Deck 5: Risk and Portfolio Management

Question 1

A diversified portfolio requires the securities of at least fifty firms.

Answer 1

False

Question 2

By accepting more risk, the investor will increase the realized return.

Answer 2

False

Question 3

Exchange rate risk refers to fluctuations in the prices of foreign currencies (i.e., foreign exchange).

Answer 3

True

Question 4

Portfolio risk is the summation of business and financial risk.

Question 5

Investors must bear the systematic risk associated with fluctuating securities prices.

Question 6

While diversification decreases risk, it also increases the chance of a large gain.

Question 7

Investors seek to minimize risk for a given return.

Question 8

Unsystematic risk refers to factors that are unique to the specific asset.

Question 9

In a world of certainty, there would be no risk.

Question 10

Diversification reduces reinvestment rate risk.

Question 11

Unsystematic risk considers how firms finance their assets and the nature of their operations.

Question 12

Systematic risk is reduced through diversification.

Question 13

The negative relationship between interest rates and securities prices is the source of interest rate risk.

Question 14

Inflation, which is a general decline in prices, is the source of financial risk.

Question 15

The dispersion around a stock's return is one measure of risk.

Question 16

A portfolio consisting of securities whose returns are highly correlated is not truly diversified.

Question 17

The tendency of individual stock prices to move together is one source of systematic risk.

Question 18

Reinvestment rate risk results from higher stock prices in the future.

Question 19

Investors may reduce risk by constructing diversified portfolios but not eliminate risk.

Question 20

The informed investor can expect consistently to outperform the market.

Question 21

The numerical value of beta for the market equals 1.

Question 22

Low beta stocks tend to generate higher returns in rising markets.

Question 23

Portfolios that offer the highest return for a given level of risk are "efficient."

Question 24

During a rising market, stocks with greater beta coefficients may be preferred.

Question 25

Unsystematic risk

A)is increased through diversification
B)is reduced when markets fluctuate less
C)is affected by the nature of how a firm finances its operations
D)increases during periods of volatile interest rates

Question 26

If the return on two stocks is highly and positively correlated (i.e., correlation coefficient=+1.0), combining these stocks will reduce the risk associated with the portfolio.

Question 27

Arbitrage pricing theory is a multi-variable model used to explain securities returns.

Question 28

Sources of risk to an investor include
1. loss when funds are reinvested at lower rates
2. fluctuations in securities markets
3. the financing decisions of the firm

A)1 and 2
B)1 and 3
C)2 and 3
D)all of the above

Question 29

The expected return on an investment in stock is

A)the expected dividend payments
B)the anticipated capital gains
C)the sum of expected dividends and capital gains
D)less than the realized return

Question 30

If a beta coefficient is 1.7, that implies the return on the stock tends to be less volatile than the return on the market.

Question 31

The beta of a portfolio is a weighted average of each asset's beta coefficient.

Question 32

Arbitrage is the act of buying a high priced asset in one market and simultaneously selling it in another market at a lower price.

Question 33

Unsystematic risk is

A)the risk associated with movements in stock prices
B)reduced through diversification
C)higher when interest rates rise
D)the risk of loss of purchasing power

Question 34

Exchange rate risk refers to fluctuations in

A)the prices of stocks on the New York Stock Exchange
B)the values of bonds and other debt instruments
C)the price of one currency relative to other currencies
D)a decline in the value of an investor's portfolio when securities are sold

Question 35

The "efficient frontier" relates all the combinations of risk and return that represent the same level of satisfaction.

Question 36

Diversification reduces

A)systematic risk
B)unsystematic risk
C)market risk
D)purchasing power risk

Question 37

Reinvestment rate risk refers to fluctuations in

A)a stock's price
B)a stock's dividend
C)rates earned when funds are reinvested
D)the cost of an investment

Question 38

A portfolio's beta coefficient tends to be stable over time.

Question 39

If a stock's return has a large standard deviation, that suggests the stock has little risk.

Question 40

If a stock has a beta of 1.0, it is risk-free stock.

Question 41

For diversification to reduce risk,

A)the returns on the individual securities should be highly correlated
B)the prices of the stocks should be stable
C)the returns on the individual securities should be negatively correlated
D)one firm should offer dividends and the other should offer capital gains

Question 42

Sources of risk include
1. fluctuating exchange rates
2. a firm's financing decisions
3. higher interest rates
4. loss of purchasing power

A)1 and 2
B)2 and 3
C)2 and 4
D)all four

Question 43

Given the following information:

a. What are the expected returns and standard deviations of the following portfolios?
1. 100 percent of funds invested in Stock A
2. 100 percent of funds invested in Stock B
3. 50 percent of funds invested in each stock?
b. What would be the impact if the correlation coefficient were -0.6 instead of 0.2?

Question 44

Sources of unsystematic risk include
1. the firm's financing decisions
2. the firm's operations
3. fluctuating market prices

A)1 and 2
B)1 and 3
C)2 and 3
D)all of the above

Question 45

An efficient portfolio
1. maximizes risk for a given return
2. minimizes risk for a given return
3. maximizes return for a given level of risk
4. minimizes return for a given level of risk

A)1 and 3
B)1 and 4
C)2 and 3
D)2 and 4

Question 46

The efficient frontier in portfolio theory

A)indicates the highest return for a given risk
B)illustrates the optimal trade-off between long and short-term capital gains
C)quantifies systematic and unsystematic risk
D)identifies the optimal portfolio for the investor

Question 47

What is the expected return on a stock that pays a 4 percent annual dividend and whose price is expected to appreciate annually at 6 percent?

Question 48

Investors who want to bear less risk should acquire stocks whose beta coefficients are

A)greater than 1.5
B)greater than 1.0
C)less than 1.0
D)less than 0.5

Question 49

(This problem illustrates the computation of beta coefficients may be solved using a statistics program or Excel.)The returns on the market and stock A and stock B are as follows:

Compute the beta coefficient for each stock and interpret the results of the computations.

Question 50

Portfolio risk encompasses
1. a firm's financing decisions
2. interest rate risk
3. loss of purchasing power

A)1 and 2
B)1 and 3
C)2 and 3
D)all of the above

Question 51

According to the arbitrage pricing theory, the return on a stock

A)is not related to the expected return on the stock
B)depends on the stock's responsiveness to unexpected changes
C)is reduced through the construction of diversified portfolios
D)equals the market return if the expected rate of inflation is realized

Question 52

The security market line does not

A)indicate the relationship between risk and return
B)relate the market return and beta to a stock's return
C)identify the optimal portfolio for the investor
D)use beta coefficients as a measure of risk

Question 53

If the dispersion around a stock's return increases

A)the expected return decreases
B)the standard deviation decreases
C)the stock's price increases
D)the stock's risk increases

Question 54

Beta coefficients
1. are a measure of systematic risk
2. relate the return on an individual security to the return on the market
3. measure the variability of as asset's return

A)1 and 2
B)1 and 3
C)2 and 3
D)all of the above

Question 55

Beta coefficients of 1.3 indicate

A)the stock has more unsystematic risk
B)the stock has less unsystematic risk
C)the stock is more volatile than the market
D)the stock is less volatile than the market

Question 56

a. What is the expected return on a portfolio consisting of an equal amount invested in each stock?

b. What is the expected return on the portfolio if 50 percent of the funds are invested in stock C, 30 percent in stock A, and 20 percent in Stock D?