a risky security has a standard deviation of 22.5%. The covariance of the stock with the market is .0149. What is the beta of the stock?

A)1.09
B)1.11
C)1.15
D)1.19
E)1.28

Question 78

A stock has an expected return of 15.10% and a beta of 1.30. What is the risk-free rate if the market rate is 13.1%?

A)6.43%
B)6.92%
C)7.01%
D)7.30%
E)7.90%

Question 79

Home Interior's stock has an expected return of 13.25% and a beta of 1.4. The market return is 10.75% and the risk-free rate is 4.5%. This stock is ________ because the CAPM return for the stock is ________%.

A)greatly overvalued; 16.50
B)slightly overvalued; 14.91
C)priced correctly; 13.25
D)slightly undervalued; 12.91
E)greatly undervalued; 16.50

Question 80

Farm Tractors, Inc., stock has a beta of 1.12 and an expected return of 12.8%. The risk-free rate is 3.84%. What is the market rate of return?

A)6.67%
B)8.90%
C)9.08%
D)11.84%
E)12.63%